Business Growth Flashcards
What, essentially, is a firm
A production unit.
What does a firm do
Transforms resources into goods and services.
What is industry
Industry is the term used to describe a collection of firms operating in the same production process.
What to firms aim to do and why
Firms aim to make profit and if they do not, they go out of business (unless they are state supported or have some other form of finance.) If firms aim to make profit and can make more profit by growing, them firms will tend to grow.
Firms grow for a variety of reasons. List me reasons why firms tend to grow
Increase market share
Benefit from greater profits
Increase sales
Increase economies of scale
Gain power
Satisfy managerial ambitions
Make the most of an opportunity
Gain expertise
Tell me about the reason why firms may decide to grow: increase market share
Increase market share and hopefully become the dominant firm in a particular industry. Thus may allow them to increase their profits or ensure that they are in a stronger position to dominate the market, or set prices to their benefit.
Tell me about the reason why firms may decide to grow: benefit from greater profits
A firm aims to maximise profits and may be able to achieve this through expansion, by increasing sales, setting price or benefitting from lower costs of production.
Tell me about the reason why firms may decide to grow: increase sales
Increase sales, through larger brand recognition and more sales outlets. These could be in the same country or even allow a firm to gain a presence abroad very quickly, with an already established brand name.
Tell me about the reason why firms may decide to grow: increase economies of scale
The firm is able to exploit its increased size and to lower long run average cost (LRAC). Furthermore, by driving down LRAC and approaching the minimum point on the LRAC curve, the firm is moving closer to productive efficiency.
Tell me about the reason why firms may decide to grow: gain power
Gain power so as to prevent potential takeovers by larger predator businesses, also allowing them to survive any major downturn in economic performance. For example, during the recession of 2009, a number of firms merged to ensure their long term survival despite falling sales.
Tell me about the reason why firms may decide to grow: satisfy managerial ambitions
Some managers will seek to grow their business so that they can satisfy their desire to run a successful business, see share prices rise if they receive shares as part of their remuneration(pay), or leave a legacy of growth and acquisition after they have left.
Tell me about the reason why firms may decide to grow: make the most of an opportunity
Some firms will have revenues that they do no want to class as ‘profit’ (subject to corporation tax) and so will use them to acquire another business.
Tell me about the reason why firms may decide to grow: gain expertise
Some firms may wish to develop a new part of their business and rather than trying to establish themselves slowly, feel they can buy an existing market leader and with it its experience in the market.
Are there reasons why some firms tend to remain small
Yes, due to constraints on business growth - explorer later.
The divorce of ownership is also known as…
The principal-agent problem
Tell me about the significance of the divorce of ownership from control: the principle-agent problem
In cases where there are a large number of shareholders, the day to day management of the business is delegated to a board of directors and from them to their managers. In such cases there can be problems associated with divorce of ownership, known as the principal agent problem.
The principal is the shareholder or owner of a business, while the person in charge of the day to day running of the business is referred to as the agent. In such cases the agent can make decisions on behalf of the business that do no necessarily match the direction in which the owners would lime to take the business. This can be a problem if the principal is not fully aware of the actions of the agent, as is often the case with large corporations, or they lack sufficient information, as a result of asymmetric information.
In such instances the manager (or agent) can behave in a way that conflicts with the objectives of the owners. This may result in the agent being dismissed when this comes to light. High profile dismissals include Anthony Jenkins of Barclays Bank in July 2015, who was said go have lost his job because, among other things, he was not able or willing to cut costs and therefore not able to increase profits fast enough.
What are the three types of firm
Private sector
Public sector
Not for profit
What are private sector firms like
Private sector firms are those that are not owned by the government. They may be owned by shareholders, as with a PLC (public limited company) such as Marks and Spencer, which is trading on a stock market and allows anyone to buy shares in it. Or they may be family owned, where the shares are not traded on the stock market, an example of which is LEGO, owned by the Christiansen family from Denmark.
Private sector firms also include sole proprietors, which are owned and run by one person, such as a newsagent. Accountancy and legal firms form partnerships, which are owned by the partners.
Private sector firms will aim to make a profit to satisfy the demands of their owners.
What do private sector firms aim to do
Make a profit and satisfy the demands of their owners.
Tell me about public sector firms
The government may own certain businesses, either because they could not survive without significant state funding or because the government wishes to determine the direction the business takes. Examples of such businesses in the United Kingdom include the National health service, which relies on taxpayer funding, and Network rail, which operates the UKs railway tracks but is owned by the government and run on the basis that it will not make a profit for shareholders but instead will reinvest any surplus funds.
