Theme 3.1 Flashcards
Why may a firm want to grow?
-To make more money
-To gain monopoly power
-For greater security
What is an economy of scale?
By growing, a firm will be able to experience economies of scale which helps them to decrease their costs of production. They will also be able to sell more goods and therefore make more revenue. Together, these will help a firm to make a larger profit: and many firms are motivated by profit.
What happens when a firm holds a greater share in their market?
A larger firm will hold a greater share of their market. This will give them the ability to influence prices and restrict the ability of other firms to enter the market, helping them to make profits in the long run. Monopoly power often means firms have monopsony power, and so will be able to reduce their costs by driving down the prices of their raw materials.
Why will a larger firm have greater security?
A larger firm will have more security as they will be able to build up assets and cash which can be used in financial difficulties. Moreover, they are likely to sell a bigger range of goods in more than one local/national market and so they will be less affected by changes to individual products or places.
Why may not all firms grow?
Some remain small because of constraints on growth: the size of the market, access to finance, owner objectives and regulation. Not all firms want to grow.
How is a separation of ownership and control seen in many large firms?
● Firms are owned by their shareholders, who play no part in the day to day running of the business.
● The chief executive and senior managers work for the company and control day-to-day decision making.
● Shareholders are represented by a Board of Directors, who oversee the way the business is run. They are able to vote directors onto and off the Board of Directors at the AGM. However, this often makes little difference and shareholders have more power through buying and selling shares: if share prices drop significantly, the board may be encouraged to change their strategy.
Why may the separation of ownership and control in larger firms cause issues?
This is due to differing objectives of different stakeholders
The owners will want to maximise the returns on their investment so will want to short run profit maximise.
● However, directors and managers are unlikely to want the same thing: as employees, they will want to maximise their own benefits.
What is the principle agent problem?
This is the principal agent problem, where one group, the agent, makes decisions on behalf of another group, the principal. In theory, the agent should maximise the benefits for those whom they are looking after but in practice agents have the temptation to maximise their own benefits. It is for this reason that many firms are not run to profit-maximise but to profit satisfice; a concept looked at in unit 3.2. The issue could be overcome by giving managers shares in the business or linking their bonuses to profits, this will mean that they personally will gain from higher profits.
What is an extreme example of the principle agent problem?
An extreme example of this problem is the Enron Scandal (2001). The executives used loopholes to hide billions of dollars in debt from the Board of Directors. The shareholders filed a lawsuit to the firm and the executives when share prices fell from nearly $100 to less than $1 in just over a year.
What is the private sector?
● The private sector refers to that part of the economy that is owned and run by
individuals or groups of individuals, including sole traders and PLCs.
What is the public sector?
The public sector refers to that part of the economy which is owned or controlled by local or central government. The purpose of these organisations is to provide a service for UK citizens and profit making is not their main aim, some may even make a loss which is funded for by the taxpayer.
How can the private sector be split down further?
They can be split into profit and not-for-profit organisations. Almost all private sector organisations are run to make a profit and to maximise the financial benefits for their shareholders. They may not necessarily profit-maximise, but their long term goal is to make money.
Some private sector organisations are not-for-profit. Any profit they do make is used to support their aim of maximising social welfare and helping individuals and groups. These organisations include charities and smaller organisations who aren’t large enough to be classified as charities.
What is organic growth?
Organic growth is where the firm grows by increasing their output, for example increased investment or more labour. They may open new stores, increase their range of products etc. Almost all growth of firms is organic.
A good example of this is Lego.
What are the advantages of organic growth?
● Integration is expensive, time-consuming and high risk, with evidence suggesting that the long-term share price of the company falls following integration. Firms often pay too much for takeovers and integration is often poorly managed with many key workers tending to leave after the change.
● The firm is able to keep control over their business.
What are the disadvantages of organic growth?
● Sometimes another firm has a market or an asset which the company would be unable to gain through organic growth. For example, integration would allow a European company to expand into the Asian market which it has no expertise in.
● Organic growth may be too slow for directors who wish to maximise their salaries.
● It will be more difficult for firms to get new ideas.
What is integration?
Integration is growth through amalgamation, merger or takeover. A merger or amalgamation is where two or more firms join under common ownership whilst a takeover is when one firm buys another.
What is vertical integration?
Vertical integration is the integration of firms in the same industry but at different stages in the production process. If the merger takes the firm back towards the supplier of a good, it is backwards integration. Forward integration is when the firm is moving towards the eventual consumer of a good.
What is a good example of vertical integration?
Tesco’s £3.7bn takeover of Booker in 2018 is an example of vertical integration. It has led to an increase in sales for Tesco.
