Theme 3 Content Flashcards
3.1 - Business Growth
How to small firms survive
3.1.1 - Sizes and types of firms
- Many small businesses act as a supplier or sub-contractor
- They might take advantage of low-price elasticity of demand (PED) and high income-elasticity (YED) for specialist ‘niche’ or ‘bespoke’ products that can be sold at a higher price with a larger profit margin per unit - by expanding you may lose the niche or bespoke aspect so reason to stay small
- Can avoid internal diseconomies of scale
- Lifestyle enterprises where owners are looking to satisfice not maximize profits
- Innovate, flexible and nimble in responding to changes in market demand
- Keep over-head costs low
- Benefit from external economies of scale
3.1 - Business Growth
What is the divorce of ownership from control?
- Large companies appoint directors rather than have owners run them, owners largely have nothing to do with day-to-day operations
- So there is a divorce of ownership from control
3.1 - Business Growth
What happens when there is a divorce of ownership from control
- The board of directors oversee the CEO and senior managers who actually run the firm
- This can result in a form of the principle agent problem where one group makes decisions on behalf of another
-> the CEO should put shareholders first
-> In practice, the agent almost always maximises their own benefit -> this could be through giving themselves large bonuses
3.1 - Business Growth
How to solve the divorce of ownership from control
- The shareholders do have control through the Annual General Meeting where they can vote people off and onto the board
- Alterately they have the opportunity to sell their shares too which can place pressure on the board if the price were to drop
3.1 - Business Growth
Why do firms want to grow?
- Economies of scale (Reduce costs so inc prof).
- Increased market influence (and over price)
- Increased market share (Inc. access to credit).
- Larger product range - more diverse / stable.
3.1 - Business Growth
Who controls private sector organisations?
Individuals
(For profit)
3.1 - Business Growth
Who controls public sector organisations?
Governmental bodies
(Not for profit)
3.1 - Business Growth
What are the constraints on growth?
[7]
- Owner’s Objectives.
- Type of product - e.g. winter gloves (seasonal).
- Market size - e.g. left-handed scissors.
- Bureacurcay, red tape and regulation - regular tax returns and health and safety requirements
- Access to finance
- Competition
- Skill shortages
3.1 - Business Growth
Through what kind of processes does organic growth of businesses occur?
Through internal processes. (relies on own resources)
3.1 - Business Growth
How is organic growth measured?
Through comparing sales/revenue year over year
3.1 - Business Growth
What are the benefits of organic growth
- Less risk -> Mergers go wrong all the time. In 2/3s of cases, the mergers make the firms less profitable (The Economist) They might suffer from
-> Diseconomies of scale
-> Cultural issues.
-> Communication problems. - No reduncy costs. - less wasted resources
- Less likely to recieve CMA attention
- Managable pace of growth
- The management know & understand every part of the business
- Builds on a businesses’ existing strengths (customer base)
3.1 - Business Growth
What are the disadvantages of organic growth
- Very slow - won’t please shareholders
- Might find it difficult to access finance if they do not have collateral.
- You might get bought out by a competitor
- Not suitable when trying to break into a foreign market
- Growth is very dependent on the growth of the overall market/consumer demand
- Not necessarily able to benefit from economies of scale
3.1 - Business Growth
What is vertical integration?
- Merging with a firm
- In the same industry
- But at a different stage in the production process.
3.1 - Business Growth
What is the difference between forwards and backwards vertical integration
- Forward vertical - moving closer to the customer. E.g. Luxotica purchasing Sunglass Hut.
- Backwards Vertical - Moving closer to the primary product E.g. Tesco and The Booker Group
3.1 - Business Growth
What are the advantages of forward vertical integration
- Creates a secure market for firms products
- Retailers profits now belong to the firm.
- Share information about consumer tastes/preferences
- Can offer better customer service and a more competitive price.
