3.1 Business Growth

Question 1

3.1.1 Sizes and types of firms

a) Reasons why some firms tend to remain small

Answer 1

• Diseconomies of scale- large firms could have higher costs so small firms can exploit this by staying small eg can be better organised
• Small firms as monopolists- small firms could hold some monopoly power as they provide a more personal, local service. (market niches)
• Owners- Managers might decide they don’t want to grow eg due to extra risks and work

Question 2

3.1.1 Sizes and types of firms

a) Reasons why others grow (firms)

Think of the Business Growth Reasons (x5)

Answer 2

• Profit motive:
  1. Increase in size enables firms to produce more goods and services = an increase in sales which would boost revenue = Higher revenue => higher profit
• Costs:
  1. Firm that increases in size often experiences lower unit costs => economies of scale
  2. Lower unit cost => higher profit
• Market power:
  1. Market power is ability of a firm to raise (control) prices and earn supernormal (abnormal) profit
  2. Larger firm gets, the more dominance over a market so they can discourage new entrants.
• Diversification:
  1. Increasing range of products or markets served by a business
  2. Degree of diversification depends on extent to which those products or markets are different from the existing products and markets served by the business Eg through entering foreign market or producing a new good/service
  3. Diversification reduces risk By expanding product range firms reduce their risk of making huge losses.
• Managerial:
  1. Managers often have renumeration packages that are determined by sales performance of firms E.g. CEOs receive bonuses for meeting sales targets => provides incentives for managers to increase size of firm
  2. Managers may also seek to increase the size of firms to satisfy their ego => leading a large firm can command respect and veneration from others
  3. Managers might want higher incomes, more holiday or more leisure time

Question 3

3.1.1 Sizes and types of firms

b) Significance of the divorce of ownership from control:
the principal-agent problem

Answer 3

Firms owned by shareholders but run by managers
Both have different objectives
=> shareholders want to maximise short run profit
=> managers want to maximise their own benefit
Therefore one group (agents) make decisions on behalf of the other group (principals)

• The agent makes the decision for the principal, but the agent is inclined to act in their own interests, rather than those of the principal. EG shareholders and mangers have different objective which might conflict, eg bonus for manager over dividend for shareholder.
• The owner (known as the principal) of a company may pass responsibilities onto a manger (the agent). This is when the agent makes decision for the principal, the agent’s acts in theirs own interests, rather than those of the principal. = Leads to profit satisfice and not profit maximise
• It called Divorce of ownership from control
  e.g of principle agent problem when the owners don’t run the business
• Divorce of ownership from control is an issue as the director may not profit maximise for owner and may have other objectives

Question 4

3.1.1 Sizes and types of firms

c) Distinction between public and private sector organisations

Answer 4

Public:
- Government has control
- Natural monopolies eg water
- Some public sector industries yield strong positive externalities eg public transport reduces congestion and pollution.
- Public sector has different objectives, social welfare might be a priority and fairer distribution of resources.

Private:
- Left to the free market and private individuals
- Private sector gives firms incentives to operate efficiency which increases economic welfare. As they have a profit incentive. = profit max

Question 5

3.1.1 Sizes and types of firms

d) Distinction between profit and not-for-profit organisations

Answer 5

Profit:
- Aims to maximise the financial benefits of its shareholders and owners.
- The goal of the organisation is to earn maximum profits.

Not-for-profit:
- Aims to maximise social welfare.
- They can make profits, but they cannot be used for anything apart from this goal and the operation of the organisation.
- Charities

Question 6

3.1.2 Business growth

a) How businesses grow

(4 ways)

4 different ways - what are they?

Answer 6

organic growth:
When firms grow through expanding their production through increasing output, widening their consumer base, by developing a new product or by diversifying their range.

forward and backward vertical integration:
a) Forward Verticle = When a firm integrates with another firm closer to the consumer eg taking over a distributor. Such as a coffee producer taking over a café.
b) Backward Vertical = When a firm integrates with a firm closer to the producer. This involves gaining control of suppliers. For example, a coffee producer might buy a coffee farm.

horizontal integration:
Merger of two firms in the same industry and the same stage of production eg two car manufacturers.

conglomerate integration:
The combining of two firms with no common connection

Question 7

3.1.2 Business growth

b) Advantages and disadvantages of:

organic growth

Answer 7

ADV:
- Less risky than inorganic growth
- Firms grow through building on their strengths and using their own funds such as retained profits to fund the growth. So the firm is not building up debt and the growth is more sustainable.
- Existing shareholders retain control so reduce conflicts in objectives that are possible in a takeover.

DIS:
- Slower which could allow another firm to out compete or upset shareholders.
- Might rely on strength of market to grow which could limit how much and fast they can grow.

Question 8

3.1.2 Business growth

b) Advantages and disadvantages of:

vertical integration

Answer 8

ADV:
- Increase efficiency, through gaining economies of scale, which could reduce their average costs. Resulting in lower costs for consumers.
- Gain more control of the market. Backwards integration can mean that firms can control the price they pay for their supplies.
- Firms can have more certainty over their production with factors such as quality, quantity and price.

