Theme 3.1 and 3.2: Business growth and objectives

Question 1

Why do firms grow?

Answer 1

-Make more sales and profit
-Gain monopoly power
-Owner’s objectives
- Diversify and enjoy risk bearing economies
-Exploit internal economies of scale

Question 1

Why do some firms not grow?

Answer 1

-Not enough finances
-Regulations put in place to stop firms from growing too big
-Niche markets
-Diseconomies of scale
-Profit satisfice

Question 2

What is organic growth

Answer 2

When firms grow by investing in themselves to increase output
E.g apple reinvested their profits to launch new products or a bank loan

Question 3

What is inorganic growth?

Answer 3

When firms grow by merging or acquiring another company
E.g. when Google bought YouTube for $1.6 billion in 2016 and then made money from YouTube’s ads

Question 4

What are the pros and cons of organic growth?

Answer 4

Firstly, using a bank loan or reinvesting profit to grow organically, a firm’s owner will keep control over the company. So the owner will take most of the firm’s profit.

However, if the owner grows organically by selling lots of shares, they will lose ownership to the shareholders. If the owner sets up many franchises, they will lose control to their franchise managers.

Secondly, organic growth is low risk because the firm expands by increasing its output in a market it is already familiar with and selling a good/service it is already good at producing. Inorganic growth is a much higher risk because a firm might move into a completely new market.

However, organic growth can also mean slower growth. Whereas a firm can grow very quickly inorganically by merging/acquiring

Question 5

Definition of vertical integration

Answer 5

Vertical integration is when a firm integrates with another firm at a different stage of the same production process.

Question 6

Definition of backwards vertical integration

Answer 6

When a firm integrates with another firm that is further away from consumers in the same production process

Question 7

Definition of forward vertical integration

Answer 7

When a firm integrates with another firm that is closer to the consumers in the same production process

Question 8

Definition of horizontal integration

Answer 8

Firms at the same stage of the production process join together

Question 9

Definition of conglomerate integration

Answer 9

When a firm merges with another firm in a different industry

Question 10

PROS of vertical integration

Answer 10

-Control of the supply chain - Can prevent other firms from entering the market, leading to huge profits. Prevents competition

-Removes intermediary costs - No middleman reduces extra costs

-Better access —> Increases quality and efficiency —> Increased profits

Question 11

CONS of vertical integration

Answer 11

-Regulation can ban vertical integration as controlling the supply chain can prevent competition —> exploits consumers by charging high prices

-Cost from diseconomies of scale and acquisition —> increases costs which reduces profits

-Firms may lack expertise of other markets —> Increases costs which reduces profits

Question 12

PROS and CONS of horizontal integration

Answer 12

Firstly, horizontal mergers can lead to economies of scale which reduce a firm’s LRAC, increasing their profit.
However, firms can also suffer from diseconomies of scale. Integrating with a new firm can lead to alienation; bureaucracy from the legal work involved in two firms integrating; and poor communication. These all increase a firm’s LRAC, decreasing their profit.

Secondly, horizontal integration can lead to rationalisation, when firms reorganise to avoid duplicated costs (e.g. only one accounting team will now be needed, not two).
However, rationalisation can lead to job losses because duplicated departments will be fired.

Thirdly, horizontal integration reduces wasteful competition because the two firms are now working together.
However, horizontal integration can lead to brand dilution if the firms’ brands are very different.

Question 13

Dairy Crest Group is a British food producer which uses a large amount of milk in its production processes to make dairy products. In March 2013, Dairy Crest Group bought Proper Welsh Milk, a firm which specialises in selling fresh milk. This takeover could lead to advantages of:

A) horizontal integration
B) backward vertical integration
C) forward vertical integration
D) conglomerate integration
E) external economies of scale

Answer 13

B

Question 14

PROS and CONS of conglomerate integration

Answer 14

Firstly, conglomerate integration can lead to risk-bearing economies. Integrating with an unrelated firm helps a firm diversify, reducing the cost of failure in one sector…because the firm will still make a profit in others.
However, firms can also suffer from diseconomies of scale. Integrating with a new firm you don’t even know can lead to alienation; bureaucracy from the legal work involved in two firms integrating; and poor communication, especially because the two firms are completely unrelated and will likely have very different attitudes. These internal diseconomies of scale all increase a firm’s LRAC, decreasing their profit.

Secondly, conglomerate integration can increase brand awareness. Consumers of one firm will become aware of the other, increasing both firms’ sales.
However, conglomerate integration can also lead to brand dilution, if one firm’s brand image negatively affects another. Like Pepsi diluting Quaker Oats’ healthy porridge image.

Thirdly, conglomerate integration can lead to knowledge transfers between firms which increases dynamic efficiency. Like the awesome tech Apple and Beats have innovated after conglomerately integrating.
However, conglomerate integration can fail if firms lack expertise. If Nando’s acquired Ferrari, Nando’s wouldn’t know how to run Ferrari so the business would fail.

Question 15

4 reasons for a demerger

Answer 15

Firstly, demergers reduce the size of the firm. This reduces diseconomies of scale, decreasing costs and increasing firm profits.

Secondly, by demerging, both firms can separate and specialise in their own goods/services, increasing productivity and quality, decreasing costs increasing sales, and growing firm profits.

Thirdly, by demerging, a firm can sell one of its divisions and its assets, to raise money. This will increase profits, which can be reinvested in other areas of the business to increase dynamic efficiency.

Fourthly, differences in culture within a firm can require a firm to demerge, to avoid conflicts between different departments. Reduced conflict will make workers happier, and more productive and increase profit.

Question 16

Explain the effects of a demerger on workers. (4 marks)

Answer 16

Workers will benefit from reduced cultural conflicts between different divisions with different attitudes. This will reduce tension, and increase productivity and job satisfaction, benefitting workers.

However, workers will suffer from lower job security. They won’t know which new division they’ll join after the demerger and if one of the divisions is sold to raise funds, workers may lose their jobs entirely.

Question 17

Explain the effects of a demerger on consumers. (4 marks)

Answer 17

Firstly, after demerging, each new smaller firm can specialise in their job, increasing efficiency, reducing costs and prices, but also increasing quality. This will benefit consumers.

However, if the demerged are too small, it might reduce economies of scale, increasing LRAC, so firms will have to put their prices up.

Question 18

Definition of Profit satisficing

Answer 18

Profit satisficing is when a company makes enough profit to satisfy its influencers, but then pursues other objectives (social, environmental, personal).