LS1 - Sizes and Types of Firms & LS2 - Business Growth

Question 1

Reason why some firms remain small

Answer 1

Some choose to remain small:
* Concerns about experiencing diseconomies of scale
* Owners do not want the risk and extra work involved with expansion
* Small firms generally face less legal requirements than larger firms
Some have to remain small:
* Unable to finance expansion - banks see small firms as risky borrowers so it is difficult to get a loan
* They might operate in a niche market with a small customer base
* Skills, knowledge and expertise may be lacking
* Lacks resources to cope with expansion

Question 1

Reasons why firms seek growth

Answer 1

• Profit - as a firm grows, they are able to produce more goods and services, allowing for more sales - boosts revenue and increased profits
• Costs - a growing firm can expereince economies of scale - lower unit costs –> higher profit
• Market power - larger firm has more market power - this is the ability of a firm to control prices, and earn supernormal profit
• Diversification - increasing the range of products or markets served by a firm - reduces dependency on primary product, more security
• Managerial objectives - bonuses provide executives with an incentive to improve profits and grow the company; allows them to satisfy their ego

Question 2

Types of firms

Answer 2

• Private sector - not owned by govt; owned by shareholders, sole proprietors, family or partnerships - aim to make profit to satisfy demands of owners
• Public sector - govt may own businesses - either because they require significant state funding, or because the govt wants to dictate the operation of the firm - no profit for sharehokders but reinvest surplus funds
• Not for profit - charities, organisations to provide services to communites - profit is not a goal

Question 3

Principal-Agent Problem

Answer 3

Principal - shareholders/owners of a business
Agent - in charge of running day to day operations of business
Problem is that the agent may behave in was that does not satisfy the principal, without their approval or awareness

Question 4

Internal growth / Organic growth

Answer 4

Firms could grow by being successful - they could become more well-known, increasing market power and profits
They can finance growth through issuing shares or through borrowing
This type of growth can be limited - a firm may only be able to grow at the expense of the other firms, if the product market is saturated. They might need to diversify their firm to find new markets for existing products or offer new products
Diversification is risky though - firm may be inexperienced in new market, and competition might be fierce, more expertise

Question 5

External growth / Inorganic growth

Answer 5

Firms can grow by merging with or acquiring other firms - acquisition might be hostile (takeover), but merging is coming together of equals to form a new single entity
Rationalisation can occur - reorganising to improve efficiency
But there might be culture clash between merged firms

Question 6

Types of mergers

Answer 6

• Horizontal merger - merger between firms in the same industry and the same stage of the production process - horizontal integration; may increase market power held by the new firm
• Vertical merger - between firms operating in same industry but in different stages of the production process, upstream or downstream - forward integration: merging upstream (later part of process) ; backward integration: merging downstream (earlier part of process) - improve rationalisation and more efficient production
• Conglomerate merger - between firms operating in different markets or industries - reduce risks faced by firms, but is not always an efficient merger