Theme 3: Business behaviour and the labour market

Question 1

Why do some firms remain small

Answer 1

• Limited access to finance: small firms might be regarded as high risk to banks, making them unwilling to lend.
• Size of market is very small: if the firm is operating in a specialist segment of the market and demand is low then the firm is likely to remain small.
• Owner objective to retain control of the business: owners may want to retain complete control of their businesses and so be unwilling to expand.
• Lack of economies of scale: there may be no incentive for a firm to grow if there are no potential cost savings.
• Individualised, personalised services: nail bars, personal trainers, and osteopaths are examples of firms that are often small because they offer a personal service and customers wish to deal with a particular person.

Question 2

Why do some firms grow?

Answer 2

• To benefit from economies of scale: larger firms often have lower costs per unit of output in the long run.
• To reduce risk: larger firms might diversify and produce a range of products, so benefitting from economies of scope. Firms specialising in one product face the risk that if demand falls, they may be forced out of business. This could be a particular problem in times of recession.
• To increase market share: a larger firm has more market power and can control prices and retain consumer loyalty. A larger market share also means that the threat of competitors is reduced.
• To meet managerial objectives: firms may wish to grow because the pay and bonuses of managers are related to sales revenue. Also, the managers might seek the higher status of being part of a large organisation.

Question 3

What is the principal-agent problem

Answer 3

The principal-agent problem occurs when the aims of a firm’s owners diverge from those of the managers, which may lead to a conflict between the aims, and the policies of these two groups.

Question 4

What is the private sector

Answer 4

The private sector is the part of the economy in which the assets are owned by individuals or groups, and not the government, eg spire hospitals, which are funded by private payments from individuals or companies

Question 5

What is the public sector

Answer 5

The public sector is the part of the economy owned by a society as a whole and regulated/provided by the government, eg NHS hospitals, which are funded mainly through taxation

Question 6

What is organic growth

Answer 6

Organic growth is the internal growth of a business, and not growth from the businesses it acquired… ie refers to the increase in output and sales of a business using internal resources.

Can be achieved by buying new capital, taking on more workers, or increasing the amount of hours people work.

Example: Walmart. This company started with the opening of one store in 1950. By 1995 it had a store in every US state and some in Canada. In 2020 Walmart had over 11,000 stores in 28 countries. This growth was achieved without mergers, but through a decision to achieve higher sales by cutting prices.

Question 7

What are the advantages of organic growth

Answer 7

• Management has a sound knowledge of the business
• The firm can respond to changes in the market quickly
• There is no need for restructuring
• There is less risk than growth through a merger/s

Question 8

What are the disadvantages of organic growth

Answer 8

• Growth may be slower than through mergers or takeovers.
• It may decrease the competitiveness of the business
• The business might not take on new ideas or people
• The firm might get too specialised in areas that are becoming out of date.

Question 9

What is external growth and what are the main ways a firm can externally grow?

Answer 9

Involves the expansion of a business by merger or takeover.

1) Horizontal integration
2) Vertical integration
3) Conglomerate integration or ‘diversification’

Question 10

What is horizontal integration

Answer 10

This is when firms merge at the same stage of the same production process.

The firms may not make exactly the same product, and are likely to want to increase the range of products they produce, or to be keen to get into new markets around the world.

Example: In 2019, Fiat Chrysler and the Groupe PSA (owners of Peugot) agreed to merge. This merger was expected to generate savings and other benefits of €3.7 billion without any factory closures.

Question 11

Advantages of horizontal integration

Answer 11

• To gain economies of scale
• To increase market share
• To increase market share
• To eliminate a competitor so enabling the firm to gain a degree of monopoly power.
• A merger reduces the risk of being bought out by a rival company
• Increased revenue for the business as a result of having a larger customer base.

Question 12

Disadvantages of horizontal integration

Answer 12

• Risk is focused on a narrow range of goods or services.
• Diseconomies of scale may occur.
• The share price of the firm being bought might rise, meaning the buyout is very expensive.
• Some workers might lose their jobs if the roles in the new bigger firm are duplicated, eg head of human resources.
• Some workers might have to travel further.
• Some assets might be sold off (eg duplicated capital equipment), which might be wasteful.

Question 13

What is vertical integration and what are the two types?

Answer 13

Vertical integration is when firms merge at different stages of the production process.

1) Backward vertical integration
2) Forward vertical integration

Example: Starbucks. It owns coffee bean farms and roasting plants, warehousing and distribution, and retail outlets.

