3.1) business growth Flashcards
size and types of firms, business growth and demergers
How many companies are there worldwide?
estimated 359 million worldwide as of 2024
Why do some firms choose to grow?
- TO MAKE MORE SALES AND PROFITS - companies require finance to expand, like Apple which got a $250,000 loan and 90,000 in investment. Smaller companies may not have the finances to grow because there are more risks associated with investing in smaller companies.
- TO INCREASE MARKET POWER (MONOPOLY) - so that they can remain a dominant producer in the market and raise their prices to achieve supernormal profits. 2024 - Apple has a 59% market share in US. BUT regulation is strict (UK competition policy) e.g. in 2016 authorities stopped 3 mobile’s acquisition of O2 in fear of their market domination
- DIVERSIFICATION AND ENJOYMENT OF RISK-BEARING EOS - expanding companies can sell a range of products so they can continue making supernormal profits even when one of the products goes out of style. Harder to do this when a company operates in a niche market
. - TO BE ABLE TO EXPLOIT INTERNAL EOS TO REDUCE LRAC AND GAIN PROFIT - although too much expansion may lead to the contrary
- PERSONAL MOTIVATIONS OF OWNERS
Why may a firm want to remain small?
- UNABLE TO ACCESS FINANCE - unlike larger companies, it is much harder to get investment due to the risks associated with investing in small firms
- NICHE MARKET - may operate in a niche market where it is much harder to diversify their products. They may not even need to as they provide a unique product, therefore the market can be more profitable.
- FOCUS ON PERSONALISED SERVICE - may focus on creating relationships with their customers and the quality of each product, which is harder to do if a company expands
- SATISFICING - owner’s goal may not be to profit maximize
- NO NEED TO - many small firms operate in monopolistic markets that have low barriers to entry
What is the divorce from ownership from control?
- As a company sells more shares and expands, the majority of the company becomes owned by shareholders, although the owners retains the CEO position
- Divorce represents the DISCONNECT between the ownership (shareholders) and control (CEO and managers) giving rise to the principal-agent problem
What is the principal-agent problem?
- when the decisions of the AGENTS(decision-makers) don’t align with the PRINCIPAL (whom the decisions will affect)
- exacerbated by INFORMATION GAPS/asymmetric info => the decisions of the agents aren’t always known by the principals as agents control the flow of info e.g. if managers were following their personal objectives like maximising revenue to maximise bonuses to expand rather than maximising profit
= can be resolved by granting share options - allowing managers to become shareholders so their interests align
What are the different types of firms?
- PUBLIC sector: owned by the government e.g. NHS, TFL, BBC - could be but are not always Not-For-Profit firms
- PRIVATE sector: owned by private individuals e.g. Apple, Barclays, TATA - most tend to focus on profit maximisation. Tend to be more efficient than public services because productivity is incentivized by profit
- NOT-FOR-PROFIT firms: usually charities e.g. Oxfam or Barnardos - aim to achieve social objectives and profits are not the main goal; although, any profit gained is used to further their objectives.
What are two ways in which a firm can grow?
- ORGANIC growth: firms grows > investing in itself > increase in ouput. Can be done by: REINVESTING PROFITS into the firm, selling shares, taking a bank loan e.g. Poundworld took a 50 million bank loan to invest in new stores
- INORGANIC growth: growth that is external - BACKWARD AND FORWARD VERTICAL integration, HORIZONTAL integration, CONGLOMERATE integration e.g. acquisitions Google acquired Youtube for 1.65 million) and mergers (T-Mobile and Orange merged to form EE)
What are the advantages and disadvantages of organic growth?
- By reinvesting your own profits or borrowing from a bank, there is no chance of the principal-agent problem because you get to keep ownership and control. If you sell shares, ownership is transferred per share.
- LOW RISK because you continue to invest in a good that the company has secure knowledge of and have continually made profit on. Inorganic growth has higher risk and is unpredicatable because they merge with new companies and enter unknown markets
BUT - organic growth is slow and expensive as opposed to inorganic growth e.g took Basecamp 20 years
What is a vertical integration?
- When firms at different stages of the same production process join together
- FORWARD vertical integration: happens when a firm takes over another firm that is further FORWARD (closer to consumer) in the production process than they are e.g. tyre factory and car manufacturer
- BACKWARD vertical integration: happens when the firm takes over another firm that is further BACK (further from the consumer) in the process e.g. a book printer buying a paper plant
What is horizontal integration?
- When firms at the SAME stage of the production process of SIMILAR products join together e.g. Ford and Jaguar
What is conglomerate integration?