3.1 - Business Growth
What are the advantages of backwards vertical integration
[4]
- Suppliers profit now belongs to the retailer.
- Firm gets priority treatment for supplies and has more power to ensure quality - create brand loyalty.
- Can offer customers with more competitive prices - win win. E.g. Tesco-Booker.
- May be cost savings -> integrating with a supplier may increase efficiency
3.1 - Business Growth
What are the disadvantages of forward vertical integration
[5]
- Firms may not be experienced in running retail.
- Cultural issues/ diseconomies of scale
- Retailer may offer reduced choice to consumers and only stock the parent companies products.
- Firms often pay too much for firms
- Key workers may leave, loss of expertise
3.1 - Business Growth
What are the disadvantages of backwards vertical integration
- Suppliers may become complacent as there will always be a customer - x-ineffiency.
- Cultural issues/ diseconomies of scale.
- Firms often pay too much for firms
- Key workers may leave, loss of expertise
3.1 - Business Growth
What are the advantages of horizontal integration?
[5]
- Rapid increase in market share/Elimination of competitors
- Firms can specialise and rationalise
- Already has expertise in industry, merger likely to be successful
- Potential for economies of scale
- Revenue synergies – 1+1=3 extra benefits. Two companies’ combined can generate more sales than the sum of the two individually
3.1 - Business Growth
What are the disadvantages of horizontal integration?
[8]
- Time-consuming, high risk
- Potential loss of control for part of firm
- Integration challenges, such as cultural differences
- More scrutiny from the competition authorities – could be worried that competition will be substantial lessened. The authorities could stop the merger
- May divert management’s attention from core operations
- Overpaying
- Reduced flexibility – more people and process means the need for more transparency and so more legal accountability and red tape. Slower innovation and increased costs
3.1 - Business Growth
What is Conglomerate integration?
The integration of firms in different industries with no common connections.
3.1 - Business Growth
What are the advantages of conglomerate integration?
- Diversify to be less reliant on the success of one product - reduce risk - diversification of risk
- Opens a new market if growth is slow in existing markets. - New opportunities for growth
- Size of a conglomerate makes it easier to obtain finance
- Capitalizing on unrelated opportunities.
- Potential for higher returns in diverse markets.
- Parts of the new business may be sold for profit as they are duplicated in other parts of the conglomerate
3.1 - Business Growth
What are the disadvantages of Conglomerate Integration
[5]
- Possible lack of expertise in new products/industries
- Diseconomies of scale can quickly develop
- Usually results in job losses - loss of experienced workers
- Worker dissatisfaction due to unhappiness at the takeover can reduce productivity
- Overpaying
3.1 - Business Growth
What are the disadvantages of mergers and acquisitions for consumers
- However, larger firms may have more market power, making demand more inelastic. Firms can raise prices to achieve greater profits and revenues, at the expense of the consumer. Less consumer surplus.
- Any cost savings made by EOS may just be paid to shareholds or CEOs, rather than benefiting consumers.
- Might create diseconomies of scale or x-inefficiency
- Less choice
3.1 - Business Growth
What are the disadvantages of mergers and acquisistions for employees
- The initial merger may lead to job losses as the firm looks for cost savings - store closures.
- Duplicate staff members will be made redundant.
3.1 - Business Growth
What is a demerger?
When a company splits off
3.1 - Business Growth
Why can company value lead to demergers?
