Business Growth Flashcards
1
Q
Why do large firms exist?(2)
A
- Economies of Scale in the industry may be significant. Only a small number of firms, producing at the minimum efficient scale of production, may be needed to satisfy total demand. The industry may be a natural monopoly where not even one firm can fully exploit potential economies of scale.
- Barriers to entry may exist which protect large firms from potential competitors.
2
Q
Why do small firms survive?(4)
A
- Economies of scale may be very small relative to the market size. A large number of firms in an industry may be able to operate at the minimum efficient scale of production. Small firms may also be able to take advantage of the higher costs of larger firms in the industry caused by diseconomies of scale. Changing technology such as the Internet can allow small firms the same cost advantage as large firms in reaching out to customers especially in small niche markets.
- The costs of production for a large scale producer may be higher than for a small company. This could be due to x-inefficiency, poor organisation in niche markets , labour market regulations (small firms can pay lower wages in informal labour market), owners of small companies prefer working for themselves despite small returns.
- Barriers to entry may be low. The cost of setting up in an industry, such as the grocery industry or the newsagents market, may be small. Products may be simple to produce or sell. Finance to set up in the industry may be readily available. The product sold may be relatively homogeneous. It may be easy for a small firm to produce a new product and establish itself in the market.
- Small firms can be monopolists, if they offer a local, flexible and personal service or if they operate in a niche market.
3
Q
What is organic growth?
A
Organic or internal growth - organic growth simply refers to firms increasing their output, for instance through increased investment or an increased labour force.
4
Q
What is external growth and what are the different types of it?
A
External growth through merger, amalgamation or takeover - a merger or amalgamation is the joining together of two or more firms under common ownership. The boards of directors of the two companies, with the agreement of shareholders, agree to merge their two companies together.
A takeover implies that one company wishes to buy another company.
- The takeover may be “amicable”. Company X makes a bid for company Y. The board of directors considers the bid and finds that the price offered is a good price for the shareholders of the company. It then recommends the shareholders to accept the offer terms. However, the takeover may be contested.
- In a “hostile takeover” the board of directors of company Y recommends to its shareholders to reject the terms of the bid. A takeover battle is then likely to ensue. Company X needs to get promises to sell at the offer price of just over 50 per cent of the shares to win and take control.
5
Q
What are the different types of mergers?(3)
A
- Horizontal integration or a horizontal merger is a merger between two firms in the same industry at the same stage of production, for instance, the merger of two building societies or two car manufacturers or two bakeries.
- Vertical integration or a vertical merger is a merger between two firms at different production stages in the same industry.
- Forward production integration involves a supplier merging with one of its buyers, such as a car manufacturer buying a car dealership, or a newspaper buying newsagents.
- Backward vertical integration involves a purchaser buying one of its suppliers, such as a drinks manufacturer buying a bottling manufacturer, or a car manufacturer buying a tyre company. - Conglomerate integration or a conglomerate merger is the merging of two firms with no common interest. A tobacco company buying an insurance company, or a food company buying a clothing chain would be conglomerate mergers
6
Q
What are the general benefits of growth?(4)
A
It is suggested that profit maximising companies are motivated to grow in size for a number of reasons:
- A larger company may be able to exploit economies of scale more fully. The merger of two medium-sized car manufacturers, for instance, is likely to result in potential economies in all fields, from production to marketing to finance. Vertical and conglomerate mergers are less likely to yield scale economies because there are unlikely to be any technical economies. There may be some marketing economies and more likely there may be some financial economies.
- A larger company may be more able to control its markets. It may therefore reduce competition in the market place in order to be better able to exploit the market.
- A larger company may be able to reduce risk. Many conglomerate companies have grown for this reason. Some markets are fragile. They are subject to large changes in demand when economies go into boom or recession. A steel manufacturer, for instance, will do exceptionally well in a boom, but will be hard hit in a recession, so it might decide to diversify by buying a company with a product which does not have a cyclical demand pattern, like a supermarket chain. Other industries face very uncertain future. It became fashionable in the 1970s and early 1980s for tobacco companies to buy anything which seemed to have a secure future, from grocery stores to insurance companies.
- Where there is a divorce of ownership from control, a larger company may justify higher salaries and bonuses to directors and managers. Since it is directors and managers who run the firm, they can take decisions about the size that will benefit them, but not necessarily bring any benefit to shareholders.
7
Q
What are the advantages(3) and disadvantages(2) of organic growth?
A
Advantages:
- Typical in smaller firms - the norm
- Cheaper and easier than mergers
- Less risk than mergers as most fail and reduce long term share price of the companies
Disadvantages:
- A merger may be better to expand geographically, with no previous experience of the country’s market
- May be too slow for managers who wish to maximise their salaries and bonuses
8
Q
What are the advantages(3) and disadvantages(4) of vertical integration?
A
Advantages:
- Cost savings. Integrating a supplier or a buyer into the firm may make the firm more efficient.
- May reduce risk. For example, a supplier might have a technology that it could offer to rival firms and give them a competitive advantage. A supplier might unexpectedly refuse to sell its product to the firm. A buyer could decide to buy from another firm.
- Forward vertical integration could give a firm more control over its market. For example, if a firm owned another firm that bought its products, it could decide at what price to sell the product and in what markets. It could better control branding of the product.
