Business Growth

Question 1

However, if a firm expands too far, it might experience:

Answer 1

internal diseconomies of scale like alienation, bureaucracy and communication

Question 2

Other times, though, owners might prefer a quieter life. Rather than profit-maximising, these owners might want to:

Answer 2

Profit satisfice

Question 3

Reasons why some firms grow

Answer 3

• Increase sales and profit
• More market power, so firms can increase prices and increase profit
• Diversify and enjoy risk-bearing economies e.g. Apple launching new products, iPod, iPhone, iPad
• Exploit internal economies of scale to decrease LRAC and increase profit
• Owners objective might be to run a hugely successful company e.g. Steve Jobs wanting to change the world

Question 4

Reasons why some firms stay small

Answer 4

• However, firms might lack the finance to expand
• However, regulations might prevent firms from growing
• However, firm might be in a niche market or selling personalised goods
• However, firm might run into internal diseconomies of scale
• However, other owners might just want a quiet life running a small firm

Question 5

The principal doesn’t know what the agent is doing - and this is because of:

Answer 5

Asymmetric information

Question 6

So, in summary, as firms grow bigger, they might experience:

Answer 6

The divorce of principal and agent

Question 7

The divorce of ownership and control can lead to the principal-agent problem which is when:

Answer 7

The principal-agent problem is when the agent (e.g. the manager who runs and controls the business) pursues different objectives to the principal (e.g. the shareholders who own the business)

Question 8

The divorce of ownership and control

Answer 8

When the managers/directors of a firm are different from the owners of the firm.

Question 9

The principal-agent problem

Answer 9

The principal-agent problem is when the agent (e.g. the manager who controls the business) pursues different objectives to the principal (e.g. the shareholders who own the business).

E.g. managers (agent) look to sales maximise for sales bonuses while shareholders (principal) look to profit maximise.

Question 10

Private sector firms

Answer 10

Private sector firms are firms owned by private individuals.

Question 11

Public sector firms

Answer 11

Public sector firms are owned by the government.

Question 12

Not-for-profit firms

Answer 12

Not-for-profit firms are not looking to just make a profit, they also pursue other social and environmental objectives.

E.g. charities like Oxfam and Young Enterprise.

Question 13

So, in summary, organic growth is when:

Answer 13

Organic growth is when a firm grows by investing in itself to increase output.

Question 14

Inorganic growth, on the other hand, is when:

Answer 14

Inorganic growth is when a firm grows by acquiring, or merging with, another firm.

Question 15

Organic growth

Answer 15

Organic growth is when a firm grows by investing in itself to increase output.

E.g. reinvesting profits, selling shares, taking a bank loan.

Question 16

Inorganic growth

Answer 16

Inorganic growth is when a firm grows by merging with, or acquiring another firm.

E.g. when Google acquired Youtube.

Question 17

Vertical integration

Answer 17

Vertical integration is when firms at different stages of the same production process join together.

Question 18

Backwards vertical integration

Answer 18

Backwards vertical integration is when a firm integrates backwards, with a firm further away from the consumer.

E.g. Ford’s car factory integrating with the tyre manufacturer.

Question 19

Forward vertical integration

Answer 19

Forward vertical integration is when a firm integrates forwards, with a firm who is closer to the consumer.

E.g. Ford’s car factory integrating with a car showroom.

Question 20

Horizontal integration

Answer 20

Horizontal integration which is when firms at the same stage of the production process join together.

E.g. T-Mobile and Orange merging to form EE.

Question 21

Conglomerate integration

Answer 21

Conglomerate integration is when two firms in unrelated industries join together.

E.g. when Pepsi acquired Quaker Oats.

Question 22

Pros of organic growth

Answer 22

• Firstly, using a bank loan or reinvesting profit to grow organically, a firm’s owner will keep ownership and control over the company, and take most of the profit.
• Secondly, organic growth is low risk because the firm expands by increasing its own output.
• Inorganic growth is higher risk because a firm might move into a completely new market.