Tell me about not for profit firms
The not for profit sector consists of charities, sometimes known as the third sector or civil society, which exist to provide services to local, national and international communities, and do not see profit as the primary goal. These include well known charities such as Oxfam and less well known organisations which act as local pressure groups or help in their local communities.
Tell me the two types of business growth
Organic growth
Inorganic growth - integration of firms
What is organic growth
Firms can grow by expanding the scale of their operations and gaining market share. This is known as internal or organic growth and is achieved by investment within the firm by the firm. It is paid for either by ploughing back profits within the firm or by borrowing (loans or issuing more shares)
What is internal growth
Internal growth is when a firm grows by investing in its current operation or by extending its range of operations. (Also known as organic growth)
What’s external growth
External growth (or inorganic growth) is when a firm grows by joining with other firms, usually through a merger or takeover.
What are the advantages of organic growth
Organic growth tends to be the lowest risk form of growth and the control of the firm remains unchanged. It means firms can build on existing strengths and continue to meet consumer expectations. Organic growth can also be good for the workers morale and means there will be more job opportunities within the firm, with increased scope for management roles.
What are the disadvantages of organic growth
Disadvantages are that organic growth tends to be slow and building on the existing knowledge of existing workers means that people might be unaware of new ideas or innovations or unwilling to take on new ideas if they involve change.
What are the different types of inorganic growth
Firms can also grow though takeovers (inorganic growth), of which there are a number of different types:
Horizontal integration
Vertical integration
Conglomerate integration
Define horizontal integration
Merger of two firms at the same stage of production
What is horizontal integration
This is a merger between two firms at the same state of production, for example the banks TSB and Banco Sabadell in June 2015 or the proposed merger of mobile phone operators O2 and 3 in March 2015. This kind of integration is often chosen to achieve economies of scale or to increase market share.
What is vertical integration
This is a merger between firms at different stages of the productive process within an industry. The reason for this kind of integration is to increase barriers to entry, to increase control over suppliers or markets, or to ensure a smooth production process.
Can be classified as a forward vertical integration or a backward vertical integration
Define barriers to entry
Obstacles to companies entering a market/industry. These can be legal barriers imposed by government in the form of permits or patents required before a firm may participate in an industry, or they may be created by the firm in The form of advertising, brand loyalty or technical expertise.
What’s a forward vertical integration
At the next stage of the production process, eg. American apparel, which designs, manufactures and sells its products, buying design, manufacture and retail components.
Define forward
Merger with a firm at the next stage of production
What’s a backward vertical integration
At the previous stage of the protection process, eg RIL, an Indian petrol producer, buying an oil extraction firm.
Define backward
Merger with a firm at the previous stage of production.
What is conglomerate integration
Form of inorganic growth. This is a merger between firms in entirely unrelated industries. The aim is often to achieve a greater spread of risk, widening the range of output to reduce exposure to any one market. It allows firms to use funds to cross subsidise investment in new areas, taking the chance to innovate without losing their revenue drivers. A pioneer of conglomerate integration in the UK has been Richard Branson at Virgin, renowned for diverse investment and entrepreneurship.
Define conglomerate merger
Merger between firms in unrelated industries
List me the constraints on business growth
Regulation
Marketing barriers
Pricing barriers
Technical barriers
Size of the market
Lack of resources and access to finance
Minimum efficient scale
Owner objectives
Avoiding attention from potential buyers
Tax thresholds and other benefits of remaining small
What are barriers to entry into or exit from an industry
Obstacles that ensure the continued monopoly power of firms in a market
Tell me about the constraint on business growth: regulation
The government itself may prevent the entry or growth of a firm. Acts of Parliament can allow monopolies to be formed and protected, such as the provision of the national lottery. The former nationalised utilities, such as water, rail and electricity, were monopolies formed and protected by acts of Parliament.
Patents will also give firms legal protection to ensure that ideas or processes are protected from competition for the life of the patent. This is important in pharmaceuticals and high-tech industries where considerable money is invested in research and development, which will only be rewarded over time. Other industries require licenses or specific qualifications before a firm or individual can operate. For example, law and accountancy firms have to be approved by their respective trade bodies, and radio stations have to obtain a license before they can broadcast.
What’s a contestable market
A contestable market is one that has low or no barriers to entry or exit. Markets that are not contestable will have high sunk costs such as advertising, the cost of which a firm may not recover once it has been spent.
Tell me about the constraint on business growth: marketing barriers
Marketing barriers are those imposed by business currently operating in an industry. This could be through branding or a new advertising campaign to re establish brand recognition. The investment in marketing cannot be recouped if the campaign fails - this is known as sunk costs. For example, Coca Cola spent millions in trying to bring its purified tap water Dasani to the U.K. market, but the product failed to take off after negative publicity. Most companies do not have the capacity to take such a risk.