Disadvantages:
- A firm making a vertical acquisition may have little expertise in that particular industry. The more distinct parts to a business, the less likely it is that senior management will be able to get the best out of every part of the business.
- Firms often pay too much for the firm they take over and the share price of the firm falls rather than rises.
- There can be difficulties in merging the two firms together into one firm. Either the costs of creating a single firm from two separate firms are too great or the two firms fail to integrate, but costs rise because extra layers of management are needed to control the new, larger firm.
- Many of the key workers in the firm that has been taken over may leave, taking with them much of the expertise that made it successful.
9
Q
What are the advantages(4) and the disadvantages(3) of horizontal integration?
A
Advantages:
- It may allow reductions in average costs due to economies of scale.
- It can reduce competition in the market by taking out a competitor.
- It can allow one firm to buy unique assets owned by another company like a new drug or operations in another part of the world.
- It allows a business to grow in a market where it already has knowledge and expertise. This is likely to make the merger more successful.
Disadvantages:
- Historically most are not successful
- Firms often pay too much for the firm they are buying
- Integration of the two firms is often poorly managed and many of the key work sets may leave following the acquisition
10
Q
What are the advantages(3) and disadvantages(4) of conglomerate integration?
A
Advantages:
- One advantage is to reduce risk. Buying another firm operating in a completely different market means that a firm is not so dependent on the ups and downs of one market.
- A conglomerate may find it easier to expand compared to a situation where the companies or operations were independent. Size gives a conglomerate more options to obtain finance to expand the business. Successful senior managers can be transferred from company to company depending on their need.
- It could be an opportunity for asset stripping. This is when a company is bought and then all of its assets are sold.
Disadvantages:
- Firms do not have expertise in the market into which they buy
- Asset stripping only benefits the buyer, the workers, customers, local economies lose out
- Firms often overpay
- Integration may be poorly managed and key workers may leave
11
Q
What are the constraints on business growth?(4)
A
- Size of the market. A firm operating in a small market may not have many opportunities for expansion, as the demand is not high enough
- Access to finance:
- Retained profits - a lot of profit is needed
- Loans/Overdrafts - depends on banks being willing to give them a loan
- Equity funding - selling shares, mostly big firms - Owner objectives. Not every owner wants to grow a firm. Owners can have many objectives. They may be content with the profit they are currently making and not wish to have the extra work or the extra risk that comes from growing the business.
- Regulation. Government can be an important factor in growth of large firms. Merger which create a company with a market share of 25 percent or more must be reported to the CMA in the U.K. It can investigate the merger and has the power to forbid the merger.
12
Q
What is a demerger?
A
A demerger occurs when a firm splits itself into two or more separate parts to create two or more firms. These firms may be of toughly equal size. Sometimes, though, the term is used to describe the sale of a small part of a business to another business.
13
Q
What are the reasons for demergers?(3)
A
- Lack of “synergies”. This means that one part of the firm is having no impact on the more efficient and profitable running of the other part of the firm. Where there are no synergies, there could even be diseconomies of scale because senior management are having to divide their time between two or more businesses which have little to do with each other.
- Price. The price of the demerged firms might be higher than the price of the single larger firm. Investors in companies base valuations on a variety of different factors but one of them is the growth prospects of a firm. If a firm has a part which is growing fast, it will be worth more than another part of equal size which is growing more slowly. The relatively poor performance of one part of a company can drag down the share price of the whole company despite the fact that other parts are performing well. Financial markets talk about ‘creating value’ by splitting up companies like this.
- Focussed companies. In the 1970s, it was fashionable to create conglomerates to diversify risk. In recent years, it has become fashionable to create firms which are highly focussed on one or just a few key markets. The argument is that management can deliver higher profits and growth by concentrating their energies on getting to know and exploiting limited range of markets. Evidence also suggests that being the market leader in terms of sales tends to be relatively more profitable than being, say, number three or four in the market so companies therefore divest themselves of i.e. sell off) parts which don’t fit in with their core activities. Sometimes, a firm will sell off a part cheaply which goes on to be very successful. It could be argued that the firm’s management sold the part too cheaply. Equally, it can be argued that it shows that a company has only limited management resources. The part sold off would never have been successful within that particular firm because management did not have the time or expertise to make it flourish.
14
Q
What is the impact of demergers on:
a) Businesses(3, 2)
b) Workers (1, 1)
c) Consumers(2, 1)
A
a) Businesses:
Advantages:
- Increased specialisation may lead to greater efficiency
- If firms are able to cut costs or develop new and innovative products then their profits should rise
- Greater efficiency will also allow firms to survive greater competition
Disadvantages:
- If the deserter leads to inefficiency
- If the emerged firms are run less well than one single firm, then profits are likely to fall
b) Workers
Advantages:
- Senior managers may gain promotion. If one firm only needs one senior financial director, each firm will need their own senior financial director
Disadvantages:
- If each firm becomes more efficiently run then some job losses are likely
c) Consumers
Advantages:
- If the firms become more efficient cut costs and lower prices
- If the firms invest more and develop innovative products
Disadvantages:
- If the demerged firms become more focused on increasing profit in their business through rising prices or reducing their product ranges
15
Q
What is the public sector?
A
Public sector: businesses which are owned/controlled by the state. There are different types of public sector businesses: government departments (health, education, security…) and more ‘commercially orientated’ businesses, like railways, BBC, utilities (in some countries)