Question 23

Cons of organic growth

Answer 23

However, if the owner grows organically by selling lots of shares, they will lose ownership to the shareholders.

Or if the owner sets up lots of franchises, they will lose control to their franchise managers.

However, organic growth can also mean slower growth, compared to inorganic where mergers/acquisitions speed up growth.

Question 24

vertical integration

Answer 24

Vertical integration is when a firm integrates with another firm at a different stage of the same production process.

Question 25

Or if an electricity-producer acquires the power grid which delivers electricity to consumers - this is an example of what sort of inorganic growth:

Answer 25

forwards vertical integration

Question 26

Vertically integrating, a firm might get too big and experience diseconomies of scale, which will:

Answer 26

Increase its LRAC and reduce its profits

Question 27

the pros of vertical integration:

Answer 27

Firstly, vertical integration enables firms to control the supply chain. For instance, if a nuclear power plant acquired a uranium mine, it could refuse to sell uranium to other power plants, preventing them from competing. Or if an electricity-producer buys a power grid, it can now prevent competitor firms from entering the market, by refusing to let them use the power grid. So the power plant and electricity producer will take over their markets, increasing sales and profit. Secondly, vertical integration can cut out intermediary (or middleman) costs - like transport costs and markups. This will reduce a firm’s costs and increasing profits. Thirdly, vertical integration improves access to consumers and raw materials. Vertically integrated forward helps receive customer feedback directly, so a firm can improve its product, increase sales and increase profit. Vertically integrated backward means a firm can control quality, improving its final product’s quality, increasing sales and profit.

Question 28

the cons of vertical integration:

Answer 28

However, vertical integration could lead to regulation if it prevents competition. Firms may be banned from vertically integrating or forced to pay penalties as high as 10% of annual turnover. This will increase firms’ costs, reducing profit. However, costs may increase because of diseconomies of scale and acquisition costs - like when eBay bought PayPal for $1.5bn. However, vertical integration can backfire because of a lack of expertise. If a firm integrates into a stage of the production process it knows nothing about, it won’t know how to organise production, decreasing efficiency, increasing costs, decreasing profits

Question 29

Our internal economies of scale are:

Answer 29

Reductions in long run average cost, as a firm’s size increases

Question 30

Horizontal integration

Answer 30

Horizontal integration involves the combination of two business operating in the same industry and at the same stage of the supply chain.

Question 31

the pros of horizontal mergers?

Answer 31

Firstly, horizontal mergers can lead to economies of scale which reduce a firm’s LRAC, increasing their profit. Secondly, horizontal integration can lead to rationalisation, when firms reorganise to avoid duplicated costs (e.g. only one accounting team will now be needed, not two). Thirdly, horizontal integration reduces wasteful competition because the two firms are now working together.

Question 32

cons of horizontal mergers?

Answer 32

However, firms can also suffer from diseconomies of scale. Integrating with a new firm can lead to alienation; bureaucracy from the legal work involved in two firms integrating; and poor communication. These all increase a firm’s LRAC, decreasing their profit. However, rationalisation can lead to job losses because duplicated departments will be fired. However, horizontal integration can lead to brand dilution if the firms’ brands are very different.

Question 33

Conglomerate integration is when:

Answer 33

Conglomerate integration is when two firms in unrelated industries join together.

Question 34

Which internal economy of scale is most likely to result from conglomerate integration?

Answer 34

risk bearing.

Question 35

Internal diseconomies of scale include:

Answer 35

alienation, bureaucracy, communication

Question 36

These knowledge transfers helped Apple & Beats come up with the new W1 wireless headphones, Apple Music (Apple’s new music streaming site), and the Beats 1 radio station! All of which have increased:

Answer 36

dynamic efficiency

Question 37

pros of conglomerate integration?