Some parts maybe worth more than company combined
3.1 - Business Growth
Reasons for Demergers
- Reducing diseconomies of scale - smaller firm means less diseconomies of scale so possible increased profit
- Increased business focus
- Cultural differences
- Remove loss making divisions
- Increase liquidity & dividend payments
- Comply with the demands of the Competition Commission - due to high levels of market share
3.1 - Business Growth
Impacts of demerger on Businesses
- Opportunity for a more narrow focus on the core business
- Removing loss-making portions of the business
- Increased efficiency and lower costs/unit
- Increasing the annual profits for the year that the demerger occurred
- Removing some difficult cultural differences
- Long term – higher returns/operating profits
- Short term costs of selling the business especially if sold at low price
3.1 - Business Growth
Impacts of demerger on Employees
- Some workers may lose their jobs
- Reduced friction from cultural differences can help build better team dynamics
- Smaller workforce provides more opportunity for promotion
- Less complication in daily tasks due to more narrow focus
- Opportunity for managers of newly demerged business to assume new responsibilities
3.1 - Business Growth
Impact of demerger on consumers
- If successful, better quality products & customer service
- If successful, lower prices due to the firms new efficiencies
- If unsuccessful, a narrower product range & perhaps worse quality/customer service
- Impact on prices depends on the effect of a demerger on the intensity of industry competition
- Impact on prices depends on whether a demerger leads to fewer economies of scale being harnessed
3.2 - Business Objectives
What are the 3 possible business objectives?
- Profit maximisation. (Directors want this)
- Sales maximisation. (Organic growth)
- Revenue maximisation. (Managers want this)
3.2 - Business Objectives
Why do firms return to profit maximisation in the long run? (Keynes)
- Shareholder pressure to maximise profits - managers might be changed.
- Survival - firms might not be able to keep running with low profits. Needs to be money for reinvestment.
- A rival might have been removed
3.2 - Business Objectives
Why do firms maximise profits?
- Dividends to distribute to shareholders, CEOs and owners. - Pressure from shareholders as they vote on directors at annual general meetings (AGM)
- Bonuses to CEOs and Managers.
- Reinvestment into the firm - Research and development for future profits. - Business expansion
- Firm survival in a competitive atmosphere. - Owners do not want to fund losses, the bank may stop lending.
3.2 - Business Objectives
What happens if firms produce beyond profit maximising price?
The cost of producing one extra unit will exceed the revenue gained from one extra unit.
Results in higher costs and lower profits.
3.2 - Business Objectives
Where is revenue maximising point?
Marginal Revenue = 0. Any more than this and marginal revenue is less than 0 so revenue will start to fall.
3.2 - Business Objectives
Why might firms revenue maximise?
- To deter new entry (reduce price, increase quantity and market share) - Over time, rivals might leave the market, reducing competitive pressure and making demand more price inelastic.
- Avoid the CMA, which might invest for anti-competitive behaviour.
- Create brand loyalty, win customers
- Amazon follows an objective of revenue maximisation to dominate the market and create brand recognition
- The Principle agent problem - Managers are rewarded bonuses and incentives based on revenue they bring to the firm.
3.2 - Business Objectives
Where is sales maximisation?
- Selling as many units as possible whilst still making normal profit.
- AC=AR
3.2 - Business Objectives
Why might firms sale maximise?
- Avoid CMA attention
- Deter new entry - charge a limit price, as there are no supernormal profits to be made
- Start up and create brand awareness - Deliveroo, Uber
- Win more market share - more agressive than revenue maximisation. E.g. Aldi, Lidl.
- Build up monopoly power, price inelastic demand to raise prices in the future.
- Or force rivals out of the market.
3.2 - Business Objectives
What is profit satisficing? Where is it?
- A compromise between revenue maximisation and profit maximisation.
- Occurs between MC=MC and MR = 0.
3.2 - Business Objectives
Why might firms profit satisfice?
- Due to the principle agent problem, managers might make enough profits to satisfy owners happy whilst increasing their own benefit.
- Enough for higher bonuses but also enough for shareholders, who won’t remove managers.
- Win market share but have enough for shareholders.
- Avoid the CMA but have enough to reinvest
3.2 - Business Objectives
Where is the profit maximising point
MC=MR
3.2 - Business Objectives
Why can a firm survive, while making a loss, in the short-run?
- Managers could be satisficing, in a temporary market downturn.
- Losses may be cross-subsidised by profits in another sector.
