3.1 Business Growth

Question 1

Why do many small firms survive ?

Answer 1

• can act as a supplier/ sub-contractor to larger enterprises (esp. in construction industry + software coding)
• take advantage of low PED + high YED (for specialist ‘niche’ or ‘bespoke’ products that can be sold at a higher price with a large profit margin)
• can avoid internal diseconomies of scale (rising LRAC)
• more innovative, flexible + nimble in responding to changes in market demand
• benefit from consumers willing to buy online (barriers to enter the market have come down)
• keep their over head costs low eg. smaller full time staff or relying on leasing equipment
• all firms can benefit from external economies of scale

Question 2

What are business objectives for smaller firms ?

Answer 2

• business survival
• revenue maximisation (grow sales)
• profit maximisation
• cost efficiency and scale (keep cost base low)
• customer service (smaller firms are often associated with higher levels of customer service and satisfaction)

Question 3

Reasons for businesses to stay small ?

Answer 3

• product differentiation + having a USP (small can be a selling point - not bland)
• concentrate on niche markets: less competitive ➡️ more profitable
• economies of scale are limited eg. coffee shop
• avoid diseconomies of scale: optimum efficiency has been achieved
• greater control + close connection w/customers: (not all firms aim at profit maximisation)
• customer service: high standard
• flexibility: meeting customer needs + more innovative/creative responding quickly to changing market trends
• customer perception: expectation of a better product from a business that ‘cares’
• more scope for adding value + charging a higher price through selling specialist expertise
• barriers to entry by larger firms in the market

Question 4

Reasons for business growth ?

Answer 4

• to increase future sales
• to increase market share
• to increase market power + influence
• gaining economies of scale
• to protect against competition
• to reduce risk eg. by diversification

Question 5

What is a stakeholder ?

Answer 5

• any individual or organisation who has a vested interest in the activities + decision making of a business

Question 6

What is a shareholder ?

Answer 6

• own the business ➡️ have an equity stake
• may work day-to-day in the business
• mainly interested in growing the value of their shareholding

Question 7

What is the divorce between ownership and control ?

Answer 7

• occurs when the owners of a business are not the same as those people who are making key day to day decisions such as pricing, investment and marketing (managers & directors) ➡️ want different things
• leads to the principal agents problem

Question 8

What is the principal agent problem ?

Answer 8

• an asymmetric information problem ➡️ arises when the interests and values of a company’s shareholders (the principals) are not aligned with those of its managers (the agents) who make decisions on their behalf.
• conflicts of interests and values between the principals and agents

Question 9

How to overcome the principle agent problem ?

Answer 9

🔔 align the aims of the principles and agents:

• employee share ownership schemes ➡️ make directors shareholders
• long term employment contracts for senior management ➡️ security of tenure may encourage managers to take pricing and investment decisions in the long term interests of the business
• rewards & incentives: directors/ manager are offered financial bonuses + other incentives when they have worked in compliance w/ the shareholders’ interests
• reporting issues
• long term stock commitment
• set targets that directors need to meet

Question 10

What is privatisation ?

Answer 10

• the transfer of assets from the public (state or govt) sector to the private sector of the economy ➡️ causes a change of ownership
• eg. British Aerospace (1980)

Question 11

Difference between public and private sector organisations ?

Answer 11

• public sector organisations are owned, controlled + managed by the government (or other state-run bodies)
• private sector organisations are owned, controlled and managed by individuals, groups or business entities

Question 12

Difference between profit and non-profit organisations ?

Answer 12

-a profit organisation is a legal organisation, which is operated with the sole aim of earning profit from the business activities
- a non-profit organisation is one that is operated with the primary objective of benefiting the society as a whole ie. charities or community organisations eg. Network Rail

Question 13

What are the different not-for-profit organisations ?

Answer 13

• producer co-operatives (owned and run by their members) ➡️ run on principles of shared ownership, shared voice and shared profits
• social enterprises (created to address a social problem) ➡️ profits reinvested for social purpose in the community
• charities + community organisations

Question 14

What is organic growth ?

Answer 14

• internal growth
• occurs when a business expands on its own operations eg. increasing output, launching new products, expanding into new markets, customer base expansions (marketing) etc. then reinvesting profits into itself

Question 15

✅ and ❌ of organic growth ?

Answer 15

✅ steady + sustainable
✅ no debt (low risk) ➡️ financed through internal funds
❌ likely to be beaten to the punch by quicker competitors
❌ slow growth
❌ growth may be dependant on the growth of the overall market
❌ hard to build extra market share if business is already a leader

Question 16

What is external growth ?

Answer 16

• business grows quickly by merger (joining another business) or takeover

✅ quick way to grow
✅ quick way to buy competitors customers
❌ expensive to do + involves getting into debt
❌ high risk (many takeovers fail to achieve expected gains)

Question 17

What is horizontal integration ?

Answer 17

• when a firm merges with/takeover another firm in the same industry at the same stage of production

Question 18

✅ of horizontal integration ?

Answer 18

• economies of scale eg. bulk buying, technical, financial ➡️ lower LRAC
• increased market influence (power + share)
• reduce competition (removing key rivals)
• economies of scope (synergies)
• reduction in some costs as duplication can be avoided eg. only 1 marketing & finance department needed, shared distribution networks etc.
• buying an existing + well known brand can be cheaper in the LR than organic growth ➡️ can then make entry barriers into a market higher for potential rivals

Question 19

❌ of horizontal integration ?

