3.1 - Business growth Flashcards
Reasons why some firms grow (3)
- Economics of scale - this will decrease their cost of production
- Greater market share - gives ability to influence prices and restrict new firms from entering the market (deter new entrants)
- More security - the assets/cash built up can be used during financial difficulty as well as selling bigger range of goods in more than 1 local/national market would mean they are less affected by individual products or places
Why some firms remain small (4)
- Size of the market
- Access to finance
- Owner’s objectives
- Regulation
What is the principal agent problem
When there is a conflict of interests between the shareholders (principals) and the managers (agents).
Shareholders want to maximise the returns on their investment (short run profit maximisation)
Managers want to maximise their own benefit in the form of higher sales or revenue
What is the solution to the principal agent problem
Shareholders can give managers the shares of the business or link their bonuses to profits
This means that they personally gain from higher profits - therefore incentivising to produce as much profit as possible
Case study for failed principal agent problem
The executives (Kenneth Lay and Jeffrey Skilling) used the Mark to Market (M2M) accounting strategy to hide billions of debt from the Board of Directors.
Shareholders filed a lawsuit to the firm and executives after share price dropped from nearly $100 to below $1 in just over a year
What are the two types of growth
- Organic growth - where the firm grows by increasing their output (e.g. increased investment or more labour)
- Integration (Inorganic growth) - where the firm grows by merger or takeover rather than an increase in the company’s own business activity
Case study of organic growth
LEGO
They introduced new products (e.g. lego friends) and board games to expand their customer base
Advantages of organic growth (2)
- Integration is often expensive, time consuming and high risk - they are poorly managed with key workers tending to leave after the change
- Preserves sovereignty - the firm is able to keep control of their business
Disadvantages of organic growth (3)
- Firm’s market restricts expansion through organic growth - integration would allow a European company to expand its customer base in the Asian market
- It may be too slow for directors who wish to maximise their salaries
- Difficult for firm to get new ideas
What is Vertical Integration
The integration of firms in the same industry at different stages in the production process
Difference between forward and backward integration
Forward integration - when the firm is moving towards the eventual consumer of a good
Backward integration - when the firm is moving back to the supplier of a good
Case study for successful vertical integration
Tesco’s £3.7 billion takeover of Booker in 2018 - it led to increased in sales for Tesco
Advantages of vertical integration (4)
- Increased potential for profits
- Less risk
- With backward integration, business control the quantity of supplies + don’t worry about high prices - this keeps costs low and allow for lower consumer prices (which increases competitiveness and sales)
- Forward integration secures retail outlets and restricts assess to these outlets to competitors
Disadvantage of vertical integration
- Firms may have no expertise in the industry
E.g. car manufacturing company would have deep knowledge in the car manufacturing but little of selling cars and visa versa
What is Horizontal Integration
This is when firms in the same industry at the same production process integrate
Case study of horizontal integration
In 2015, AstraZeneca acquired ZS Pharma for $2.7 billion - this gave them access to new compounds and long term deal intended to strengthen a specific sector of the business
Advantages of horizontal integration (3)
- Reduces competition - increases market share (giving more ability to influence the market)
- Specialise and Rationalise
- Higher chances of a successful merger - this is because they already have the expertise of the industry
Disadvantage of horizontal integration
- Increased risk - if that particular market fails, they will have nothing to fall back on (putting all your eggs in one basket)
What is Conglomerate integration
When firms in different industries have no obvious connections integrate
Case study of Conglomerate integration
General Electric started off as a lighting business but is now involved in various industries such as aircraft, providing financial services, and water.
The reason for their success model was due to extensive market research and being the market leaders
Advantages of conglomerate integration (2)
- Useful for firms who have no room for growth in their present market
- Reduces risk for firms - due to diversifying range of product
Disadvantage of conglomerate integration
- The firms are going into markets where they have no expertise - this can be often damaging for the business
What is a demerger
The process when a single business is split into two or more components - either to be operated, sold off or dissolved
Case study of demerger
In 1997, Pepsi announced the demerger of Pizza Hut, KFC and Taco Bell to focus on competition with Coca Cola
This was welcomed by shareholders as the restaurants failed to live up to their expectations
Reasons for demergers (4)
- Lack of synergies
- Increase value of the company / share price
- Focused companies
- Avoid attention of competition authorities
Impact of demerger on workers
Some workers may benefit as they might be promoted
Other workers may result in job losses
Impact of demerger on businesses
Concentrating on a smaller core business may enable more efficient operation, innovation and survival of higher competition
The smaller size of business could result in a loss of economies of scale and reduce efficiency
Impact of demerger on consumers
Consumers may gain from greater innovation or efficiency in the form of higher quality products and/or lower prices
Demerged firms may be less efficient through loss of economies of scale or raise prices/lower quality as they are motivated by profits