Tell me about the constraint on business growth: pricing barriers
Firms already in the market may try to prevent new firms entering in two very distinct ways - explorer later xx
Tell me about the constraint on business growth: technical barriers
Often, a few large firms dominate an industry thanks to their size. They use existing technical expertise and economies of scale to ensure that they operate at the lowest possible average cost, and new firms entering the industry will find it impossible to compete because their average cost will be so much higher at a smaller scale. To be able to compete, the new firm would have to operate on a similar scale to the existing firm, which might result in supply increasing quite significantly and therefore a lowering of price, eroding any potential profits to be made.
Define horizontal merger
Firms joining at the same stage of the production process
Tell me a recent example of a horizontal merger
In June 2015 TSB bank merged with Sabadell bank of Spain
Tell me advantage of a horizontal merger to firms
Increased market share; economies of scale; reduced competition
Tell me a disadvantage of a horizontal merger to firms
Risks - too many eggs in one basket, unknown costs, weakening or dilution of brand
Tell me the pros and cons of a horizontal merger to employees or other stakeholders
Some opportunities for promotion; increased prestige of firm
Loss of jobs for those duplicating work or unable to move to new headquarters
Define a horizontal demerger
Firms splitting at the same point of the production process
Tell me a recent example of a horizontal demerger
BHP Billiton, a mining company, sold off south 32 in May 2015 to allow it to concentrate on core products such as iron ore, coal and copper, with south 32 specialising in aluminium, silver and nickel.
What are the pros and cons of a horizontal demerger to the firm
Reduced exposure to what might be a risky market, removal of diseconomies of scale.
Might be seen as a sign of weakness, share price might fall.
Tell me the pros and cons of a horizontal demerger to employees or other stakeholders
Less risk in the company might mean increased job security
Some loss of jobs as parts of the business are pared down
Define backward vertical merger
A firm merger with a firm closed to the suppliers in a production process
Tell me a recent example of a backward vertical merger
Petronas, a state owned petroleum company in Malaysia, bought star energy plc, supplier of gas storage equipment, in 2008 so petronas could store and sell more gas in the EU.
Tell me the pros and cons of a backward vertical merger to firms
Assured supplies in timing and quality, reduced costs of supply
Lack of expertise, over exposure to end product in one market.
Tell me the pros and cons of a backward vertical merger to employees and other stakeholders
Widening expertise and opportunities from promotion, increased market presence and profitability might increase share price in the long run.
Initial costs may damage profitability and therefore share price in the short run
Define forward vertical merger
A firm merges with a firm closer to the market or consumers in a production process
What’s a recent example of a forward vertical merger
Titanic brewery bought five pubs in Staffordshire, June 2010
Tell me the pros and cons of a forward vertical merger to firms
Greater access to customers, removal of competing suppliers; better information about the final consumer, prevent the hold up problem when suppliers refuse to supply in order to achieve their own goals.
Lack of expertise, over exposure to end product in one market
Tell me the pros and cons of a forward vertical merger to employees or stakeholders
Widening expertise and opportunities for promotion; increased market presence and profitability might increase share price in the long run
Initial costs may damage profitability and therefore share price in the short run
Define vertical demerger
Firms at different stages of the production process are broken up
Tell me an example of a vertical demerger
In July 2015, eBay, an online auction site, demerged paypal, a payment system, listing its shares separately.
Tell me the pros and cons of a vertical demerger to firms
Avoids negative attention from competition authorities, decreases ; exposure to risk in market as a whole
Cost savings are lost, loss of investment in goodwill, branding and human capital.
Tell me the pros and cons of a vertical demerger to employees or stakeholders
Can focus on core product - scope for specialisation and increased returns to investors
Narrows expertise and opportunities for promotion
Define diversification/conglomeration
When firms that are involved in unrelated business areas merge
Tell me a recent example of a conglomeration
Microsoft, a software company, merged with Nokia, a mobile phone manufacturer, In April 2014.
Tell me the pros and cons of conglomeration to firms
Spreads the risk, widens brand awareness
Dilution of brand, especially if new lines are failing companies
Tell me the pros and cons of a conglomeration to employees or stakeholders
Increased job security and opportunities to become occupationally mobile
Firm might become unwieldy (too large to function efficiently)
Tell me about the constraint on business growth: size of the market
If a firm serves a niche market that will not support expansion, there is little scope for growth. For instance, manufacturers of cricket bats or a local grocery store might have expanded as far as their market will allow. In these cases, it may be the case that the firm has a local monopoly and any further expansion will put this at risk. Some small firms may survive on the basis that they are able to provide a personal service that customers prefer and would lose some of their loyal customers if they were to expand.
