business behavior (paper 1) Flashcards
what are the reasons why some firms remain small?
1) existing firms with large market power. Due to their dominance, firms with monopoly power will have price setting power, which could be used to discourage new firms from entering the market or to grow. They may even have monopsony power which means they’re able to bargain for lower prices of raw materials, etc. For example: the NHS is the main buyer of drugs in the UK. Existing firms who are well established in the market already have great brand loyalty and a large customer base. it maybe hard trying to attract customers of your own if the largest firms are already so well known.
2) limited access to credit - smaller firms may be less likely to receive large enough loans from banks, as they are deemed riskier investment than a pre-existing firm looking to expand. Large firms are more likely to have to pay back a smaller amount of interest as they are viewed more stable.
3) no aspiration to grow. Some smaller businesses maybe content with their size and the lifestyle it provides, so they may not see the benefit in growing anymore if they’re already satisfied with their company’s size. For example: a family-owned bakery.
what are the reasons why a firm may grow?
Operating in a niche market. This is where there’s only a small amount of customers looking for your specific good, yet it’s extremely profitable as people are after your expertise and are willing to pay the higher prices.
Diversification. By expanding your product range, firms reduce their risk of making a loss, as they have other areas within the market to fall back on. For example, a company that produces wheels for cars may start to also produce windows too.
Prioritizing revenue maximization in the short run rather than profit. This is a simple way of increasing your customer base, as your typically low prices will entice customers to switch to you. This will increase your market share, and once a body of customers has been generated you can start to profit maximise.
what is the principal agent problem? (divorce of ownership from control)
including how such problem could be tackled
As firms grow, the owner will hire managers to run the business for them in different areas of the country, etc. There is a divorce between who owns the company and who runs it then. This creates the problem where owners and managers have conflicting interests. For example: shareholders wanting to maximise profits, yet managers wanting to maximise their salaries, or sales for that day so they can make a bonus.
This problem is exacerbated by information gaps – where the managers have a lot more information on the day to day running of the company in comparison to the owners. The managers can also control what information reaches the owners.
Evaluation: one-way owners aim to tackle this, is by giving their staff shares in the company, this will unite a shared want to profit maximise rather than any other objective. For example, the CEO may be partly paid in dividends rather than a salary, or the staff may all have their own small shares in the company - like John Lewis.
what is the difference between a public and private sector organisation?
public sector organizations – owned and controlled by the government. Their goal is not to maximize profit, instead it’s to provide a service - and thus maximise utility. For example, the NHS.
Private sector organizations – owned and controlled by private individuals. The goal of most private organizations is to maximise profit.
what is the distinction between a profit and not for profit organisation?
Both profit and not-for-profit organisations are found in the private sector, they are not owned by the government but rather private individuals in the market.
A “for profit” organisation is your average firm that wans to maximise profit in the market. For example: adidas.
However a not-for-profit organisation will still need to make some profit in order to survive in the market, yet its ultimate goal is not to profit maximise, but rather to provide a service for the public / utility maximise. For example, the British heart foundation. Many sell goods (like charity shops) and use the profit made to further advance in their objective/goal.
what is organic growth?
Organic growth – when a business expands its own operations without relying on a merger or takeover. Their growth is internal. It is achieved through re-investing your own profits to grow. This can occur through:
-Investment in capital or tech that increases their capacity
-Using marketing to attract a larger customer base
-Launching new products to attract new attention
-Borrowing money from the bank to open a new store
what are the advantages to organic growth?
1) It is less risky than a merger. The growth is financed by profit and the majority of mergers end up failing.
2)The pace of growth is manageable. You have the ability to plan ahead as the outcome is more predictable.
3) you maintain control - maintains existing management and culture, not need to compromise with another companies ethics.
what are the disadvantages to organic growth?
1) The growth id very slow, as it is mainly financed by profit made in previous years (or equally small loans made by the bank)
2) makes it harder to compete with other firms in the market who have grown through mergers - and have the benefit of greater expertise, human capital, economies of scale, etc.
3) Harder to benefit from internal economies of scale as your scope of production is likely to be smaller and reliant on other manufacturers, etc. for certain stages of production. this means the “middle man” company will also be making a profit - profit your company is now missing out on.
3) limited access to credit in the beginning stages - for the bank to loan to a smaller firm just starting up, this is a riskier loan than loaning to a pre-established firm with market presence, as it is less clear if such smaller firm will be able to pay it back as well. whereas companies who are already experiencing economies of scale and have more promising figures of turnover, etc, will be able to access more credit / funding.
what is vertical integration?
where a firm buys another firm in their supply chain. This can be either forwards or backwards.
-forwards: a car manufacturer buying a car dealership. They are moving forward to the end product.
-backwards: a clothes store buying a sweatshop. They are moving back down the supply chain.
what are the advantages to vertical integration?
1) reduces the cost of production as the middleman’s profits are eliminated. For example, the cost of shipping your product to the seller.
^you absorb the once profits - for example, the farm would’ve been making a profit on the milk they’ve sold to the ice cream place. You now absorb this profit yourself.
2)Better control over the quality of the product, if it’s backwards integration. For example: watering or feeding your plantations with more care than the previous company will lead to better crops.
3) can increase brand visibility, which makes it easier for businesses to distinguish themselves and gain loyal customers.
what are the disadvantages to vertical integration?
