3.9.1 Assessing a change in scale

Question 1

What is retrenchment?

Answer 1

when a business decided to significantly cut or scale back its activities, and use their resources more effectively/carefully

Question 2

What are factors that cause retrenchment?

Answer 2

• An uncompetitive cost structure
• Inadequate returns on investment
• Poor competitive position
• Financial distress (e.g. decline in sales revenue)
• Market decline – more people buy online rather than going to department stores
• Failed takeovers
• Economic downturn (e.g. during a recession, a firm will reconsider their options)
• Change of ownership

Question 3

What are methods of retrenchment?

Answer 3

• Reduced output and capacity
• Product and market withdrawal
• Downsizing/rationalisation
• Disposals of business units
• De-mergers

Question 4

State the reasons why businesses grow

Answer 4

• Profit
• Costs
• Market share
• Risk
• Managerial

Question 5

Why do businesses grow for profit?

Answer 5

Firms grow to achieve higher profits and provide better returns for shareholders. The return to shareholders might be a combination of a rising share price allied with a share of profits via dividend payments

Question 6

Why is costs a reason firms grow?

Answer 6

Economies of scale in the long run increase the productive capacity of the business whilst also leading to lower average costs. Experiencing economies of scale help a business to raise their profit margins at a given market price

Question 7

Why is market share a reason firms grow?

Answer 7

Firms may wish to increase market dominance giving them increased pricing power. This market power can also be used as a barrier to the entry of new businesses in the long run

Question 8

Why is risk a reason that firms grow?

Answer 8

growth might be motivated by a desire to diversify production and/or sales so that falling sales in one market might be compensated by stronger demand in another sector.

Question 9

Why are managers a reason for firms to grow?

Answer 9

motivational theories of the firm predict that business expansion might be accelerated by the demands of senior and middle managers whose objectives differ from major shareholders

Question 10

Explain what organic growth is?

Answer 10

This involves expansion from within a business, for example by expanding the product ranges or number of business units and location
It builds on the business’ own capabilities and resources. For most firms, this is the only expansion method used

Question 11

What are ways of organic growth?

Answer 11

• Developing new product ranges
• Launching existing products directly into new international markets (e.g. exporting)
• Opening new business locations – either in the domestic market or overseas
• Investing in additional production capacity or new technology to allow increased output and sales volume

Question 12

What are advantages of organic growth?

Answer 12

• Less risk than external growth (e.g. takeovers)
• Can be financed through internal funds (e.g. retained profits)
• Builds on the firms strengths (e.g. brands, customers)
• Allows the business to grow at a more sensible rate

Question 13

What are disadvantages of organic growth?

Answer 13

• Growth achieved may be dependant on the growth of the overall market
• Hard to build market share if business is already a leader
• Slow growth – shareholders may prefer more rapid growth as they will receive lower dividends
• Franchises (if used) can be hard to manage effectively

Question 14

Explain what external growth is

Answer 14

• This involves expansion from outside the business mostly through mergers (where two company’s work together usually because both are starting to become unsuccessful) and takeovers (original company no longer exists – e.g. Asda is owned by Walmart but is still called Asda in the UK)
• For positive synergy to occur, the result should mean higher revenue or profits than the two individual businesses achieved

Question 15

What are barriers to growth?

Answer 15

• Economies of scale (including technical, purchasing, and managerial) and diseconomies of scale
• Economies of scope
• The experience curve
• Synergy
• Overtrading

Question 16

What is economies of scope?

Answer 16

• This occurs when it is cheaper to produce a range of products rather than specialise in an handful of products
• The management structure, administration systems, and marketing departments are capable of hung out these functions for more than one product
• Expanding the product range to exploit the value of existing brands is a wag of exploiting economies of scope
• Brand extension to widen the brand appeal

Question 17

What is an example of economies of scope?

Answer 17

Easy Group under the control of Stelios where the distinctive Easy Group business model has been applied (with varying degrees of success) to a range of markets (e.g. EasyJet, EasyMoney, EasyBookings, EasyCar etc)

Question 18

What is the experience curve and what does it look like?

Answer 18

a curve showing the theory that the more experienced the firm is apt making a product, the better, faster, and cheaper it is able to make it

Question 19

Explain the logic behind the experience curve

Answer 19

• As firms grow, they gain experience
• Experience provides an advantage over the competition in the industry
• The ‘experience effect’ of lower unit costs is likely to be particularly strong for large and successful businesses (market leaders)
• Therefore:
• • Experience is a key barrier to entry
• Firms should try to maximise their market share to gain experience
• External growth (e.g. takeovers) may be the best way to do this

Question 20

What are evaluative factors of the experience curve?

Answer 20

• Market leaders often become complacent
• Experience can cause resistance to change and innovation
• This could cancel out cost benefits of experience
• The experience curve concept is a relatively old theory that is less relevant in a competitive environment that changes is rapidly

Question 21

What are two examples of experience being key to business success?