Answer 19

• costly
• increased workload + responsibilities
• legal issues/creating a monopoly ➡️ risk of attracting inbestigation from authoroities
• risk of diseconomies of scale (eg. clashes of management culture, problems with integrating businesses that operate in different ways)
• reduced flexibility ➡️ addition of more personnel & processes + need for more transparency therefore more accountability + red tape which can slow down the rate of innovation/getting new products to marker
• destroying shareholder value rather than creating it (if the synergies never materialise ➡️ most large scale merges fail to achieve the gains in shareholder value that were forecasted)

Question 20

What is forward vertical integration ?

Answer 20

• involves acquiring a business in the same industry but further forward in the chain of production

Question 21

✅ of forward vertical integration ?

Answer 21

• guaranteed outlet for products
• the firm can exercise greater control over sales + prices
• the firms own retail stores serve as a better source of customer feedback ➡️ better control over quality
• firm can improve its profits by reducing the costs of distribution + costs of middlemen (reduced unit costs)
• integration can ensure that the handling + transportation costs are reduced

Question 22

❌ of forward vertical integration ?

Answer 22

• since its processes are interdependent, a slight interruption in one process may dislocate the entire production system
• very difficult to efficiently manage an integrated firm bcs every business has its own structure, technology + problems
• fewer economies of scale as most of production is at different stages
• problems of communication + coordination ➡️ can lead to diseconomies of scale where the new bigger firm is less efficient

Question 23

What is backward vertical integration ?

Answer 23

• involves acquiring a business in the same industry but further back in the chain of production

Question 24

✅ of backward vertical integration ?

Answer 24

• increased control
• guarantees sources of raw materials/component goods
• can’t be held to ransom by suppliers demanding higher prices at a critical time
• reduces competitors access to important markets + scarce resources
• increased profits due to improved cost control (removal of the middle man mark up)
• a retailer is able to cater to the changing customer needs more rapidly if it owns the production or manufacturing firm that produces its products

Question 25

❌ of backwards vertical integration ?

Answer 25

• leads to lack of supplier competition ➡️ will lead to low efficiency resulting in potentially higher costs
• fewer economies of scale because most of the production is at different stages of production
• create new problems of communication + coordination within the bigger more disparate firm ➡️ can lead to diseconomies of scale where the new bigger firm is more inefficient

Question 26

What is conglomerate integration ?

Answer 26

• when firms making completely different products merge eg. Supermarket and music producer
• a conglomerate has acquired a large number of diversified businesses eg. Samsung

Question 27

✅ of conglomerate integration ?

Answer 27

• spreads risk: less vulnerable to losses in one area (diversification)
• spreads ideas
• cross subsidisation: charging higher prices to one type of consumers to artificially lower prices for another group
• expanded customer base: the company may have excess cash but not enough opportunities to grow in its existing market ➡️ increased revenue
• increased sales from the larger market

Question 28

❌ of conglomerate integration ?

Answer 28

• company is taking over another company w/o having any experience about the industry ➡️ increases chances of mismanagement + overpricing (inefficiency)
• the company is shifting its focus from its core business to other business➡️ may result in the company performing badly in both areas
• difficult to merge cultural value, employees & other things as compared to merger between companies working in the same industry

Question 29

What constraints are there on business growth ?

Answer 29

• size of the market ➡️ limited no. of goods you can sell
• access to finance ➡️ need finance to grow (often borrowed) so if banks etc. not willing to loan money it will be difficult to grow or banks charging ‘risk premium’ when lending to smaller firms
• owners objectives ➡️ owners main objective may not be growth (happy where they are)
• regulations eg. competition & market authority, govt ➡️ more regulations/laws will make it more difficult to expand/increase the cost of growth
• competition ➡️ threat of entry from rival firms, technological change had the effect of reducing barriers to entry in the market
• skills shortage ➡️ struggle to recruit the skilled personnel needed
• red tape/bureaucracy ➡️ legal requirements

Question 30

What is a demerger ?

Answer 30

• happens when a firm decides to split into separate firms eg. by spinning off/ selling parts of their business

Question 31

What are the reasons for demergers ?

Answer 31

• focusing on core businesses ➡️ streamline costs + improve profit margins (single focus = management clearly aligned & understands customers, attracts employees with specific skills needed + right technology)
• reduce the risk of diseconomies of scale + diseconomies of scope ➡️ by reducing the range of functions in a business + achieve lower management costs
• raise money from asset (part of the company) sale + return it to shareholders
• defensive tactic ➡️ avoid attention of competition authorities who might be investigating possible monopoly power in a market (stay under the radar)
• growth ➡️ each part of the firm grows at different rates therefore faster growing part may separate
• sell of non-profit making parts of the firm

Question 32

Impact of demergers on businesses ?

Answer 32

• long term = higher returns
• short term = money raised from selling asset ➡️ increased profits

Question 33

Impact of demergers on employees ?

Answer 33

• expected job losses (although new jobs may be created)
• opportunities for managers of newly demerged business

Question 34

Impact of demergers on consumers ?

Answer 34

• impact on prices depends on scale of competition