Tell me about the constraint on business growth: lack of resources and access to finance
The owner of the firm may lack the knowledge, expertise or funds needed for expansion. As the firm expands and employs more people, it may encounter a greater level of bureaucracy, such as needed to complete national insurance returns or having to comply with greater levels of financial regulation, which will either add to its costs or be beyond the managers level of expertise.
Tell me about the constraint on business growth: minimum efficient scale
In some cases a firm might have already exploited economies of scale and be operating at the most productively efficient point: that Is, the optimum efficiency might have been achieved. Any further increase would result in inefficiencies and in an increase in average cost: in other words, the firm would experience diseconomies of scale. Take the case of a family run restaurant. Any expansion, such as opening another restaurant, may require the hiring of a manager and the training of a chef. The loss of personal managerial control may result in increased costs and eventually losses.
Tell me about the constraint on business growth: owner objectives
Expansion may result in increased rewards but perhaps the opportunity cost in terms of lost leisure will be too much for a sole trader and therefore they remain small: in other words, they lack the motivation to expand. This is an example of satisficing, where a firm makes just enough profit to stay in business and then allows other motives to take precedence. Some managers may not be willing to undertake the risks that are necessary to expand a business, instead seeking to avoid such expansion. Behavioural economists might try to explain such risk averse behaviour, but it could come down to something as simple as wishing to avoid taking risks with the family finances, mortgage or savings.
What is satisficing behaviour
When a firm aims to make a minimum acceptable level of profit and then pursues other aims
Tell me about the constraint on business growth: avoiding attention from potential buyers
The growth of the firm and its increased profits may result in unwanted overtures from larger firms wishing to buy out the sole trader. It is therefore an advantage to remain small and avoid attention.
Tell me about the constraint on business growth: tax thresholds and other benefits of remaining small
Small firms are able to access additional training grants and government financial support. For example, firms with profits of less than £10,000 are not liable for corporation tax and firms with turnover of less than £81,000 are not liable for VAT in the UK. Since 2009, the government has supported small firms with a turnover of up to £41 million through the Enterprise Finance Guarantee, which allows smaller firms to access bank loans of between £1000 and £1.2 million, and the government guarantees 75% of the risk of firms being unable to pay back the loan.
What are the reasons for demergers
Some firms may grow too large and experience diseconomies of scale. As a result of the growth of output, the business and managers may lose focus and control over day to day management of the firm and therefore long run average costs may tend to increase. To avoid this, or to reduce the impact of diseconomies of scale, a firm may decide to break up - in other words, to demerge. This may then create a number of smaller firms, all able to concentrate on their specialist areas and maximise their own economies of scale and, with that, increase shareholder value and profits. As a result, parts of the business may also be shut, resulting in a loss of jobs.
Define demerger
The separation of a larger firm into two or more smaller organisations often as the un-merging of an earlier merger.
Why are demergers sometimes required by the government
Sometimes demergers are required by governments, eg on the direction of the Competition and Markets Authority (CMA), because the business is seen to be acting against the public interest.
An example in 2014 was when Lloyds TSB was ordered by the European Commission to sell off its TSB part of the business because it was receiving state aid in the wake of its takeover of HBOS in 2009.
What are the impacts of a demerger on businesses
The impact on the business is to make it smaller, which might mean it has less control in the market (reduction of market share) and less monopoly power. This might make the business less profitable, but it might also make it more profitable if it becomes more efficient (it is likely to sell off its least profitable or its loss making parts)
What are the impacts of demergers on workers
Workers are often the main losers when it comes to demergers. Some might be forced to move location: for example, if they are working in the headquarters of a part of a firm that experiences a change in ownership. They might even lose their job if the new owners find they have workers in similar roles already.
What are the impacts of demergers on consumers
Consumers tend to face short term problems: for example, their bank might change its name and the way it works, or branches might close. But the intended long term effect, if it has been instigated by the government, is to create more competition in the market and therefore lower prices and more choice for the consumer.
How may firms grow
Either by joining with another firm in a vertical, horizontal or conglomerate merger, or by internal growth such as through investment in the business itself.
Tell me why some firms remain small
Perhaps there are barriers to entry to a variety of industries, a lack of economies of scale, or competitive advantages in staying small (possibly the firm reacts more quickly to change), or they have a better relationship with customers than larger firms do.
Tell me how a demerger occurs/is decided on
Some firms may decide to become smaller through the process of a demerger, and some of the issues that arise as a demerger occurs: including the impact on various stakeholders - the advantages of a small but focused firm are set against those of a firm enjoying economies of scale and market power.
