Size Of Firms Flashcards
Why do some firms remain small?
-Limited access to capital markets
-Limited market demand
-Managerial Capacity
-Lack Of Finance for Expansion
-Owners wish to maintain control
Why do some firms grow?
- Access to Large Amounts Of Capital
- High Demand Products
- Limited Regulations
Why might some firms not aim to profit maximise?
- To undercut competition in the short run by charging below other’s ac curve (to create barriers to entry)
- Maximise market share by revenue maximisation
- Maximise brand awareness by sales maximisation
What is the Principal-Agent Problem?
When the divorce of ownership with control occurs (usually as a firm becomes big)
The managers may choose to priories their objectives over the owners of the firm
This problem can be overcome by giving shares to the managers - thereby shifting their objectives with the owners
Benefits Of Horizontal Integration
Economies of Scope (firms can use the same factories and logistics networks for multiple products, avoiding duplication of processes), allowing lower average costs, which may be passed on to consumers depending on the market structure and degree of competition.
Greater Economies Of Scale - Negotiate lower prices with suppliers due to bulk buying and obtain lower interest loans as they appear more stable
Increased Market Share (Can be used to obtain greater price control and charge above MC, allowing the supernormal profits)
Benefits of Backwards Vertical Integration
Cost control: The firm can reduce supply costs by eliminating middlemen and securing better prices for raw materials.
Supply chain control: Ensures a reliable supply of inputs, reducing risks of shortages or price volatility.
Increased profit margins: By cutting out suppliers, the firm can capture more of the profit from the production process.
Improved quality control: Direct control over the quality of raw materials or components can lead to better final products.
Benefits Of Forwards Vertical Integration
Market control: The firm gains direct access to consumers, reducing dependence on third-party retailers.
Higher profit margins: By cutting out intermediaries, the firm can capture more of the profit from the sale of its products. (Reduced Commission Fees)
Improved customer experience: Direct control over the distribution process can improve service quality and customer satisfaction. (Ensure Consistent High Quality)
Better market intelligence: Direct interaction with consumers gives the firm valuable insights into customer preferences and demand.
Benefits Of Diversification
Risk reduction: Spreading investments across different products or markets reduces dependence on a single income stream, lowering the overall business risk.
Revenue growth: Entering new markets or product lines creates additional sources of revenue, which can boost overall sales and profitability.
Economies of scope: Sharing resources, such as marketing or distribution, across diverse products can lower average costs.
Market power: A diversified firm may have greater bargaining power with suppliers or customers, improving its competitive position.
Disadvantages Of Horizontal Integration
Monopoly concerns: Increased market power may attract regulatory scrutiny or lead to anti-competitive behavior, risking legal action.
Integration challenges: Merging two firms can lead to cultural clashes, inefficiencies (think managing complex production lines), and difficulties in aligning business practices.
Over-reliance on one market: The firm may become too dependent on the same market or industry, which could be risky if market conditions change.
Reduced flexibility: A larger, more integrated firm may be less agile in responding to market changes due to bureaucratic processes.
Disadvantages Of Backwards Vertical Integration
High Initial Investment:
Backwards vertical integration often requires a large capital investment to acquire or set up the supply chain operations (e.g. factories or raw material sources). This can strain financial resources and create debt.
Increased Complexity:
Managing new parts of the supply chain, such as production facilities or raw material sourcing, adds complexity to the firm’s operations. This can lead to inefficiencies if the firm lacks expertise in these areas.
Reduced Flexibility:
Once a firm has invested heavily in a specific supplier or production facility, it becomes less flexible in adapting to changes in the market. The firm may be locked into certain suppliers or production processes, making it harder to switch to new, more efficient options.
Focus Dilution:
Firms that are more focused on their core business activities may find it challenging to manage the newly acquired supply chain operations effectively, leading to a dilution of focus from their primary goals and objectives.
Disadvantages Of Forwards Vertical Integration
Lack of Flexibility:
Once a firm invests heavily in its own retail or distribution network, it becomes less flexible in responding to market changes. If consumer preferences shift or the market dynamics change, the firm may be less agile than firms that are not tied to a specific retail channel.
Regulatory Scrutiny:
A firm that integrates forwards may face antitrust or anti-competitive concerns, especially if it gains too much control over the market, potentially leading to regulatory challenges or legal action.
Disadvantages Of Diversification
Lack of Expertise:
When a firm diversifies into new markets or products, it may lack the knowledge or experience required to succeed in these new areas. This can lead to poor decision-making and inefficiencies.
Management Complexity:
Managing a wider range of products or markets increases the complexity of operations. This can lead to diluted focus, with the firm struggling to allocate resources effectively across different business units.
High Costs:
Diversification often requires significant investment in new markets, products, or acquisitions. This can lead to high initial costs and long payback periods, which may reduce short-term profitability.
What is a key disadvantages of any merger/takeover? A* Gold Dust
“There is an opportunity cost in purchasing or acquiring a firm for backwards vertical integration. The capital spent on acquiring the supplier may reduce the firm’s ability to invest in other areas, such as R&D or innovation.
This reduces dynamic efficiency, as the firm may not be able to improve or develop new products, which can harm its long-term competitive advantage and consumer appeal.
Additionally, without sufficient focus on innovation, costs may not decrease as much as they could, preventing the firm from achieving the lowest possible cost structure and reducing long-run profitability.”
Advantages Of Organic Growth
- No integration challenges and no risk of culture clash, allows for high moral and productivity from staff
- Higher Profit Margins (No premium paid for acquisition) allows for more to be invested in R&D
- Retained Brand Identity can keep the customer base less volatile and allow for stable revenues - encouraging investment as investors can confidently plan for the future
Disadvantages Of Organic Growth
- Can be slower, making it longer for the firm to grow and be able to obtain economies of scale, meaning firm may lose competitive advantage to larger firms who have lower costs per output and charge lower prices
- Lack of new ideas can keep firms using potentially inefficient production lines, causing the firm to be operating with x-inefficiency, reducing availability of retained profits for R&D, which reduces dynamic efficiency