- When two firms in unrelated industries join together e.g. TATA acquiring the Ritz Hotel and Jaguar
- Usually done by a company to diversify their investments and exploit risk-bearing economies of scale
What are the advantages and disadvantages of vertical integration?
- You can gain more control of the production process by taking over suppliers or retailers, which can lead to higher quality or efficiency. Better access to:
- Consumers: Ford with showrooms meant that Ford could better communicate with its consumers and gain information on how to better design cars -> increase profits
- Raw materials: e.g. Co-Op acquiring the farms that produce for them -> better access to food stock -> better food quality and better communication with the farmers -> increased efficiency and quality and increased profits
BUT may backfire if the firms lack expertise in the market they are entering -> reduced productivity -> increased costs -> decreased profits
- Can create barriers to entry by preventing the competition from accessing these distribution and resource channels BUT this will likely be faced by regulation e.g. Ofgem preventing mergers between electricity producers and the power grid, arguing that it gave them the chance to exploit customers with prices and fines
- Costs will be reduced because suppliers and retailers are only attached to one company so can negotiate prices. This is also because there will be fewer intermediary costs like transport BUT the contrary may happen due to DEOS -> increased LRAC and a decrease in profits. The whole process of an acquisition is expensive in itself.
What are the advantages and disadvantages of horizontal integration?
- Companies can exploit internal economies of scale, such as marketing and purchasing BUT could also lead to internal DEOS e.g. a lack of communication between BMW and Rover when they merged in 1994
- When two firms merge together, they can begin to reorganise to cut costs e.g. like the software used in both companies can be reduced to one major network and they can also reduce the number of employees required BUT reorganisation is costly and many lose their jobs e.g. 1200 job losses when orange and t-mobile reorganised
- Reduced competition will lead to fewer price wars and undercutting BUT can also lead to brand dilution - expensive and reputed brands being associated with lower classed nrands, possibly reducing the sales of the aforementioned brand
What are the advantages and disadvantages of conglomerate integration?
- Internal EOS can be exploited, especially risk-bearing; thanks to diversification; cost of failure being reduced BUT extreme expansion can lead to internal DEOS
- Increased brand awareness - increasing the sales of both firms involved due to more information available in various markets BUT can be affected by brand dilution if the brands are completely different e.g. Pepsi and Quaker Oats, Quaker became diluted in its image as a healthy brand
- Knowledge transfers lead to an increase in innovation e.g. Apple and Beats collaborating leading to increase in dynamic efficiency BUT a lack of expertise and r&d may lead to a fall in productivity -> increase in costs -> decrease in profits
How does the growth of firms affect consumers?
+ a larger firm will benefit from EOS which could lead to price reductions for customers
+ the combined creativity of two firms may lead to the creation of superior products
- but consumers may have less choice
- a reduction in competition may lead to higher prices for consumers because companies realise that consumers now have fewer alternatives
- merged firms may produce less output than two separate firms, which will lead to DEOS
What are demergers? And what may cause a firm to demerge?
Demerger is the breaking up of a firm into separate firms
- cultural differences
- if a firm faces disadvantages due to excessive expansion into different markets or DEOS
- if demerging will allow each section to make more profit in their respective markets than as a part of a bigger firm - business focus
- selling off a ‘weak link’ that isn;t making profit to stabilise the company. Sold for a low price but hopefully improves profits for the rest of the firm and increase share price
- in response to government intervention: a firm could be forced to demerge by the authorities if it is deemed to have too much market power
What are the impacts of a demerger on businesses, workers and consumers?
Businesses:
- a demerged business may become more efficient as it has more time to improve its production process by reinvesting profits
- although EOS will be reduced, DEOS will also be reduced
- firm will have greater independence e.g. a demerged firm can negotiate its contracts rather than having to depend on its parent company
- firm’s market value is likely to increase
BUT
- selling off an unprofitable part of a firm may be done at a huge loss and harm the image of the demerged firm
Workers:
- communication is likely to be better in a smaller, demerged firm as they will have fewer employees, enabling more efficiency
- reduced friction from cultural differences can help build better team dynamics
- job creation as a new demerged firm will need to hire staff for marketing, finances, and HR
BUT
- a demerger may create anxiety in relation to job losses if the situation around it is not explained clearly to employees
Consumers:
- likely to be improved consumer choice as competition will rise, possibly causing prices to fall
- consumers are likely to understand what each company does better
- will benefit from having smaller firms that are more focused on customer needs and services
BUT
- if unsuccessful, a narrower product range and perhaps worse quality/customer service
