Topic 2.1 - Growing the Business pt.1

Question 1

organic growth

Answer 1

When expansion takes place from within a business, for example by expanding the product range, or number of locations .

Question 2

market share

Answer 2

The percentage of the total market revenue that a single firm has e.g. Costa had an 8% market share of ‘out-of-home’ coffee in the UK in 2020

Question 3

Unit cost

Answer 3

The total cost of producing one unit of output

Question 4

product diversification

Answer 4

Occurs when a firm is able to increase the number of products that it offers

Question 5

retrenchment

Answer 5

a business scaling down its operations as it evolves

Question 6

3 ways a business will retrench

Answer 6

• Reducing the size of the workforce
• Closing less profitable outlets
• Exiting existing markets

Question 7

what is the purpose of retrenchment

Answer 7

• to reduce costs
• so the business will break even
• to ensure survival

Question 8

5 things a business can do to stimulate organic growth

Answer 8

any 5 from:
- Gaining a greater market share
- Product diversification
- Opening a new store
- International expansion (new markets)
- Investing in new technology/production machinery

Question 9

advantages of organic growth (3)

Answer 9

• The pace of growth is manageable
• Less risky as growth is financed by profits
• The management knows & understands every part of the business

Question 10

disadvantages of organic growth (3)

Answer 10

• The pace of growth can be slow and frustrating
• Not necessarily able to benefit from lower unit costs (e.g. bulk purchasing discounts from suppliers) no economies of scale since business is smaller
• Access to finance may be limited

Question 11

merger

Answer 11

when two or more companies combine to form a new company

The original companies cease to exist and their assets and liabilities are transferred to the newly created entity

Question 12

takeover

Answer 12

when one company purchases another company, often against its will

The acquiring company buys a controlling stake in the target company’s shares (>50%) and gains control of its operations

Question 13

why would a company pursue mergers or takeovers? (5)

Answer 13

Strategic fit
A company may acquire another company to expand into new markets, diversify its product offerings, or gain access to new technology E.g. in 2010 Kraft Foods purchased Cadbury’s to increase its product offering and expand business sales in the United Kingdom

Lower unit costs
Larger companies are able to achieve lower unit costs as they receive many benefits from being large (e.g. bulk purchase discounts on supplies and better interest rates from banks on loans)

Synergies
Synergies are the benefits that result from the combination of two or more companies, such as increased revenue, cost savings, or improved product offerings

Elimination of competition
Takeovers are often used to eliminate competition and the acquiring company increases its market share. E.g. Meta, the parent company of Facebook purchased WhatsApp in 2014 and continued to run the messaging service alongside their own Facebook Messenger

Shareholder value
Mergers and takeovers can also be used to create value for shareholders. By combining companies, shareholders can benefit from increased profits, dividends and higher stock prices

Question 14

dividends

Answer 14

A sum of money paid each year by a company to its shareholders from its profits

Question 15

two ways of inorganic growth (as in vertical, backward etc

Answer 15

vertical integration (forwards or backwards)
horizontal integration

Question 16

inorganic growth

Answer 16

when a firm experiences growth by integrating with another company (via a merger or a takeover)

Question 17

vertical integration

Answer 17

Refers to a merger/takeover of another firm in a different stage of the production process
e.g: a supplier merging with a retailer

Question 18

horizontal integration

Answer 18

A merger/takeover of a firm at the same stage of the production process e.g ice cream manufacturer buys another ice cream manufacturer

Question 19

forward vertical integration

Answer 19

Forward vertical integration involves a merger or takeover with a firm further forward in the supply chain
E.g. A dairy farmer merges with an ice cream manufacturer

Question 20

backward vertical integration

Answer 20

Backward vertical integration involves a merger/takeover with a firm further backwards in the supply chain
E.g. An ice cream retailer takes over an ice cream manufacturer

Question 21

pros of vertical integration (4)

Answer 21

Reduces the cost of production as middleman profits are eliminated

Lower costs make the firm more competitive

Greater control over the supply chain reduces risk as access to raw materials is more certain

