3.2 Business Growth Flashcards
How is Diseconomies of Scale defined?
Rising long-run average costs as a business expands beyond its minimum efficient scale.
How is Economies of Scale defined?
The reduction in average costs enjoyed by a business as output increases.
How is External Economies of Scale defined?
The cost reductions available to all businesses as the industry grows.
e.g. local colleges may offer specialist training courses to improve the relevant skills levels of the local workforce
How is Internal Economies of Scale defined?
The cost reductions enjoyed by a single business as it grows.
How is Minimum Efficient Scale defined?
The output that minimises long-run average costs.
What is Growth?
- Growth is a measured increase in the key indicators of a business, such as sales revenue, units sold or profits.
- It can also be viewed in the context of asset ownership or increases in number of employees.
What is Economies of Scale?
Reductions in unit cost caused by the growth of a business
- the size of a business has a major impact on average costs of product, there is a range of output over which average costs fall as output rise –> economies of scale.
- In this instance, a business can negotiate better deals against smaller rivals or suppliers who want business.
- Businesses can also invest in more efficient machinery to allow them to reduce average costs per unit.
What is the Law of Diminishing Returns?
- As a firm keeps expanding its operations the same level of output can be produced more efficiently e.g. with a bigger plant
- Furthermore in the long-run the average costs fall due to economies of scale and will continue to do so until they hit minimum efficient scale –> the point where average costs cannot be reduced any further through expansions
- Clearly you can’t just keep getting better deals through size. At a certain point, production capacity will be reached.
- If the business then increases capacity through new machinery, or increased facilities, this leads to increased capital costs this is called diseconomies of scale
What are Internal Economies of Scale?
Internal economies arise within the business as a result of the growth of the firm.
- Purchasing and marketing economies - greater buying power
- Technical economies - buy specialized machinery / equipment to reduce unit costs
- Managerial economies - employ specialist managers - e.g. Training Manager and Recruitment Manager not just HR Manager
- Specialisation economies
- Financial economies
- Risk bearing economies
What are Purchasing and Marketing Economies as part on Internal Economies of Scale?
- Large firms are likely to get better rates when buying raw materials and components in bulk
- Also administration costs involved do not rise in proportion –> therefore the cost to process and order of 1000 units doesnt treble when processing 3000 unit
- A number of marketing economies exist. A large company may find it cost-effective to acquire its own fleet of vans and lorries
What is Technical Economies as part of Internal Economies of Scale?
- Technical economies arise because larger plants are often more efficient
- Principle of increase dimensions –> the capital costs and the running costs of plants do not rise in proportion to their size –> increasing size may mean doubling output but not doubling cost therefore average costs with fall
- Indivisibility –> I machine costs the same price if it is used only once or everyday, as the business expands, more use will be made of it and so the average cost of the machine will fall.
- may switch to mass production techniques –> flow production allows greater use of specialised machinery which is more efficiency as labour is replaced by capital
- law of multiples –> as a businesses expand its can buy more slow machines to match the capacity of faster machines, this way as they operate together they are running at full capacity
What is Specialisation and Managerial economies as part of Internal Economies of Scale?
- As the firm grows it can afford to employ specialist managers –> finance, marketing, production etc.
- if a business employs a specialist in these fields efficiency may improve and average costs fall
- if employed in a small firm they would be an indivisibility
What is Financial Economies as part of Internal Economies of Scale?
- Large firms have a wider variety of sources from which they can raise funds from compared to the like of a sole trader
- Very large firms will often find it easier to persuade institutions to lend them money since they will have large assets to offer as security
- large firms borrowing very large amounts of money can often gain better interest rates
What is Risk-bearing economies as part of Internal Economies of Scale?
- As a firm grows it may well diversify to reduce risk e.g. more products, new markets
- Large businesses can also reduce risk by carrying out research and development which may give them a competitive edge over smaller rivals
What are External Economies of Scale?
External economies usually occur when there is a growth in the industry the business operates in.
- Labour
- Ancillary services
- Co-operation
- Disintegration
What is Labour in External Economies of Scale?
- The concentration of firms may lead to the build-up of a labour force equipped with the skills required by the industry
- Training costs may be reduced if workers have gained skills at another firm in the same industry
- Local schools and colleges, or even local government, may offer training courses which are aimed at the needs of the local industry
What is Ancillary and Commercial Services as part of External Economies of Scale?
- An established industry, particularly if it is growing , tends to attract smaller firms trying to serve its needs
- A wide range of commercial and support services may be offered. Specialist banking, insurance marketing, waste disposal, maintenance etc.
What is Co-operation as part of External Economies of Scale?
