Chapter 3 - Size of Business Flashcards
Explain 2 problems when attempting to measure business size
- Several different ways of measuring size. Often give different comparative results, might appear large by one measure, and small by another.
- No internationally agreed upon definitions of small, medium, or large business.
Describe the different measures of business size (5)
(include limitation)
- Number of Employees. Simplest measure. Easy to understand. Business employing many employees is likely large, however some businesses only need to employ a few people even though they have invested a lot of capital and achieve high sales.
- Revenue. Especially comparing in the same industry. Less effective comparing different industries as some might be engaged in high value production whilst others might be in low-value production.
- Capital Employed. The larger the enterprise the greater the value of capital needed for long term investment or the greater the amount of capital employed.
- Market capitalisation. Only for businesses that have shares quoted on stock exchange. Share prices tend to change so form of comparison is not stable.
- Market Share. If high market share, must be along leaders in industry, comparatively large. If size of total market is small, high market share will not indicate large firm.
State the formula for “Market capitalisation”
Current share price x total number of shares issued
Explain “market share”
The sales of the business as a proportion of total market sales.
Formula:
(Total sales of the business / Total sales of the industry) X 100
Explain the importance and economic benefits of small businesses (6)
- They create employment. They employ a high proportion of the working population.
- Often run by dynamic entrepreneurs with new ideas for consumer goods/services. Helps create variety and consumer choice in a market
- They create competition for larger businesses. Without competition, large firms would exploit customers with high prices and poor service.
- They can be important suppliers for larger businesses. Supply specialist goods and services to important industries.
- All great businesses were small at one time. If more small firms are encouraged to become established and expand, economy will benefit from large scale organisations in the future.
- They have lower average costs. Wages rates may be less than salaries paid in large organisations. Tend to have lower administration/management costs. Cost benefits passed on to consumer.
Explain the advantages of small businesses (6)
- Managed and controlled by owner. Little risk of losing control.
- Often able to adapt quickly, meet changing customer’s needs.
- Offer personal service to customers to help build customer loyalty.
- Easy to know each worker.
- If family owned, business culture informal, employees well motivated, family members perform multiple roles.
- Can usually be started up and operated with low capital investment.
Explain the disadvantages of a small business (5)
- Limited access to sources of finance.
- Owner has to carry large burden of responsibility, unable to employ specialist managers
- If owner / important worker is absent / ill, other employees may not have the necessary skills to operate the business.
- May not be diversified. Greater risk of external change having a negative impact.
- Few opportunities for economies of scale. Average costs could be high.
Explain the strengths of a family business (3)
- Commitment.
Often show dedication, seeing future business grow, prosper, passed onto next generations. Incentive to work harder and re-invest part of profits into business to allow it to grow long-term. - Reliability and pride.
Family name and reputation associated with products, family businesses strive to increase quality of output and maintain good relationship with stakeholders. - Knowledge continuity.
Families make it a priority to pass accumulated experience, knowledge, and skills to next generation. Increases level of commitment and could provide family members with necessary tools to run business.
Explain the weaknesses of family businesses (4)
- Succession / continuity problem.
Many family businesses fail to be sustainable long term. High rate of failure often explained by lack of skills and ability of later generations or splitting of management responsibilities between several family members, so each has role. - Informality.
Run themselves, little interest in setting clear and formal business practices and procedures. As grow larger, can lead to inefficiencies and internal conflicts. - Tradition.
Reluctance to change systems and procedures, family members preferring to continue to run business as it was run historically. Lack of innovation. - Conflict. Problems in family may reflect on management of the business and make effective decisions less likely.
Explain reasons why a business would wish to remain small (3)
- Remaining in control
- Avoiding taking too many risks
- Preventing workloads from becoming too heavy
Explain reasons for business growth (5)
- Increased profits. Expanding business and achieving higher sales.
- Increased market share. Higher marker profile and greater bargaining power with both suppliers and retailers
- Increased economies of scale
- Increased power and status of owners and directors. Opportunities to gain publicity or influence government policy will increase is business is large and well known.
- Reduced risk of being a takeover target. Larger businesses may become too large a target for a potential predatory company.
Define “organic growth”
The expansion of a business by means of opening new branches, shops or factories. Also known as internal growth.
Define “external growth”
Business expansion achieved by integrating with another business by either merger or takeover.
Define “merger”
An agreement by owners and managers of two businesses to bring them together in a new combined business.
Define “takeover”
When a company buys more than 50% of the shares of another company and becomes its controlling owner. It can be called an aquisition.
State the different forms of external growth (4)
- Forward vertical integration
- Backward vertical integration
- Horizontal Integration
- Conglomerate integration
Define “horizontal integration”
Integration with a business in the same industry and at the same stage of production.
Explain the advantages of Horizontal Integration (4)
- Eliminates 1 competitor and increases market share and power.
- Potential economies of scale.
- There is a scope for rationalising production, concentrating all output on one site as opposed to 2.
- There may be increased power over suppliers to obtain lower prices.
