Theme 3: Business Growth

Question 1

Why do some firms decide to stay small?

Answer 1

1. Economies of scale relative to market size- large firms might only experience small economies of scale compared to their size so might make their costs higher.
2. Diseconomies of scale- large firms could have higher costs
3. Small firms as monopolists- small firms could hold some monopoly power as they provide a more personal, local service.
4. Owners- Managers might decide they don’t want to grow

Question 2

Why do firms decide to grow?

Answer 2

1. Profit motive- By growing firms get the opportunity to earn higher profits. Economies of scale.
2. Market power- More dominance over a market so they can discourage new entrants.
3. Diversification- By expanding product range firms reduce their risk of making huge losses.
4. Owners- Managers might want higher incomes, more holiday or more leisure time.

Question 3

Principle agent theory

Answer 3

The agent makes the decision for the principal, but the agent is inclined to act in their own interests, rather than those of the principal. EG shareholders and mangers have different objective which might conflict, eg bonus for manager over dividend for shareholder.

Question 4

Public sector distinctions

Answer 4

• Government has control
• Natural monopolies eg water
• Some public sector industries yield strong positive externalities eg public transport reduces congestion and pollution.
• Public sector has different objectives, social welfare might be a priority and fairer distribution of resources.

Question 5

Private sector distinctions

Answer 5

• Left to the free market and private individuals
• Private sector gives firms incentives to operate efficiency which increases economic welfare. As they have a profit incentive.

Question 6

Profit organisation

Answer 6

aims to maximise the financial benefits of its shareholders and owners. The goal of the organisation is to earn maximum profits.

Question 7

Not-for-profit organisations

Answer 7

Has a goal which aims to maximise social welfare. They can make profits, but they cannot be used for anything apart from this goal and the operation of the organisation.

Question 8

4 ways firms grow?

Answer 8

1. Organic growth (or internal)
2. Forward and backward vertical integration
3. Horizontal integration
4. Conglomerate integration

Question 9

Organic growth

Answer 9

When firms grow through expanding their production through increasing output, widening their consumer base, by developing a new product or by diversifying their range.

Question 10

Advantages of organic growth

Answer 10

1. Less risky than inorganic growth
2. Firms grow through building on their strengths and using their own funds such as retained profits to fund the growth. So the firm is not building up debt and the growth is more sustainable.
3. Existing shareholders retain control so reduce conflicts in objectives that are possible in a takeover.

Question 11

Weaknesses of organic growth

Answer 11

1. Slower which could allow another firm to out compete or upset shareholders.
2. Might rely on strength of market to grow which could limit how much and fast they can grow.

Question 12

Forward vertical intergration

Answer 12

When a firm integrates with another firm closer to the consumer eg taking over a distributor. Such as a coffee producer taking over a café.

Question 13

Backward vertical intergration

Answer 13

When a firm integrates with a firm closer to the producer. This involves gaining control of suppliers. For example, a coffee producer might buy a coffee farm.

Question 14

Advantages of forward and backward vertical integration

Answer 14

1. Increase efficiency, through gaining economies of scale, which could reduce their average costs. Resulting in lower costs for consumers.
2. Gain more control of the market. Backwards integration can mean that firms can control the price they pay for their supplies.
3. Firms can have more certainty over their production with factors such as quality, quantity and price.

Question 15

Disadvantages of forward and backward vertical integration

Answer 15

1. Diseconomies of scale
2. Create barriers to entry which could discourage new entrants of new firms which could lead to a less efficient market.

Question 16

Horizontal integration

Answer 16

Merger of two firms in the same industry and the same stage of production eg two car manufacturers.

Question 17

Advantages of horizontal integration

Answer 17

1. Firms can grow quickly which can give them a competitive edge over other firms in the market.
2. Increase output quickly so they can take advantage of economies of scale.
3. The two firms have expertise in the same industry, so the merged firm can gain advantages, such as in marketing

Question 18

Disadvantages of horizontal integration

Answer 18

1. Quick growth could lead to monopoly power and lower efficiency.
2. Could be disagreements in the objectives of the two firms which merged.

Question 19

Conglomerate intergration

Answer 19

The combining of two firms with no common connection.

Question 20

Advantages of conglomerate integration

Answer 20

1. Can help both firms become stronger in the market
2. Reach out to a wider consumer base
3. Economies of scale eg risk bearing economies of scale

Question 21

Disadvantages of conglomerate integration

Answer 21

1. Reduce market competition
2. Risk of spreading product range too thinly and there might not be sufficient focus on each range. Which might reduce quality and increase production costs.
3. Lack of synergy

Question 22

Constraints on business growth

Answer 22

1. Size of the market
2. Access to finance
3. Owner objectives
4. Regulation (red tape)
5. Recession

Question 23

Reasons for demergers

Answer 23

1. Lack of synergies
2. Growth
3. Diseconomies of scale
4. Focussed companies
5. Resources
6. Finance

Question 24

Impact of demergers on businesses

Answer 24

firms can dispose of underperforming or loss making parts of the firm. It allows the larger firm and the new, demerged firm to focus on their core activities. Which allows them to adapt to their unique market.

Eliminate diseconomies of scale

Question 25

Impact of demergers on workers

Answer 25

Workers might be confused and their roles might be shifted between demerged firm and parent firm. There could also be job cuts.

Question 26

Impact of demergers on consumers

Answer 26

The removal of diseconomies of scale could lead to lower prices for consumers. There could be a net welfare gain if the demerger results in higher level of efficiency. If two firms in the same industry and same stage of production demerge such as two airlines, thing would increase choice for consumers.