Theme 3 Flashcards
Business size can be measured by:
-Market share
-Profit (growth or absolute)
-Employees/ outlets
-Market power
-DIversification (risk spread)
Economies of scale
Refer to the cost advantage (average cost falling) experienced by a firm when it increases its level of output
Diseconomies of scale
Occur as average costs start to rise beyond a certain level of output
Principle- Agent problem
-Refers to the divorce of ownership between the principal and agent
- ie shareholders and managers have different objectives which might conflict. Managers might choose to make a personal gain, such as a bonus, rather than maximise the dividends of the shareholder. (to fix this managers could be given shares in the business)
Public sector business
Controlled by the government e.g. schools, hospitals, libraries, (TAX)
Government (or state) has control of an industry, such as the NHS. Many industries in UK were nationalised after 1945 (railway, coal, electricity, steel)
A number of these were natural monopolies. For example, only one firm will provide water because it is inefficient to have multiple sets of water pipes.
Public sector industries have different objectives to private sector industries. Social welfare or industrial strategy might be a priority of a public sector industry.
Private sector business
Aim to make a profit, from small local businesses to large businesses
Free market economists will argue that the private sector gives firms incentives to operate efficiently, which increases economic welfare.
Firms have to produce the goods and services consumers want, which increases allocative efficiency and might mean goods and services are of a higher quality.
Competition might also result in lower prices. This is because firms operating on the free market have a profit incentive, which public sector firms do not.
Why do businesses grow
-Shareholder pressure
-Increase profit
-Increase market share
-New locations
-Survive
-Innovation
-Gap in market
-Achieve economies of scale
-Meet demand
-Managerial objectives like sales bonuses
-Synergy effects- new revenue streams
Organic Growth
Refers to a business growing gradually with their own resources
Methods of organic growth
-New customers- opening a new outlet or store
-New products- developing a new range of products
-New markets- - e.g. finding customers in a different location- Tesco tried to open in the USA, it was a flop
-Franchising- e.g. allowing other businesses to trade under your name (Subway, McDonald’s)
Organic Growth Advantages
-Lot less riskier than inorganic growth- cultures, practises, the way they do things are all established.
-Much cheaper than inorganic- can be financed through retained profit rather than borrowing or raising share capital.
-Retain Capital
-Less likley to experience diseconomies of scale
Organic Growth Disadvantages
-Slow pace of growth- might be hard to keep shareholders happy- they want high returns quick.
-May get left behind if rivals are all growing inorganically
-Cant tap into knowledge and expertise of other businesses as would be the case with inorganic growth.
Two Types of External Growth( inorganic)
-Merger- two businesses join together for mutual benefit.
-Takeover/ acquisition- one business acquires another along with all its assets. Can be hostile or voluntary.
Horizontal Integration
Merging or taking over a business at the same level of the supply chain, or in same industry at the same stage of production. It can create economies of scale and sharing expertise (synergies). For examples in 2019, The Walt Disney Company acquired 21st Century Fox’s entertainment assets in a deal that marked horizontal integration in the media and entertainment industry. The acquisition included film and television studios, cable and international TV businesses, and various other assets.
Forwards vertical Integration
Occurs when a company expands its operations by acquiring or controlling businesses that are closer to the end consumer or the distribution side of the supply chain. Allows businesses to determine how products are promoted and build relationships with consumers. For example : In 2017, Amazon, an e-commerce and technology giant, acquired Whole Foods Market, a high-end grocery store chain. This acquisition was a forward vertical integration move for Amazon, as it allowed the company to enter the brick-and-mortar retail space and expand its reach into the grocery industry.
Backwards vertical integration
With backward vertical integration, a company acquires or takes control of businesses positioned earlier in the production or supply chain.
By doing so, the company aims to ensure a stable and reliable source of raw materials, reduce dependency on external suppliers, and achieve cost savings through economies of scale.
It also means that business dont have to pay extra (profit margins) to suppliers.
For example, a car manufacturer may backward integrate by acquiring a steel manufacturer to secure a supply of steel for their car production.
For example, Nike owns its own factories, which gives it more control over the production of its shoes & apparel. Nike also owns its own retail stores, which gives it more control over the distribution of its shoes.
Tesla use forward and backwards vertical integration.
Conglomerate
A conglomerate has acquired many diversified businesses. It takes over businesses in a different market, spreading risk.
The world’s biggest conglomerates include businesses such as 3M in the United States, Siemens from Germany and Philips (Netherlands).
Samsung – the South Korean electronics giant - makes military hardware, apartments, ships and is also operates an amusement park.
Advantages of inorganic growth
-Greater profitability
-Market share and assets become larger
-Additional skills and expertise of new staff
-Easier to obtain capital when needed
Disadvantages of inorganic growth
-May be additional debt acquired
-Possibly large upfront cost
-Management challenges with integrating acquisitors
-More regulation (Asda/Sainsbury’s got stopped)
-Resistance to chnage
Vertical integration
Vertical integration is a business strategy where a company expands its operations by acquiring or controlling other businesses that are either upstream or downstream in the supply chain.
This means that a company integrates different stages of production or distribution within the same industry under its ownership.
The main goal is to gain more control over the entire value chain, from raw materials to the final product or service delivery.
There are two types of vertical integration – backward and forward
Adv of forward vertical integration
-Increased market power: A company can gain more control over distribution channels and access to final customers. This can increase market power and bargaining position with retailers or distributors.
-Enhanced control over distribution: Forward integration allows a company to have control over how its products are distributed and displayed to customers. This can lead to better brand representation, consistent messaging, and improved customer experiences.
-Profitability: By cutting out distributors, a company can capture a larger portion of the value chain, leading to higher profit margins on its products.
Benefits of vertical integration
-Control of the supply chain – this helps to reduce unit costs and improve the quality of inputs into the production (supply) process
-Improved access to key raw materials perhaps at the expense of rivals who must then pay more for them
-Better control over retail distribution channels + adding new channels to sales platforms to build business revenues
-Removing suppliers and taking market intelligence away from competitors which then helps to make a market less contestable (it increases a firm’s market power)
Drawbacks of vertical integration
-Mergers can often create new problems of communication and coordination within a bigger and more disparate firm. It can then lead to diseconomies of scale where the new bigger firm is more inefficient.
-Companies might lose the benefits of specialized expertise when they integrate various stages of the supply chain.
-In some cases, vertical integration may raise competition concerns, especially when a company gains significant control over an entire industry or market.
-With internal control over different stages, companies may become complacent and rely less on external innovation
Adv of Horizontal integration
-Exploit internal economies of scale (leading to lower LRAC) – lower average costs can lead to increased profits
-Cost savings from the rationalization of the business – this often this involves job losses in a bid to increase productivity.
-Create a wider range of products - (diversification) – this creates opportunities for economies of scope.
-Reduces competition by removing one or more key rivals – this increases market share and long-run pricing power.
-Buying a well-known brand can be cheaper in the long run than organically growing a brand and makes entry barriers higher for potential rivals
DisAdv of Horizontal Integration
-Reduced flexibility – the addition of more personnel and processes in the merged business means more legal accountability and extra red tape which can then slow down the rate of business innovation
-Risk of diseconomies of scale (which causes an increase in long run average cost) from the enlarged businesses especially if there are clashes of management style and corporate culture
-Risk of attracting scrutiny from competition authorities who might be worried that a merger might lead to a lessening of competition which could lead to higher prices and a decline in consumer welfare. For example, a merger between Sainsbury & Asda was blocked on competition grounds (2019)