3.1 Business Growth

Question 1

Why would firms choose to grow?

Answer 1

● To make more money
● To gain monopoly power
● For greater security

Question 2

How can a firm growing help to make more money?

Answer 2

By growing, a firm will be able to experience economies of scale which helps them to decrease their costs of production. They will also be able to sell more goods and therefore make more revenue​. These will help a firm to make a ​larger profit​ which many firms are motivated by

Question 3

How can a firm growing help to gain monopoly power, and why is this useful?

Answer 3

A larger firm will hold a greater share of their market. This will give them the ability to influence prices and ​restrict the ability of other firms to enter the market, helping them to make profits in the long run. Monopoly power often means firms have monopsony power​, and so will be able to reduce their costs by driving down the prices of their raw materials

Question 4

How can a firm growing help increase security?

Answer 4

They will be able to ​build up assets and cash ​which can be used in financial difficulties. Moreover, they are likely to sell a bigger range of goods in more than one local/national market and so they will be less affected by changes to individual products or places

Question 5

What is the principle agent problem?

Answer 5

A conflict of interest that occurs when one group (the agent) makes decisions on behalf of another group (the principal), but the two have different objectives

Question 6

Why does the principle agent problem occur?

Answer 6

Because owners (principals) and managers (agents) have different objectives
● The owners will want to maximise the returns on their investment so will want to short run profit maximise
● However, directors and managers are unlikely to want the same thing: as employees, they will want to ​maximise their own benefits​.

In theory, the agent should maximise the benefits for those whom they are looking after but in practice ​agents have the temptation to maximise their own benefits

Question 7

How can the principle agent problem be reduced?

Answer 7

By aligning incentives, e.g
● Giving managers shares in the business
● Linking their bonuses to profits, this will mean that they personally will gain from higher profits.

Question 8

What is the private sector?

Answer 8

The private sector refers to the part of the economy that is ​owned and run by individuals or groups of individuals

Question 9

What is the public sector?

Answer 9

The public sector refers to the part of the economy which is owned or controlled by local or central governmen​t

The purpose of these organisations is to provide a service for UK citizens and profit making is not their main aim, some may even make a loss which is funded for by the taxpayer

Question 10

What two types of organisations is the private sector split into?

Answer 10

● Profit organisations
● Not-for-profit organisations

Question 11

What are profit organisations?

Answer 11

Almost all private sector organisations are run to make a profit and to ​maximise the financial benefits for their shareholders​. They may not necessarily profit-maximise, but their long term goal is to make money.

Question 12

What are non-profit organisations?

Answer 12

Some private sector organisations are not-for-profit. Any profit they do make is used to support their aim of ​maximising social welfare and helping individuals and groups​. These organisations include charities and smaller organisations who aren’t large enough to be classified as charities.

Question 13

What are the two main types of growth for firms?

Answer 13

● Internal/organic growth
● Integration

Question 14

What is organic growth?

Answer 14

Where the firm grows by ​increasing their output​, for example increased investment or more labour. They may open new stores, increase their range of products etc. Almost all growth of firms is organic

An example of a firm who grew through organic growth is LEGO. They introduced new products, such as Lego Friends and board games to expand their customer base.

Question 15

What are the advantages of organic growth opposed to growth through integration?

Answer 15

● Integration is ​expensive, time-consuming and high risk​, with evidence suggesting that the long-term share price of the company falls following integration. Firms often pay too much for takeovers and integration is often poorly managed with many key workers tending to leave after the change.
● The firm is able to ​keep control ​over their business

Question 16

What are the advantages of integration instead of organic growth?

Answer 16

● Sometimes another firm has a ​market or an asset which the company would be unable to gain through organic growth. For example, integration would allow a European company to expand into the Asian market which it has no expertise in
● Organic growth may be ​too slow​ for directors who wish to maximise their salaries
● It will be more difficult for firms to get ​new ideas

Question 17

What is integration?

Answer 17

Growth through amalgamation, merger or takeover. A merger or amalgamation is where two or more firms join under common ownership whilst a takeover is when one firm buys another.

Question 18

What is vertical integration?

Answer 18

The integration of firms in the ​same industry but at different stages in the production process​. If the merger takes the firm back towards the supplier of a good, it is ​backwards integration​. ​Forward integration is when the firm is moving towards the eventual consumer of a good

Question 19

What is forward (vertical) integration?

Answer 19

When a firm merges with or takes over another firm that is at a later stage of production, closer to the final consumer

Question 20

What is backward (vertical) integration?

Answer 20

When a firm merges with or takes over another firm that is at an earlier stage of production, closer to the raw materials or supplier

Question 21

What is an example of vertical integration?

Answer 21

Tesco’s £3.7bn takeover of Booker in 2018 is an example of vertical integration. It has led to an increase in sales for Tesco.

(backward integration)

Question 22

What are the advantages of forward and backward vertical integration?

Answer 22

● Increased potential for profit ​as the firm takes the potential profit from a larger part of the chain of production.
● There will be less risks as suppliers do not have to worry about buyers not buying their goods and buyers do not have to worry about suppliers not supplying the goods.
● With backward integration, businesses can ​control the quality of supplies and ensure delivery is reliable​. Moreover, they don’t have to worry about being charged high prices for supplies, keeping ​costs low and allowing lower prices for consumers. This can increase competitiveness and sales.
● Forward integration secures ​retail outlets and can restrict access to these outlets for competitors.