Answer 37

Firstly, conglomerate integration can lead to risk-bearing economies. Integrating with an unrelated firm helps a firm diversify, reducing cost of failure in one sector...because the firm will still make profit in others. Secondly, conglomerate integration can increase brand awareness. Consumers of one firm will become aware of the other, increasing both firms’ sales. Thirdly, conglomerate integration can lead to knowledge transfers between firms which increase dynamic efficiency. Like the awesome tech Apple and Beats have innovated after conglomerately integrating.

Question 38

cons of conglomerate integration?

Answer 38

However, firms can also suffer from diseconomies of scale. Integrating with a new firm you don’t even know can lead to alienation; bureaucracy from the legal work involved in two firms integrating; and poor communication, especially because the two firms are completely unrelated will likely have very different attitudes. These internal diseconomies of scale all increase a firm’s LRAC, decreasing their profit. However, conglomerate integration can also lead to brand dilution, if one firm’s brand image negatively affects another. Like Pepsi diluting Quaker Oats’ healthy porridge image. However, conglomerate integration can fail if firms lack expertise. Like if Nando’s acquired with Ferrari, Nando’s wouldn’t know how to run Ferrari so the business would fail.

Question 39

Secondly, Sergio argued demerging into two smaller firms would help:

Answer 39

D both firms specialise and increase productivity

Question 40

4 reasons for a demerger

Answer 40

Firstly, demergers reduce the size of the firm. This reduces diseconomies of scale, decreasing costs and increasing firm profits. Secondly, by demerging, both firms can separate and specialise in their own goods/services, increasing productivity and quality, decreasing costs and increasing sales, and increasing firm profits. Thirdly, by demerging, a firm can sell of one of its divisions and its assets, to raise money. This will increase profits, which can they be reinvested in other areas of the business to increase dynamic efficiency. Fourthly, differences in culture within a firm can require a firm to demerge, to avoid conflicts between different departments. Reduced conflict will make workers happier, more productive and increase profit.

Question 41

How might a business benefit from a demerger:

Answer 41

Firstly, demergers reduce the size of the firm. This reduces diseconomies of scale, decreasing costs and increasing firm profits. Secondly, by demerging, both firms can separate and specialise in their own goods/services, increasing productivity and quality, decreasing costs and increasing sales, and increasing firm profits. Thirdly, by demerging, a firm can sell of one of its divisions and its assets, to raise money. This will increase profits, which can they be reinvested in other areas of the business to increase dynamic efficiency. Fourthly, differences in culture within a firm can require a firm to demerge, to avoid conflicts between different departments. Reduced conflict will make workers happier, more productive and increase profit.

Question 42

By demerging into two smaller firms, each new firm’s output will:

Answer 42

Each new firm’s output will be lower, and diseconomies of scale will decrease

Question 43

If a firm gets too small it will reduce economies of scale, so:

Answer 43

Its LRAC will increase

Question 44

Explain the effects of a demerger on workers. (4 marks)

Answer 44

Workers will benefit from reduced cultural conflicts between different divisions with different attitudes. This will reduce tension, increase productivity and job satisfaction, benefitting workers. However, workers will suffer from lower job security. They won’t know which new division they’ll join after the demerger and if one of the division is sold to raise funds, workers may lose their jobs entirely.

Question 45

Explain the effects of a demerger on consumers. (4 marks)

Answer 45

Firstly, after demerging, each new smaller firm can specialise in their job, increasing efficiency, reducing costs and prices, but also increasing quality. This will benefit consumers. However, if the demerged are too small, it might reduce economies of scale, increasing LRAC, so firms will have to put their prices up.

Question 46

Reasons for demergers

Answer 46

1. Demergers reduce diseconomies of scale. 2. Demergers enable each new separate firm to specialise. 3. A firm can sell one of its demerged divisions and its assets to raise funds. 4. Demergers reduce conflicts between different cultures within a firm.