- Firms in the same industry are more likely to co-operate if they are concentrated in the same region.
- They might join forces to fund a research and development centre for the industry
- An industry journal might be published, so information can be shared
What is Disintegration as part of External Economies of Scale?
Disintegration occurs when production is broken up so that more specialisation can take place.
- When an industry is concentrated in an area, firms might specialise in the production of one component and the transport it to a main assembly car plant.
How does a business gaining market power affect their Customers?
- Dominant businesses can charge higher prices if competition becomes limited.
- If there are less competitive forces in the industry, there is less need to spend money on new products.
- This also reduces the need to spend resources on innovation and development
How does a business gaining market affect their Suppliers?
- Dominant businesses can force cost reductions with suppliers of materials or commercial services
- This will particularly be the case if the business is the main customer of the supplier.
- However if a business becomes too dominant, it may draw the attention of the authorities, which could lead to investigation on competition grounds.
How does a business increasing market share affect its brand image?
- As businesses grow, their share of the market is also likely to grow. This will give them more power and enjoy increased brand recognition.
- As their market share increases, the business will become a greater part of the consumer’s conscious as they see the increased product placement in store or additional advertising.
What are the benefits of brand recognition?
- As a brands becomes stronger a business may be able to:
- Charge a higher price,
- Differentiate the product from those of rivals,
- Create customer loyalty,
- Enhance product recognition,
- Develop an image and launch new product
- Larger businesses also attract more media attention, which increases promotion of the businesses
What are the benefits of increased profitability?
- By combining the benefits of increased brand recognition through market share, by negotiating with customers and suppliers better pricing and by benefiting from economies and scale, a business will benefit from increased profitability.
- This then further benefits the business’ growth potential as it allows for further investment and innovation, subject obviously to the Law of Diminishing returns
What problems arise from Growth?
Diseconomies of Scale - the inefficiencies related to growing as a business that can lead to upward pressure on unit costs
- Poor internal communication - growth can lead to a worsening of comms in a org - messages need to pass through more layers, effectiveness of communication is affected by the motivation levels of sender and receiver which can have a negative impact on communication
- Poor employee motivation - as a business grows personal contact between staff and mangers can reduce leading to a reduction in motivation
- Poor managerial coordination - as org grows the boss has less time to spend with staff as he did when business was small. This failure to keep an eye on everything can lead to mistakes that drive up costs
- Overtrading - occurs when a business experiences cash flow problems as a result of expanding too quickly without sufficient cash in the bank
What are the problems that arise from Internal Diseconomies of Scale if a business grows?
- Communication becomes complicated and co-ordination of large firm, with multiple departments, is more difficult.
- Control and co-ordination is demanding, managing thousands of employees and £bn budgets requires more supervision.
- Motivation can be damaged as individuals see themselves as minor in the overall structure of the organisation.
- Technical issues can arise where multiple plants needed due to the differing products being made
What are the problems with External Diseconomies of Scale if a business grows?
- Over crowding of similar industry in a certain area may lead to reduction in resource availability.
- The price of land, labour, services and materials increase as firms compete for resources
- Congestion can also lead to delays in workers arriving or products being distributed.
What are the problems with Internal Communication if a business grows?
- As businesses grow, internal communication can become an issue, as messages need to be disseminated across an increased number of people.
- Whilst ICT has resolved some of these issues (email), its difficult to convey full meaning without a face to face meeting.
- Resources could be wasted due to ineffective communication. Also, duplication of work or work being missed due to misunderstanding.
- Departments can “silo”, where integration with other areas becomes limited, reducing efficiency and leading to missed opportunities.
What problems can arise from Overtrading if a business grows?
- If a business grows too quickly there is the potential for it to suffer from overtrading. This is more likely to happen in young, rapidly growing businesses.
- Over trading occurs when a business tries to fund large volume of new business without sufficient resources. This can lead to cash flow issues.
When does overtrading occur?
- Businesses do not have sufficient capital. If they do not have enough cash to buy the resources needed to meet the growing orders
- A business offers too much trade credit, this means that the business has to wait that length of of time, or more, to be paid. During this time it will be short of cash to buy the resources needed to meet new order
- A business operates with slim profit margins, in order to make an impact in the market, a new business may offer its products at lower prices. However, with lower prices and subsequent lower profit margins, it may not generate enough profit to fund the growing volume of business
How is Backward Vertical Integration defined?
Joining with a business in the previous stage of production.
How is Forward Vertical Integration defined?
Joining with a business in the next stage of production.
How is Horizontal Integration defined?
The joining of businesses that are in exactly the same line of business.
How is Integration defined?
The joining of two businesses as a result of a merger or takeover.