Answer 21

Yorkshire Tea was founded in 1886 in Harrogate and has remained one of the leading brands for tea bags – it has recently overtaken Tetley to become the 2nd largest tea brand in the market (shows market share is expanding due to the experience they have gained throughout the years they have been in business) OR Amazon who have learnt that their model of selling more than any other retailer is their key strategy and it works very effectively

Question 22

What is synergy?

Answer 22

It happens when the value of two businesses brought together is higher than the sum of the value of the two individual businesses

Question 23

What is cost and revenue synergy?

Answer 23

• Cost synergy is where cost savings are achieved as a result of external growth – this is an example of economies of scale
• Revenue synergy is where additional revenues are achieved as a result of external growth

Question 24

How can businesses achieve cost synergies?

Answer 24

• Eliminating duplicated functions and services (e.g. combining the two accounting departments) – achieve managerial economies of scale
• Getting better deals from suppliers which might be possible if combining two businesses gives them improved bargaining power – achieve purchasing economies of scale
• Higher productivity and efficiency from shared assets; can capacity utilisation of the combined businesses be improved, perhaps by closing down spare capacity – achieve commercial economies of scale

Question 25

How can businesses achieve revenue synergies?

Answer 25

• Marketing and selling complimentary products
• Cross selling into a new customer base
• Sharing distribution channels
• Access to new markets (e.g. through existing expertise of the takeover target)
• Reduced competition – more control over the market

Question 26

What is overtrading?

Answer 26

This happens when a business expands too quickly without having the financial resources (capital employed and working capital) to support such a quick expansion. If suitable sources of finance are not obtained, then overtrading can lead to business failure

Question 27

What are symptoms of overtrading?

Answer 27

• High revenue growth but low gross and operating profit margins
• Persistent use of a bank overdraft facility
• Significant increases in the payables days and receivables days ratios
• Significant increase in the current ratio (current assets and current liabilities)
• Very low inventory turnover ratio
• Low levels of capacity utilisation

Question 28

How can businesses manage the risk of overtrading through managing cash flow and working capital?

Answer 28

• Reducing inventory levels
• Scaling back the pace of revenue growth until profit margins and cash reserves have improved
• Leasing rather than buying capital equipment
• Obtaining better payment terms from suppliers
• Enforcing better payment terms with customers (e.g. through prompt payment discounts)

Question 29

What is Greiner’s Model of Growth and what does it look like?

Answer 29

this suggests and attempts to predict that there are six phases and five crises that businesses may experience as they grow

Question 30

What are the phases of Greiner’s Model of Growth?

Answer 30

• Phase 1 - Creativity -> Leadership Crisis
• Phase 2 - Direction -> Autonomy Crisis
• Phase 3 - Delegation -> Control Crisis
• Phase 4 - Coordination ->Red Tape Crisis
• Phase 5 - Collaboration ->Growth Crisis

Question 31

Explain Phase 1 of Greiner’s model of growth, Creativity -> Leadership Crisis

Answer 31

When a business is starting up it is often very creative and everyone in the business can share ideas easily. Once the business gets to a certain size, there is a need for strong leadership to give the company direction and structure.

Question 32

Explain Phase 2 of Greiner’s model of growth, Direction -> Autonomy Crisis

Answer 32

Leaders set up a formal organisational structure with defined departments and roles.
As employees become more experienced they will want more say in decisions, and the business will be too big for senior managers to manage everything. So more autonomy through delegation is needed.

Question 33

Explain Phase 3 of Greiner’s model of growth, Delegation -> Control Crisis

Answer 33

More power and responsibility is delegated down to middle-managers and the organisational structure may become decentralised. Leaders may try to regain some control in order to have a more coordinated business that is optimising its use of the resources available.

Question 34

Explain Phase 4 of Greiner’s model of growth, Coordination -> Red tape Crisis

Answer 34

As control is regained by senior managers, certain decisions become more centralised and new procedures to coordinate different areas of the business are implemented. However, there can be too many procedures, which will decrease efficiency as people are constantly waiting for decisions to be made and approved.

Question 35

Explain Phase 5 of Greiner’s model of growth, Collaboration -> Growth Crisis

Answer 35

To continue growing, some formal procedures are replaced by collaboration between departments and teams. More focus is put on communication and information management. At this point the company might struggle to grow internally and may have to consider external growth.

Question 36

What are the evaluative points of Greiner’s growth model?

Answer 36

• Growth is a difficult thing to achieve
• Growth poses many management and leadership challenges (crises) that firms have to overcome
• Leadership and organisational structure have to evolve to reflect the growth of a business
• Businesses that don’t adjust as they grow will experience lower growth than those that do

Question 37

What are the disadvantages of Greiner’s growth model?

Answer 37

• Like most models, it is simplistic
• Not every business will suffer crises as it grows as many adapt easily without enduring any obvious panics or crises – this could be due to the type of business, the environment they operate in, and the style of leadership they adopt
• The model doesn’t really take account of the pace of growth, particularly in an increasingly dynamic external environment

Question 38

What are the constraints on growth?