Question 23

What is a disadvantage of forward and backward vertical integration?

Answer 23

Firms may have ​no expertise in the industry they took over, for example a car manufacturing company would have deep knowledge of car manufacturing but little knowledge of selling cars and vice versa

Question 24

What is horizontal integration?

Answer 24

This is where ​firms in the same industry at the same stage of production integrate

Question 25

What are the advantages of horizontal integration?

Answer 25

● Helps to ​reduce competition as a competitor is taken out and ​increases market share​, giving firms more power to influence markets ● Firms will be able to ​specialise and rationalise​, reducing the areas of the businesses which are duplicated ● The business is able to grow in a market where it ​already has expertise, which is more likely to make the merger successful.

Question 26

What is are disadvantages of horizontal integration?

Answer 26

● It will ​increase risk for the business as if that particular market fails, they have nothing to fall back on and will have invested a lot of money into that area. They are ‘placing all their eggs in one basket’ ● Can put firms at risk of investigation from the CMA ● Potential diseconomies of scale

Question 27

What is conglomerate integration?

Answer 27

Where ​firms in different industries with no obvious connections ​integrate​ ## Footnote They can sometimes be linked by common raw materials/technology/outlets

Question 28

What are some advantages of conglomerate integration?

Answer 28

● Useful for firms where there may be ​no room for growth in the present market​. ● The range of products ​reduces the risk ​for firms and if a whole industry fails, they will still survive due to the other parts of the business. ● It will make it ​easier for each individual part ​of the business to expand than if they were on their own as finance can be easily obtained and managers can be transferred from company to company within the firm

Question 29

What is a disadvantage of conglomerate integration?

Answer 29

Firms are going into markets in which they have ​no expertise​. It can often be ​damaging​ for the business.

Question 30

What things can constrain business growth?

Answer 30

● Size of the market ● Access to finance ● Owner objectives ● Regulation

Question 31

How can the size of a market constrain business growth?

Answer 31

​A market is limited to a certain size and so not all businesses are able to mass produce because their goods would not be bought by consumers. This can happen no matter how big the market is, and there will always be limits on growth. In particular, niche markets (specific products that few people want) and markets for luxury items or restricted prestige markets make it difficult for businesses to grow

Question 32

How can access to finance constrain business growth?

Answer 32

Firms use two main ways to finance growth: retained profits and loans ● If firms do not make enough profit or have to give out too much to shareholders, they will not be able to use retained profits to grow ● Banks may be unwilling to lend firms money, particularly smaller businesses that they see as high risk. As a result, firms will be unable to grow as they can’t finance it.

Question 33

How can owner objectives constrain business growth?

Answer 33

Some owners may not want their business to grow any further as they are happy with their current profits and do not want the extra risk or work that comes with growth.

Question 34

How can regulation constrain business growth?

Answer 34

In some markets, the government may introduce regulation which prevents businesses from growing.

Question 35

What is a demerger?

Answer 35

A business strategy in which a ​single business is broken into two or more components​, either to operate on their own, to be sold or to be dissolved.

Question 36

What are the reasons for demergers?

Answer 36

● Lack of synergies​ ● Value of the company/share price ● Focussed companies ● May want to avoid attention from the ​competition authorities​.

Question 37

What is meant by lack of synergies and why might it cause a firm to demerge?

Answer 37

This is when the different parts of the company have no real impact on each other and fail to make each other more efficient. Lack of synergy means managers are splitting their time between areas which are so different it could lead to diseconomies of scale; firms may split in order to avoid these diseconomies.

Question 38

How can the value of a company/share price cause a firm to demerge?

Answer 38

Some companies demerge because the value of the separate parts of the company is worth more than the company combined. This is because some parts of the business are operating well and have potential to grow but the overall value is brought down because of the lack of success or lack of potential for growth of other parts of the business. Financial markets talk about ‘creating value’ by splitting up companies like this.

Question 39

How can a company wanting to focus on one area cause a firm to demerge?

Answer 39

Some people believe if the company and the management are more focussed on individual markets they become more efficient and successful, and make higher profits. Management have limited time and skills and they are unable to spend the required time to make all areas of a huge diverse business successful. By focusing on one area, managers can improve their skills and knowledge and become more successful.

Question 40

What are the impacts of a demerger on workers?

Answer 40

● Workers could gain or lose through a demerger ● Separate firms may need their own managers and leaders so people could get a ​promotion​ ● However, the goal of making the firm more efficient may result in ​job losses​

Question 41

What are the potential impacts of a demerger on businesses?

Answer 41

● Concentrating on a smaller core business may enable it to be more efficient and concentration may lead to more ​innovation and surviving higher competition ● However, the smaller size of the business could lead to a ​loss of economies of scale ​and reduce efficiency.

Question 42

What are potential impacts of a demerger on consumers?

Answer 42

● Consumers could gain or lose They may gain from innovation and efficiency, leading to ​better products and cheaper prices​ ● However, demerged firms may be less efficient through loss of economies of scale or ​raise prices/reduce quality or range of goods ​as they become motivated by profits