3.1 Business Growth

Question 1

Reasons why firms grow

Answer 1

-owners/ shareholders desire to run a large business and continually seek to grow it
-owners desire higher levels of profit
-desire for stronger market power (monopoly)
-desire to reduce costs by benefiting from economies of scale
-growth provides opportunities for product diversification
-larger firms often have easier access to finance

Question 2

Reasons why small firms exist

Answer 2

-they offer a more personalised service and focus on building relationships with their customers
-unable to access finance for expansion
-provide a product that is in the niche market (smaller market size but very profitable)
-many operate in mass markets with low barriers to entry
-rapid growth can cause diseconomies of scale which can be difficult to deal with
-owners goal is not profit maximisation but rather an acceptable quality of life

Question 3

The principal agent problem

Answer 3

-Can be linked to the theory of asymmetric information
-when the owners and managers goals differ
-e.g shareholders want to maximise profits but workers want to maximise their salaries

Question 4

Solutions to align goals

Answer 4

-give shares to directors
-strengthen shareholder power e.g force management to publish reports such as pay rises
-long term contract
-link bonus to area shareholders see as important

Question 5

Public sector organisations

Answer 5

-owned and controlled by the government
-aim is not profit maximisation but to provide a service
-e.g channel 4, BBC, NHS
-natural monopolies
-some industries yield strong positive externalities like public transport reduces congestion and pollution
-social welfare is prioritised more and leads to fairer distribution of resources

Question 6

Private sector organisations

Answer 6

-owned and controlled by private individuals
-goal is normally profit maximisation as a result tends to be more efficient with higher levels of productivity
-competition may lower prices and higher quality as these firms have an incentive for profit

Question 7

Not for profit organisations

Answer 7

-provide a service or meet a need
-many sell goods/services and use the profit they generate to further their objectives e.g British heart foundation
-government exempts them from paying direct taxes
-regulated by the uk charity commission

Question 8

Distinction between profit and not for profit organisation

Answer 8

-Profit organisation aims to maximise the financial benefit of its shareholders and owners. The goal of the organisation is to earn maximum profits
-A not for profit organisation had a goal which aims to maximise social welfare. They can make profits but can’t be used for anything apart from this goal and operation of the organisation

Question 9

Organic growth

Answer 9

-when firms grow by expanding their production through increasing output, widening their customer base, by developing a new product or diversifying their range of

Question 10

Advantages of organic growth

Answer 10

-less risk
-existing shareholders retain control over the firm which may reduce conflicts in objectives that are possible when there is a takeover
-profits are reinvested therefore there is no debt buildup and is more sustainable

Question 11

Disadvantages of organic growth

Answer 11

-long term strategy meaning competitors could gain more market power by expanding in the meantime
-firms might rely on the strength of the market to grow which could limit how much and how fast they could grow

Question 12

Forward vertical integration

Answer 12

-When a firm merges with or buys a firm in the same industry but further forward in the chain of production
-e.g a coffee producer buying a cafe

Question 13

Benefits of forward vertical

Answer 13

-guaranteed outlet for products
-firm can exercise greater control over sales and prices of its products
-improved profits by reducing cost of distribution and middle men
-integration can ensure handling and transport costs are reduced

Question 14

Drawbacks of forward vertical

Answer 14

-since processes are interdependent, a slight interruption in one process may dislocate the entire production system
-difficult to efficiently manage an integrated form because every business has its own structure, technology and problems

Question 15

Vertical backwards integration

Answer 15

-when a firm merges with or buys another firm in the same industry but further back in the chain of production
-e.g a coffee producer buying a farm

Question 16

Benefits of vertical backwards

Answer 16

-increased control
-guarantees sources of raw materials
-can’t be held to ransom by suppliers demanding a higher price at a critical time
-reduces competitors access to important markets and scarce resources
-increased profits due to improved cost control

Question 17

Drawbacks of vertical backwards

Answer 17

-leads to lack of supplier competition that will lead to low efficiency resulting in potentially higher costs

Question 18

Conglomerate integration

Answer 18

-When firms making completely different products merge
-e.g a supermarket and music producer

Question 19

Benefits of conglomerate

Answer 19

-spreads risk as less vulnerable to losses in one area
-spreads ideas
-cross subsidisation
-company may have excess cash but not enough opportunities to grow in its existing market

Question 20

Drawbacks of conglomerate

Answer 20

-company has no experience in the new industry therefore chances of mismanagement and over pricing the target company increase substantially
-company is shifting from its core business to other businesses which in turn may result in the company performing poorly in both areas
-difficult to merge cultural value, employees and other things as compared to mergers between companies which are working in the same industry

Question 21

Horizontal integration

Answer 21

-when a firm merges with/ takeover another firm in the same industry at the same stage of production
-makes the same product e.g Disney acquisition of Pixar

Question 22

Advantages of horizontal

Answer 22

-economies of scale
-lower average running costs
-increased market influence
-reduction in competition
-reduction in some cost and duplication can be avoided

Question 23

Disadvantages of horizontal

Answer 23

-costs
-increased workload
-increased responsibility
-anti-trust
-legal issues/ creating a monopoly

Question 24

Constraints on business growth

Answer 24

-size of the market
-access to finance
-owner objectives
-regulation (red tape)