3.3 - Revenues, costs and profits
At what point does MR begin to decrease?
When TR = 0.
3.3 - Revenues, costs and profits
Total revenue when price is constant?
3.3 - Revenues, costs and profits
Average and marginal revenue when price is constant?
3.3 - Revenues, costs and profits
Total revenue when price is falling
PED = 1 when TR is maximised and MR = 0
3.3 - Revenues, costs and profits
Average and marginal revenue when price is falling
- AR falls as price falls with increases in output
- MR falls twice as fast
- AR = D as it shows the average price received at each level of output
3.3 - Revenues, costs and profits
Give examples of fixed costs and variable costs.
- Fixed cost: printer
- Variable costs: ink + paper
3.3 - Revenues, costs and profits
Diagram showing the relationship between TC, TVC and TFC:
3.3 - Revenues, costs and profits
Why are Long run and short run cost curves shaped they way they are
SR - due to law of diminishing returns.
LR - due to EoS.
3.3 - Revenues, costs and profits
What happens to the AC and MC curve if costs decrease?
They always move as a pair.
AC shifts down, MC shifts out (to the right).
3.3 - Revenues, costs and profits
What is the minimum efficient scale?
The lowest quantity where AC stops decreasing. (Where all EoS have been utilised).
(Productive efficiency).
3.3 - Revenues, costs and profits
What are diseconomies of scale?
- Disadvantages that arise in large businesses that reduce efficiency and cause average costs to rise.
- Decreasing returns to scale - Δ% in output < Δ% in inputs
3.3 - Revenues, costs and profits
What are economies of scale
- Falling long run average cost as output increases in the long run
- Increasing returns to scale - Δ% in output > Δ% in inputs
3.3 - Revenues, costs and profits
What are constant returns to scale?
When a firm increases inputs and receives an increase in output by same percentage
3.3 - Revenues, costs and profits
What are external economies of scale?
Advantages which arise from the growth of the industry within which the firm operates, independent of the firm itself.
3.3 - Revenues, costs and profits
Types of interal economies of scale
- Technical - Gains productivity/efficiency from scaling up long-run production - specialisation, containerisation, learning by doing
- Marketing - A large firm can purchase factor inputs in bulk at lower prices if it has monopsony power
- Managerial - Division of labour where firms employ specialists –lower ac as productivity
- Financial - Larger, more established firms to be more credit worthy – better access to loans with more favorable rate
- Risk-bearing - Spreading the risk of failure by increasing number of products i.e. product diversification – which lowers failure and so lowers AC
- Networking - The marginal cost of adding one more user or customer to a network is close to zero - The long run cost-per-user diminishes
- Labour - Successful businesses in same areas find labour comes to that area - reduces cost and time taken. Staff from other businesses
3.3 - Revenues, costs and profits
Potential benefits to consumers from businesses utilizing economies of scale
- Lower prices leading to higher real incomes and increased consumer surplus
- Producer surplus has value – reinvested in capital spending and research & development
- Consumers as employees – higher real wages and profit shares
- Consumer benefits from network externalities
3.3 - Revenues, costs and profits
Evaluation of consumer benefits from economies of scale
- It is possible to question the extent to which EoS leads to lower prices – EoS can also reinforce market (monopoly power allowing dominant firms to raise prices to consumers perhaps using algorithms. Creates social costs
- Price is not the main metric for measuring consumer welfare – service quality and pace of innovation are also very important
3.3 - Revenues, costs and profits
Significance of economies of scale for firms
- Price competitiveness improving from cutting unit costs
- The extent of the economies of scale varies due to the minimum efficient scale compared to the size of the market
- Increased profits
- Good for share price
- Retained profits
- Less vulnerable to a hostile takeover bid
3.3 - Revenues, costs and profits
Diseconomies of scale - why do average costs rise
- Managerial Diseconomies: As firms become very large, the management structure can become overly complex and less efficient. Communication breakdowns and bureaucracy may increase, leading to higher costs.
