3.1 - Business Growth Flashcards
Why do firms want to grow?
- Larger firms often have easier access to finance
- Growth provides opportunities for product diversification
- Owners/shareholders desire for higher levels of profit
- Desire for stronger market power (monopoly) so as to increase profits
- Desire to reduce costs by benefitting from economies of scale
- Owners/Shareholders/Managers desire to run a large business & continually seek to grow it
Why do small firms exist?
- They offer a more personalised service & focus on building relationships with their customers
- Rapid growth can cause diseconomies of scale which can be difficult to deal with & so many owners choose to avoid these
- Many small firms operate in mass markets with low barriers to entry
- Owners goal is not profit maximisation but rather an acceptable quality of life (satisficing)
- Unable to access finance for expansion
- They provide a product that is in a niche market - smaller market size but can be very profitable
What is divorce of ownership of control?
- As firms grow, the owners (or shareholders) often appoint managers to run the business for them - separation (divorce) between the owners and the managers who control the day-to-day running of the business
What is the principle agent problem?
- The principal-agent problem arises when the interests of a company’s owners (the principals) are not aligned with those of its managers (the agents) who make decisions on their behalf
- This can lead to conflicts of interest, as managers may prioritize their own goals over the objectives of the company’s owners
What is the distinction between public and private organisations?
- Public sector organisations are owned & controlled by the Government - their goal is not profit maximisation but to provide a service, e.g. corporations like BBC or civil service departments like education
- Private sector organisations are owned & controlled by private individuals (vary from sole traders to partners to company shareholders) - goal is usually profit maximisation -> often causes the private sector to be more efficient than the public sector with higher levels of productivity
What is the distcinction between profit and not-for-profit organisations?
- Most firms In the private sector exist to make a profit, even if their goal is not profit maximisation
- Exceptions to this are not-for-profit organisations which also operate in the private sector - exist to provide a service or meet a need
- Many sell goods/services & use the profits they generate to further their objectives, e.g. The British Heart Foundation
- The government exempts them from paying direct taxes
What are the different types of business growth?
- organic growth
- forward and backward vertical integration
- horizontal integration
- conglomerate integration
What are different ways of organic growth?
- gaining greater market share
- product diversification
- opening a new store
- international expansion
- investing in new technology/production machinery
What is the distinction between organic and external growth? Give real-life examples of inorganic!
- Organic: growth driven by internal expansion using reinvested profits or loans
- External: growth that occurs as a result of mergers or takeovers e.g. Google bought Youtube for $1.65bn in 2006 or T-mobile merged with orange -> EE - 30mil customers
What are the advantages and disadvantages of organic growth? Real-life examples?
Advantages:
- The pace of growth is manageable
- Less risky - growth is financed by profits & there is expertise in the industry
- Avoids diseconomies of scale
- Keep ownership and control
Disadvantages:
- Slower growth for directors who wish to maximise salaries - e.g. Basecamp grew to $100mil in revenue per yr in 20yrs
- Not necessarily able to benefit from economies of scale
- Access to finance may be limited
- Lose ownership and control by selling shares/franchises - e.g. Uber’s founder sold too many shares -> owns only 10%
- Difficult for firms to get new ideas
What is forward vertical integration? Examples?
- Involves a merger or takeover with a firm further forward in the supply chain
E.g. A dairy farmer merges with an ice-cream manufacturer or Ford integrated with its tire manufacturer
What is backward vertical integration?
- Involves a merger/takeover with a firm further backward in the supply chain
E.g. An ice-cream retailer takes over an ice-cream manufacturer
What are the advantages and disadvantages of vertical integration?
Advantages:
- Reduced COP as middleman profits are eliminated
- Lower costs make the firm more competitive
- Greater control over the supply chain reduces risk as access to raw materials is more certain
- Quality of raw materials can be controlled
- Forward integration adds additional profit as the profits from the next stage of production are assimilated
- Forward integration can increase brand visibility
Disadvantages:
- Diseconomies of scale occur as costs increase e.g. unnecessary duplication of management roles
- Culture clash between the two firms that have merged
- Possibly little expertise in running the new firm results in inefficiencies
- The price paid for the new firm may take a long time to recoup
What is horizontal integration?
A merger/takeover of a firm in the same stage of production and business area e.g. T-mobile and Orange merged to make EE
What are the advantages and disadvantages of horizontal integration?
Advantages:
- Rapid increase of market share
- Gain monopoly power
- 2+2=5 output rises exponentially due to increased expertise gained
- Reductions in the cost per unit due to economies of scale
- Reduces competition
- Existing knowledge of the industry means the merger is more likely to be successful
- Achieving corporate objectives
Disadvantages:
- Diseconomies of scale may occur as costs increase e.g. unnecessary duplication of
management roles
- Decentralised leading to less tight control of businesses taken over
- There can be a culture clash between the two firms that have merged