Explain the disadvantages of horizontal integration
- Rationalisation may bring bad publicity and redundancies
- There may be customer opposition to less competition and less choice.
- It may lead to a monopoly investigation if combined business exceeds certain market share limits.
Explain the impact on shareholders of horizontal integration (5)
- consumers have less choice, may have to pay higher prices
- Workers may lose job security because of rationalisation
- Suppliers may have to offer lower prices to bigger integrated business
- Shareholder impact depends on whether profit rises or not
- Local communities may have job losses.
Define “forward vertical integration”
Vertical integration (integrating with business in same industry) with a customer business. E.g. a car manufacturer integrating with a car dealership
Explain the advantages of forward vertical integration (2)
- The business is able to control the promotion and pricing of its own products
- It gives a secure outlet for the business’ products. May now exclude competitors products from retail outlets.
Explain the disadvantages of forward vertical integration (2)
- Consumers may suspect an attempt to act uncompetitively and react negatively.
- The business may lack experience in this sector of the industry. A successful manufacturer does not necessarily make a good retailer.
Explain the impact on stakeholders of forward vertical integration (4)
- Workers may have greater job security because business has secure outlets
- There may be more varied career opportunities for employees.
- Consumers may resent the lack of competition in the retail outlet because of the withdrawal of competitor products.
- Shareholder impact depends on whether profit rises or not.
Define “backward vertical integration”
Vertical integration (integrating with business in same industry) with a supplier business. E.g. a bakery chain integrating with a wheat farm / clothing brand integrating with a textile factory.
Explain the advantages of backward vertical integration (3)
- It gives control over quality, price and delivery times of supplies.
- Encourages joint research and development into improved quality and components.
- The business may now control supplies of materials to competitors.
Explain the disadvantages of backward vertical integration (2)
- The business may lack experience in managing a supplying company. E.g. a successful steel producer will not necessarily make a good manager of a coal mine.
- The supplying business may become complacent due to having a guaranteed customer. Less pressure to be competitive.
Explain the impact on stakeholders of backward vertical integration (4)
- Workers may have more career opportunities
- Consumers may obtain improved quality and more innovative products.
- Control over supplies to competitors may limit competition and choice for consumers.
- Profit might rise to benefit shareholders.
Define “conglomerate integration”
Integration with a business in a different industry. E.g. a soft drink company buys a clothing brand
Explain the advantages of conglomerate integration (2)
- It diversifies the business away from its original industry and markets.
- This should spread risk and may take the business into a faster growing market.
Explain the disadvantages of conglomerate integration (2)
- There may be a lack of management experience in the acquired business sector
- There may be a lack of clear focus and direction now that the business is spread across more than 1 industry.
Explain the impact on stakeholders of conglomerate integration (3)
- Workers may have more career opportunities
- There may be more job security because risks are spread across more than one industry.
- Profits could rise to benefit shareholders.
Explain why a merger’s objectives to increase efficiency and profitability might be achieved (4)
- Integrated business share research facilities and pool ideas that achieve better results than 2 separate businesses.
- Economies of scale should cut average costs and increase efficiency.
- The larger combined business can save on marketing and distribution costs by using same sales outlets and sales teams.
- Rationalisation of property and other assets reduce duplication and costs.
Explain common reasons for a merger to fail to achieve objectives (4)
- Integrated business too big to manage and control effectively. Diseconomies of scale.
- A different business and management culture. Two sets of managers and workers may find it difficult to work effectively and cooperatively together.
- May be little benefit from combined research departments or marketing/distribution facilities if original business produced different product.
- The rate of growth is too rapid for directors to manage effectively.
Explain the financial problems of growth through a takeover/merger (3)
- Takeovers can be very costly, stretching financial resources
- Additional fixed capital and working capital required quickly.
- Can lead to negative cash flow and increase long term borrowing and interest payments.
Explain possible strategies to overcome the financial problems of a merger/takeover (3)
- Use internal sources of finance e.g. retained earnings
- Raise finance from share issues
- Offer shares, not cash, to pay for takeover.
Explain the managerial problems of growth through a merger or takeover (3)
- Existing management may be unable to cope with problems of controlling an operation which may have doubled in size very quickly
- May be lack of coordination between divisions of an expanding business
- A culture clash between two management teams
Explain possible strategies to overcome the managerial problems of a merger/takeover (3)
- New management systems and structures required. Policy of delegation and employee empowerment should reduce pressure on managers
- A decentralisation policy could provide motivated managers with a clear local focus
- A new management culture needs to be put in place rapidly.
Define “synergy”
Literally means that “the whole is greater than the sum of parts”. Often assumed that the new integrated business will be more successful than the original separate businesses.
Define “strategic alliance”
An agreement between 2 organisations to commit resources to achieving a specific objective while remaining independent.
For example: A business might form an alliance with a supplier, to produce components and materials that will be used in a new range of products. This may help reduce total development time for getting new products to the market, thereby gaining competitive advantage.