- Coordination and Control Problems: Larger firms often struggle to maintain effective control and coordination among various departments and divisions, leading to inefficiencies and higher costs.
- Worker Alienation: In very large organizations, employees may feel disconnected from the company’s goals and values, which can result in lower productivity and higher turnover rates.
- Communication Challenges: With an increase in size, communication becomes more challenging, leading to misunderstandings and errors that can increase costs.
3.3 - Revenues, costs and profits
When can firms making subnormal profits survive?
- In the SR - cross subsidise
- In the LR, cannot survive - firm will leave market reducing supply + increasing price
3.3 - Revenues, costs and profits
What is the shut-down condition for firms? Represent this on a diagram:
Where AR = AVC.
3.3 - Revenues, costs and profits
What is supernormal profit, where does it occur and what does the graph look like
The profit above normal profit
Occurs when AR>AC
3.3 - Revenues, costs and profits
What is subnormal profit, where does it occur and what does the graph look like
Is a loss - not sustainable - will lead to firm shutting down in the long run
Occurs when AC>AR
3.3 - Revenues, costs and profits
What is normal profit, where does it occur and what does the graph look like
Normal profit is the minimum level of profit required to keep a firm in the industry. It is the profit that covers all explicit and implicit costs of production but provides no extra income above those costs
AR=AC
3.4 - Market structures
Where is the allocative efficient point?
Maximise social welfare by having price at marginal cost. p=mc
MC=AR
3.4 - Market structures
Where does productive efficiency take place?
At the bottom of the AC curve.
Where AC = MC.
3.4 - Market structures
How can dynamic efficency be achieved by a firm
By achieving supernormal profits first, and then reinvesting these profits into research and development to try and lower costs. Thus being dynamically efficient
3.4 - Market structures
What happens if there are supernormal profits in perfect competition and what does it look like?
New firms join ↑ comp.: incentivised and there are no barriers.
The new firms joining increase supply, which reduces market price.
In the LR, firms make normal profit.
3.4 - Market structures
What does perfect competition diagram look like in the long run
3.4 - Market structures
What happens if there are subnormal profits in the short run
Then firms will leave the market as they are making a loss, leading to shift of market supply so increase in price until normal profits are made for the remaining firms
3.4 - Market structures
What are the affects of an indirect tax on monopolistic competition?
Increase in costs.
AC shifts up, MC shifts inwards.
(This is also true for oligopoly, monopoly).
3.4 - Market structures
Draw the diagram for monopolistic competition supernormal profits in the short run
3.4 - Market structures
What happens to supernormal profits in monopolistic competition in the long run?
Supernormal profits are eroded away - new firms entry the market due to lack of barriers to entry.
Increases overall market supply and decreases demand for each firm.
Until the point where AR = AC.
In the long run, a monopolistically competitive firm can make neither supernormal profits nor losses.
3.4 - Market structures
How do firms predatory price?
By setting price below AVC to drive out competitors. (P2)
Prices are increased once competitors are removed (due to losses from lost consumers)
Profits increase for the original firm.
3.4 - Market structures
How do firms limit price?
- They set the price at sales maximising price, below the AC of potential new entrants, who have not yet built up any Economies of Scale.
- No new firms will enter as they will incur losses.
- In the long run, demand is more inelastic for the incumbent firms. Higher prices in future.
3.4 - Market structures
Are oligopolies efficient?
No - they charge above allocatively efficent price. There is a deadweight loss.
3.4 - Market structures
Draw the payoff matrix for oligopoly (Game theory)
3.4 - Market structures
What happens to average costs if an industry experiences external economies of scale (diagram)
Average costs fall for all firms (spillover effect)
3.4 - Market structures
What is (third degree) price discrimination?
When different groups of consumers are charged different prices for the same g/s.
E.g. higher P for peak gym membership.
Adult + child cinema tickets.