Question 14

What is backward vertical integration

Answer 14

Occurs when a firm merges with a supplier.

Question 15

What are the advantages of backward vertical integration

Answer 15

• Control over raw materials means supply and quality are guaranteed.
• Other firms might be prevented from getting the supplies
• The mark-up that a supplier makes can become profit for the buying firm

Question 16

What are the disadvantages of backward vertical integration

Answer 16

• The firm might not need to buy all the supplies
• The firm might not have specialist knowledge of production - diseconomies of scale might set in.
• The firm might find it hard to adapt to changes in consumer demand, eg buying a sugar plantation might be unhelpful if demand shifts to artificial sweeteners.

Question 17

What is forward vertical integration

Answer 17

This means buying another firm in the same production process but closer to the customer. For example, a brewery buying a chain of pubs.

Question 18

Advantages of forward vertical integration

Answer 18

• Buying a retail outlet might guarantee that consumers see a firm’s products at their best.
• The consumer may not be distracted by competition from other products.
• Market research is more effective and the firm can adapt in response to consumer preferences.

Question 19

Disadvantages of forward vertical integration

Answer 19

• The firm on its own might not have a wide enough range or choice for customers.
• The firm might not have marketing and sales expertise
• Risk of larger losses, ie if demand for the final product falls.

Question 20

What is conglomerate integration or ‘diversification’

Answer 20

Occurs when a firm buys another firm in a completely unrelated business, ie the firm diversified.

Example: Honeywell is involved in a wide range of markets including aerospace, building technologies, materials technology and safety products.

Question 21

Advantages of conglomerate integration

Answer 21

• It spreads the risk - profitable areas can cross-subsidise loss-making areas
• Different products do well at different parts of the business cycle
• Brands gain more recognition

Question 22

Disadvantages of conglomerate integration

Answer 22

• There might be a lack of expertise in new areas.
• Brands might become diluted
• Differences in culture may result in conflict and low productivity

Question 23

What are the constraints of business growth

Answer 23

• Government regulation: some firms are unable to grow because governments might use regulations to ensure markets remain competitive and to prevent the development of monopolies
• Capacity constraints: a firm might have insufficient machinery to expand. Linked with this point is the fact that the business may face a shortage of finance for expansion. Further, labour constraints might be a problem. For example, the firm might have difficulty in recruiting workers and/or there may be a shortage of skilled labour.
• Market constraints: if demand is limited or if individual tastes have to be satisfied, then large-scale production would be inappropriate. Further, the existing competition in the market may deter a firm from expanding.
• Vision constraints: the owner’s attitude, eg a lack of ambition, might be the key reason why a firm does not expand. Some firms like to ‘keep it in the family’ by employing family members and avoid taking on people from outside. This may make the firm easier to manage and workers might have greater loyalty and be more productive.
• The state of the economy: if the economy was in recession, teh owners might think that demand would be limited and so there would be no point in expanding.

Question 24

What are demergers

Answer 24

These involve the separation of a large company into two or more smaller companies. This might involve the dissolution of an earlier merger.

Example: Whitbread, which sold off to Costa Coffee chain after pressure from some investors.

Question 25

What are reasons for demergers?

Answer 25

• To focus on the core business: this might enable higher profits to be made by developing that part to gain the benefits of specialisation.
• To increase profit: this could be achieved if under-performing or loss-making parts of the business are sold.
• To raise finance: this would be possibly by selling the shares in the new company. The money raised could be used for investment in the core business.
• To avoid diseconomies of scale: merger firms can be difficult to manage if they involve different core activites.
• To meet demands of regulators: a firm might be required to spin off part of its business by a regulatory authority as a means of increasing competition.

Question 26

What are the impacts of demergers on businesses

Answer 26

Demergers allow focus on the core business, raising funds from selling part(s) of the business, and removing loss-making parts of the business.

Question 27

What are the impacts of demergers on workers

Answer 27

There might be an increase in job security if loss-making parts of the business are demerged, a reduction in conflict between cultures and an increased focus on the business to enable it to be more profitable - but some may lose jobs.

Question 28

What are the impacts of demergers on consumers

Answer 28

Greater competition leads to lower prices. More focused businesses are able to better meet consumer needs - but some parts of the service might be limited. For example, when Lloyds TSB split into two firms, some consumers were left without a local bank branch.