Answer 38

• Resistance to change by employees and unions
• The cost of implementation
• Availability of finance
• The time period required
• The effect upon the brand image and marketing
• Types of organisational culture

Question 39

Growth means that a business will incur all sorts of fixed, variable, and sunk costs. How can this restrict a business from changing?

Answer 39

• Short term owners (shareholders) may not see the need for the change which undermines their profit and dividends
• Fixed costs in terms of an increase in salaries and management systems
• Variable costs in terms of an increase in payments to reward performance
• Sunk costs in terms of reorganising employees and training

Question 40

Growth of the business will always require finance. But how might it be difficult to source additional funds?

Answer 40

Banks may be unwilling to lend to a business that needs to change as the risk may be deemed too high
The returns from the growth are difficult to quantify and hence justify finance

Question 41

How can business growth affect how the good or service is perceived by the customer?

Answer 41

• Bad social media or press reviews may undermine the morale of the employees as the organisation changes
• Marketing campaigns may need to be adapted to signal a change in the organisation of the business and how it affects customers
• Attention must be paid to the quality of service and the goods to ensure that they meet the expectations of the customer
• The change may cause an aggressive response from competitors

Question 42

What are the possible implications for change when there is a change in organisational structures?

Answer 42

Question 43

What are the possible implications for change when there is new leadership or ownership?

Answer 43

Question 44

What are the possible implications for change when there are fewer people?

Answer 44

Question 45

What is backwards vertical integration and give an example?

Answer 45

• This involves acquiring a business operating earlier in the supply chain (e.g. a retailer buys a wholesaler)
• Example = IKEA buying forests in Romania and Bulgaria in order to reduce unit costs and have a sufficient supply of raw materials at the right price. This also eliminates suppliers as they have their own prices for the materials now

Question 46

What is conglomerate integration and give an example of it?

Answer 46

• This involves the combination of firms that are involved in unrelated business activities (e.g. investment funds that fund in entrepreneurs)
• Example = when Walt Disney and American Broadcasting Company merged and the combined company brought together the most profitable television network and its ESPN cable service with Disney’s Hollywood film and television studios, the Disney Channel, its theme parks and its well-known cartoon characters and the merchandise sales they generate

Question 47

What is forward vertical integration and give an example.

Answer 47

This involves acquiring a business further up in the supply chain (e.g. a vehicle manufacturer buys a car parts distributer)
Example = Bookers took over £40m worth of Budgens and Londis grocery stores. This would’ve caused positive synergy to occur because neither grocery stores had sufficient market share and bookers has a large market share in the wholesaled industry. Because of this, their profits/revenue would be much huger combined

Question 48

What is horizontal integration and give an example.

Answer 48

• Businesses in the same industry and which operate at the same stage of the production process are combined
• Example = Marriott bought Starwood to become to largest and most successful hotel chain in order to reduce competition and expand their hotels into other cities and areas. This would’ve caused positive synergy to occur because their net profit would be much more than what it was before

Question 49

Explain what mergers are.

Answer 49

• A merger can be seen as a decision made by two businesses that are broadly “equal” in terms of factors such as size, scale of operations, customers etc.
• The enlarged, merged business, through the changes made by combining both together, can cut costs, grow revenues and increase profits – which should benefit shareholders of both the original two businesses.
• What typically happens in a merger is that a new company is formed – and the shares in the new company are distributed to the shareholders of the two original businesses in a suitable split.

Question 50

What is a takeover?

Answer 50

This involves one business acquiring control of another business
Takeovers are the most common form of external growth, particularly by larger businesses.

Question 51

What are the reasons for undertaking takeovers?

Answer 51

• Increase market share
• Acquire new skills
• Access economies of scale
• Secure better distribution
• Acquire intangible assets (brands, patents, trade marks)
• Spread risks by diversifying
• Overcome barriers to entry to target markets
• Defend itself against a takeover threat
• Enter new segments of an existing market
• Eliminate competition

Question 52

Why are takeovers preferred over organic growth?

Answer 52

• Existing products are in the later stages of their life cycles, making it hard to grow organically
• The business (in particularly its management) lacks expertise or resources to develop organically
• Speed of growth is a high priority
• Competitors enjoy significant advantages that are hard to overcome other than acquiring them

Question 53

What are disadvantages of takeovers?

Answer 53

• Takeovers are the highest risk method of growth
• High cost involved – with the takeover price often proving too high
• Problems of valuation (see the price too high, above)
• Upset customers and suppliers, usually as a result of the disruption involved
• Problems of integration (change management), including resistance from employees
• Incompatibility of management styles, structures and culture
• Questionable motives

Question 54

Give reasons as to why takeovers fail.

Answer 54

• Price paid for takeover was too high (over-estimate of synergies)
• Lack of decisive change management in the early stages
• The takeover was mishandled
• Cultural incompatibility between the two businesses
• Poor communication, particularly with management, employees and other stakeholders of the acquired business
• Loss of key personnel and customers post acquisition
• Competitors take the opportunity to gain market share whilst the takeover target is being integrated