Forward integration can increase brand visibility

Question 22

cons of vertical integration (4)

Answer 22

There may be unnecessary duplication of employee or management roles

There can be a culture clash between the two firms that have merged

Possibly little expertise in running the new firm results in inefficiencies

The price paid for the new firm may take a long time to recoup

Question 23

pros of horizontal integration (5)

Answer 23

The rapid increase of market share

Reductions in the cost per unit due to receiving more beneficial terms for bulk purchases (economies of sale)

Reduces competition

Existing knowledge of the industry means the merger is more likely to be successful

The firm may gain new knowledge or expertise

Question 24

cons of horizontal integration (2)

Answer 24

Unit costs may increase (for example: due to unnecessary duplication of management roles)

There can be a culture clash between the two firms that have merged

Question 25

stock market floatation

Answer 25

Occurs when a business becomes a public limited company and seeks to raise capital by selling shares to the public on a stock exchange such as the Londons Stock Exchange. This initial sale of shares is called an initial public offering (IPO)

Question 26

initial public offering (IPO)

Answer 26

the initial sale of shares of a PLC on a stock exchange

Question 27

pros of PLC (5)

Answer 27

• Significant amounts of capital can be raised very quickly
• The risks associated with ownership are spread among a larger group of shareholders
• value of company shares can increase easily
• company will have a board of directors made up of individuals from outside of the company management, and representatives from major shareholders, which can extend decision-making process
• increased visibility with customers, suppliers, investors -> helps company attract more business

Question 28

cons of PLC (5)

Answer 28

• Increased Regulation
• Loss of Control: board of directors has power (founders lose complete control)
• Costly to Set Up: IPO, legal + accounting advice
• Market Pressure: PLCs are expected to deliver consistent growth and profits to shareholders
• Risk of hostile takeover

Question 29

capital expenditure

Answer 29

spending on fixed assets such as equipment, buildings, IT equipment and vehicles

Question 30

revenue expenditure

Answer 30

spending on raw materials or day to day expenses such as wages or utilities

Question 31

internal sources of finance (3)

Answer 31

• retained profits
• owner’s personal savings
• sale of assets

Question 32

opportunity cost

Answer 32

the loss of alternative choices when one choice is chosen (e.g: reinvesting retained profit means that shareholders do not receive dividends for their investment)

Question 33

assets

Answer 33

resources owned by a business

Question 34

pros of internal finance (4)

Answer 34

Internal finance is often free (e.g. it does not involve the payment of interest or charges)

It does not involve third parties who may want to influence business decisions

Internal finance can usually be organised very quickly and without significant paperwork

Businesses that may fail credit checks (necessary for a bank loan) can access internal finance sources more easily

Question 35

cons of internal finance (3)

Answer 35

There is a significant opportunity cost involved in the use of internal finance e.g. once retained profit has been used it is not available for other purposes

Internal finance may not be sufficient to meet the needs of the business

Using an internal finance method is rarely as tax-efficient as many external methods e.g. loan repayments may be treated as a business cost and offset against tax bills

Question 36

external sources of finance (2)

Answer 36

• bank loans
• share capital

Question 37

pros of bank loans (2)

Answer 37

Bank loans are usually unsecured and are typically repaid over two to ten years

Interest rates are fixed for the term of the loan so repayments are made in equal instalments - which helps with business planning

Question 38

cons of bank loans (1)

Answer 38

Interest is payable and the business assets are at risk if the business does not make repayments as planned

Question 39

pros of share capital (2)

Answer 39

Large amounts of money can be quickly raised from wealthy investors (especially when becoming a public limited company)

Shareholders who buy a large amount of shares may also bring and share expertise which can be beneficial to the business

Question 40

cons of share capital (3)

Answer 40

Shareholders are the owners of shares and they are entitled to a share of the company’s profit when dividends are declared

Shareholders usually have a vote at a company’s Annual General Meeting (AGM) where they can have a say in the composition of the Board of Directors -> loss of founder control

risk of hostile takeover