1) This can create barriers to entry for other new, potential firms wanting to enter the market. For example, if Nike owns a shoe factory they’ll charge more for other companies to use it.
2)Possibly little expertise in that specific field. For example, an ice cream company won’t know how to milk a cow. This may result in inefficiencies. Evaluation: it is more likely that the firm buying the new firm will keep on the majority of that firm’s workers, as they’re aware they will have more expertise than training new staff.
3) there may be a culture clash between the two companies. Existing employees will have existing ethos and expectations that the other company merging may not agree with. (like standards surrounding breaks, pay, etc.)
what is horizontal integration?
Horizontal integration – where a firm merges or takes over with another firm at the same stage in production. For example: Nike buying adidas.
what are the advantages to horizontal integration?
1) rapid increase of market share, reducing competition and possibly allowing negotiation power with companies below the supply chain.
2)Economies of scale will lead to a reduction in cost making the final product more profitable.
3) existing knowledge of the industry means the merger is more likely to be successful from two experts coming together.
what are the disadvantages to horizontal integration?
1) there can be a cultural clash between the two companies. For example, each firm will have their ethos and way of doing things. Disagreement may occur over standards of pay, holiday, breaks, pensions, etc.
2)Diseconomies of scale may occur. For example, being reluctant to make workers redundant during the initial merger, duplicating managers roles in the process to not upset anybody.
^managerial diseconomies of scale
^communicational diseconomies of scale
3) You’re still limited to one market. If market conditions change you have nothing else to fall back on as you’re fully committed. Equally, the CMA is likely to get involved.
what is Conglomerate integration?
a merger or takeover of a firm in an entirely different market. For example: John Lewis (retail) and Waitrose (supermarket).
what are the advantages to conglomerate integration?
1) reduces overall risk of business failure. If your company owns companies in multiple markets, you can fall back on your other companies if market conditions change in one specific industry. For example last year John Lewis made a loss of 4% yet Waitrose made a profit of 5% so overall the company made a profit of 1%.
2)If you’re already a big firm the CMA may block any horizontal growth, therefore conglomerate growth is another way to ensure you still grow without annoying the CMA.
what are the disadvantages to conglomerate integration?
1) possible lack of expertise in this new market
2)A culture clash
3) Diseconomies of scale - either firm maybe reluctant to lay off their own workers. This may lead to both communicational diseconomies of scale yet also managerial diseconomies of scale.
what are the constraints on business growth?
The size of a firm
A niche market will have limited opportunities for business expansion as it requires a certain taste for their products to sell. This is due to their limited customer base. However, larger firms will have a wider scope for innovation and a larger customer base in order to help grow.
Diseconomies of scale
As a firm gets larger, they may begin to experience diseconomies of scale rather than continue to grow at such a fast rate.
Access to finance
Smaller firms new to the market tend to have less access to finance than larger, well-established firms. This is because they’re viewed as riskier by the banks since the 2008 financial crisis. Without access to credit, firms cannot invest and grow as much.
Owners’ objectives
Some owners may have different objectives to others. Some may aim to maximized welfare, others may have an environmental impact in mind when making decisions, or some may simply want to maximize profits.
Regulations
Excessive regulation can limit the quantity of output that a firm produces. For example, environmental laws like pollution permits limit the amount of greenhouse gases a company can emit. Also, excessive corporation tax discourages firms from making huge profits as they don’t keep much of it.
what is a demerger?
when a firm sells off one part of the company or splits itself into two or more separate firms again.
what are the reasons for a demerger?
-cultural differences
-reducing diseconomies of scale
-complying with the demands of the CMA
what are the impacts of demergers on both the consumer and workers?
on workers – some may be made redundant. However, there may now be a better team dynamic if the reason the demerger happened was due to a culture difference. Thes people may see an opportunity for promotion as positions may start to open up.
On consumers – customers will have more variety now in the market as there has been an increase in competition. this may lead to lower prices in the long-run.
what is the business objective to profit maximise?
draw diagram
This is known as the rational business objective, and is the underlying assumption of neo-classical economics. profit maximisation occurs where marginal cost MC = MR marginal revenue on the diagram.
^if MR is bigger than MC, additional profits can still be made by producing another unit. yet if MC is bigger than MR, you are now making a marginal loss.
the profit made is supernormal profit.
what are the limitations to having profit maximisation as your business objective?
- in the real world it is very hard for a business to work out what their MC and what their MR is. This is especially hard because it is difficult to know the PED for a good, which effects the MR.
- in the short-term firms may not want to change their price as soon as MC changes, as this becomes confusing for consumers. Instead they may choose to absorb some of these higher marginal costs themselves, and thus sacrifice their profit maximising level of output.
what is the business objective to revenue maximise?
draw diagram
revenue maximisation occurs where MR = 0. At this output profit is still being made, but not the maximum level of profit.
Revenue maximisation can occur due to the principal agent problem. occurs when the agent makes decisions on behalf of the principle, which leads to them often placing their own agenda above the principle’s agenda. For example, the principal may want to maximize profit to pay off their dividends, however the agent may want to maximize revenue to reach their targets and get a bonus, etc. firms that look to revenue maximize are more likely to use price discrimination to extract extra revenue from consumers.