3.1 Business Growth Flashcards
Why do firms grow?
Increase profit - firms may need to increase output to the point where mc=MR and they are maximising profits
Increase market share - as a firm expands it becomes more recognisable as a brand and is more easily distributed to consumers
EOS (bulk buying as firm grows) = lower AC
The larger the firm becomes, the more they can negotiate costs with suppliers = push comp out of market = firm becomes price maker = gains power
Diversify risk =expanding into diff markets
Managerial motives conflict with owners e.g prestige and higher salary
Disadv of growth
DEOS
High sunk costs e.g by staying small = less advertising expenditure to increase brand loyalty
Niche market = little room for expansion as market to purchase your goods may not exist
Opportunity cost since expanding business will mean less leisure time
The principal-agent problem
A situation of asymmetric information where an agent is expected to act in the best interest of a principal but the age t has different incentives to the principal, leading to a conflict of interests and the best outcomes not being achieved for the principle
How the principal agent problem occurs
A principal delegates an action to another individual but 1) the principal does not have full info about how the agent will behave and 2) the interests of the principal diverge from that of the agent, meaning that the outcome is less desirable than the principle expects.
Performance-Based pay
A way to over come PA problem by linking the agents compensation to their performance as it can motivate them to act in the principals best interest e.g managers could receive bonuses based on the company’s profitability or stock performance
Private sector
Businesses are operated and owned by private individuals and companies.
Private sector businesses are generally run for profit - to earn returns for the business owners e.g shareholders
Public sector
Businesses are owned and run on behalf of the public either by gov or by org which report to gov
Not run for profit generally but exist to provide g+s to public using public funds e.g Network rail (controlled by gov)
Much larger number of organisations provide goods and services which are owned by public bodies e.g NHS
Primary industry
Directly involve extracting raw materials from the earth e.g fishing and farming
Secondary industry
Involves changing raw materials into finished or part finished goods
Tertiary industry
Involve providing a service to the public e.g hairdressing
Organic growth
The internal growth of a business which builds on a business’ own capabilities and resources rather than growth through M&A
How to grow organically
Expansion into new markets
Developing new products
Increasing market share
Opening new stores
Adv of organic growth
Sustainable and controlled expansion
Lower financial risk as it relies on internal resources
Builds on existing strengths and expertise
Disadv of organic growth
Slower growth compared got other strategies
Limited in terms of rapid market capture
Requires time and patience to see substantial results
External growth
A company growing by acquiring another company (M&A)
Horizontal integration
A takeover of another business in the same industry at the same stage of production
Exp of horizontal integration
2019 - Walt Disney acquired 21st Century Fox’s entertainment assets (media and entertainment industry). Acquisition included film and tv studios and cable and International TV businesses
Adv of horizontal integration
Rapid increase of market share
Reduction in the cost per unit due to economies of scale
Reduces competition decreasing contestability
Existing knowledge of the industry means the merger is more likely to be successful
Disadv of horizontal integration
DEOS may occur as costs increase e.g unnecessary duplication of management roles
There can be culture clashes between the two merged firms
May be investigated by CMA
Vertical integration
Where a company expands its operations by acquiring or controlling other businesses that are either upstream or downstream in the supply chain
Supply chain
Supplier - Manufacturer - Distributor - Retailer - End consumer
Forward vertical integration
A business buys another business further upstream in the supply chain e.g a dairy farmer acquires an ice cream manufacturer
Backward vertical integration
A business merges or acquires an ice cream manufacturer e.g H&M purchasing a fabric manufacturer
Adv of vertical integration
Control of the supply chain which helps to reduce unit costs
Improved access to key raw materials perhaps at the expense of rivals who must then pay more from them
Reduces CoP leading to higher profits
Removes suppliers and takes market intelligence away from competitors which helps to make a market less contestable (increases a firms market power)
Disadv of vertical integration
New problems of communications and coordination within a bigger and more disparate firm = DEOS = inefficiency
Companies may lose benefits of specialised expertise when they integrate various stages of the supply chain
May raise competition concerns, where a company gains significant control over an entire industry
Conglomerate integration
A business who operates in many different industries or markets e.g Mitsubishi operates in banking, automobile and chemical industry
Adv of conglomerate integration
Diversification reduces risks of business failure
Increased EoS e.g shared management and services
Increased brand strength
Disadv of conglomerate integration
Lack of expertise in new industries/products
DEOS can quickly develop
Regulatory issues due to potential monopoly power
Constraint on business growth
Size of the market - Niche markets or luxury markets often remain small as there is limited ability to secure further raw materials or revenue
Access to finance - Businesses can finance growth through retained profits or loans. However using retained profits require approval from shareholders and loans charge interest. Banks may also be unwilling to lend to small businesses as they are deemed risky (low amounts of collateral)
Constraints on business growth pt2
Owner objectives may clash with growth as they may not wish to grow since they have alternative objectives e.g stakeholder interests
Regulation - if a firm grows too big, the CMA may regulate firm to ensure there is no monopoly power abuse by increased prices and restricted output
Demerger
When a firm decides to split into separate firms. A company spins off one or more of its divisions, subsidiaries or business units as separate entities
How is a demerger done
Distribution of shares in the new companies to the existing shareholders of the parent company
Exp of demerger
2021 - Johnson and Johnson
Multinational pharmaceutical and consumer goods company based in USA announced demerger, where they would spin off their orthopaedics business, including joint replacement products as a separate publicly traded company
Motivation for demerger
Focus on core businesses to cut AC and thus improve profit margins and returns to shareholders through selling off loss making subsidiaries
Reduce risk of DEOS and diseconomies of scope by reducing range of functions in a business = lower management costs
Raise money from asset sales and return to shareholders
Defensive tactic to avoid CMA attention of investigating monopoly power
Detailed example of de mergers
Costa Coffee sold by Whitbread to Coca Cola in 2019 so Whitbread can focus on structural growth opportunities for leading hotel business, Premier Inn in Uk and Germany + majority of net cash proceeds (£3.8 billion) to be returned to shareholders
Impact of demerger on employees
Job uncertainty as some positions may be duplicated or no longer needed in the new entities = layoffs
Changes in compensation (salaries, bonuses) and benefits
Creates opportunities for employees to take on new roles, develop new skills and contribute to the growth of newly independent companies
Impact of demergers on customers
May experience delays in services or changes in quality of goods as systems and operations are divided between new entities
Increased competition between new entities which can lead to lower prices and improved quality of service
Customers could face renegotiations or changes in pricing and terms if they have ongoing contracts with the de-merged entity
Impact of demerger on business
If DEOS is prevented, this can lead to cost saving in long run so long run profits can be maximised
Greater efficiency as businesses focus more on core activities