DIS:
- Diseconomies of scale
- Create barriers to entry which could discourage new entrants of new firms which could lead to a less efficient market.

Question 9

3.1.2 Business growth

b) Advantages and disadvantages of:

horizontal integration

Answer 9

ADV:
- Firms can grow quickly which can give them a competitive edge over other firms in the market
- Increase output quickly so they can take advantage of economies of scale.
- The two firms have expertise in the same industry, so the merged firm can gain advantages, such as in marketing

DIS:
- Quick growth could lead to monopoly power and lower efficiency.
- Could be disagreements in the objectives of the two firms which merged.

Question 10

3.1.2 Business growth

b) Advantages and disadvantages of:

conglomerate integration

Answer 10

ADV:
- Can help both firms become stronger in the market- Reach out to a wider consumer base
- Economies of scale eg risk bearing economies of scale.

DIS:
- Reduce market competition
- Risk of spreading product range too thinly and therefore might not be sufficient focus on each range. Which might reduce quality and increase production costs.
- Lack of synergy

Question 11

3.1.2 Business growth

c) Constraints on business growth:

state the 4

Answer 11

1. Size of the Market
2. Access to Finance
3. Owner Objectives
4. Regulation

Question 12

3.1.2 Business growth

c) Constraints on business growth:
Size of the market

Answer 12

• Market is limited to certain size so not all business are able to mass produce as goods would not be purchased
• Can happen no matter how big market is and there will always be limits on growth - Especially in niche markets and markers for luxury items or restricted prestige markets make it difficult for businesses to grow

Question 13

3.1.2 Business growth

c) Constraints of Business Growth:
Access to Finance

Answer 13

• Firms use two main ways to finance growth => retained profits and loans
• If firms do not make enough or give too much to shareholders, they cannot use retained profits to grow
• Banks may be unwilling to lend money so unable to use loans - Therefore firms may not be able to grow if they cannot finance it

Question 14

3.1.2 Business growth

c) Constraints of Business Growth:
Owner Objectives

Answer 14

• Some owners may not want their business to grow any further as they are happy with the current profits and do not want the extra risk or work that comes with growth

Question 15

3.1.2 Business growth

Constraints of Business Growth:
Regulation

Answer 15

• In some markets, the government may introduce regulations which prevent businesses from growing

Question 16

3.1.3 Demergers

What is a Demerger

Answer 16

A business strategy in which a single business is broken into two or more components, either to operate on their own, to be sold, or to be dissolved

Question 17

3.1.3 Demergers

a) Reasons for demergers

answers in bold (5 reasons)

Answer 17

**Lack of synergies **
- Cost (higher efficiency, better deals)
Revenue (more customers etc)
- Different parts of the company have no real impact on each other and fail to make each other more efficient
- Lack of synergy means managers are splitting time between areas which are so different it could lead to diseconomies of scale
- Firms may split to avoid these diseconomies

Growth
- Some companies demergers because the value of the separate parts of the company is worth more than company combined
- This is because some parts of the business are operating well and have potential to grow but the overall value is brought down because of lack of success or lack of potential for growth of other parts of the business
- Financial markets talk about creating value by splitting companies like this

Focussed companies
- Some people believe if company and the management are more focussed on individual markets, they become more efficient and successful => higher profits
- Management have limited time and skills and they are unable to spend required time to make all areas of a diverse business successful
- But focussing on one area, managers can improve skills and knowledge => more successful

Competition Authorities
- Firms may split up as they may be getting too big and the market which they are in may have regulations against monopolies and other competition policies
- This leads to competition authorities getting involved
As a result, firms may split to prevent their involvement

Question 18

3.1.3 Demergers

b) Impact of demergers on businesses

6 points

Answer 18

• Firms can dispose of underperforming or loss making parts of the firm.
• It allows the larger firm and the new, demerged firm to focus on their core activities. Which allows them to adapt to their unique market.
• Eliminate diseconomies of scale
• Concentrating on a smaller core business may enable it to be more efficient and contraction may lead to more innovation and surviving higher competition
• However smaller size of business could lead to a loss of economies of scale and reduced efficiency
• Gain profit from selling off a part of the company, source of finance.

Question 19

3.1.3 Demergers

b) Impact of demergers on workers

3 points

Answer 19

• Separate firms may need their own managers and leaders so people could get a promotion
• However, the goal of making the firm more efficient may result in job losses
• Workers might be confused and their roles might be shifted between demerged firm and parent firm = inefficiency (unmet skill set)

Question 20

3.1.3 Demergers

b) Impact of demergers on consumers

3 points

Answer 20

• Gain from innovation and efficiency, leading to better products and cheaper prices = net welfare gain if the demerger results in higher level of efficiency
• If two firms in the same industry and same stage of production demerge such as two airlines, thing would increase choice for consumers.
• Demerged firms may be less efficient through loss of economies of scale or *raise prices */ reduce quality or range of goods as they become motivated by profit