Unit 3: Chapter 1 - The birth and growth of firms Flashcards
What are ways in which you can measure the growth of a company?
Internet traffic, sales volume, market capitalisation, revenue, size of investments, profit, number of employees, number of markets operated in (product and geographic), market share, number of outlets and number of customers
What are the stages of a product?
Raw materials, manufacturers, retailers
What is horizontal integration?
Occurs when two business in the same industry merge, at the same stage of production
What is an example of horizontal integration?
Electricity distributer and gas distributer
What are the advantages of horizontal integration?
Eliminate competitors and gain market power, increases market share and pricing power; rationalisation - can eliminate duplications (may not need the same worker twice); synergies i.e. pooling resources can give a greater combined output; gain economies of scale as the size of the business increases, improved competitiveness and profits; create a wider range of products (diversification)
What are economies of scale?
When long run average cost (LRAC) falls as a firm increases its size output
What are the disadvantages of horizontal integration?
Gain diseconomies of scale; culture clash between the merged firms - can lose focus and productivity
What are diseconomies of scale?
LRAC rises as output increases
What is vertical integration?
The joining of two firms in the same industry but at different stages of production
What is an example of forwards vertical integration?
A car manufacturer purchasing a car dealership
What is backwards vertical integration?
Taking over a firm in a preceding stage of production
What is forwards vertical integration?
Taking over a firm in the next stage of production - gets closer to the consumer
What are the advantages of vertical integration?
Greater control of supply chains helps to reduce costs and improve quality of inputs; better control over retail distribution channels e.g. pub companies can ensure beers are sold in tenanted clubs; improved access to raw materials used in manufacturing
What are the advantages of backwards vertical integration?
Eliminate third party profit; gain control over a supplier - can guarantee the continued survival of the firm and can stop selling to rivals
What are the advantages of forward vertical integration?
Can guarantee a continued retailer of a product
What are the disadvantages of vertical integration?
Risk of entering an unknown market (operating outside core competence)
What is conglomerate integration?
The joining of two firms in completely unrelated markets - there is no link along the chain of production
What are the advantages of conglomerate integration?
Spread risks - use cross subsidisation; lowering risk by diversifying and smoothing out earnings
What are the disadvantages of conglomerate integration?
Risk of entering an unknown market - operating outside core competence
What is lateral integration?
Integration between firms that are in different but related industries
What are examples of lateral integration?
Google and Youtube; Skype and Ebay
What are demergers?
Firms that have previously merged split up into two different companies again
Why does a demerger occur in terms of lack of synergies?
This occurs when one part of a firm is having no beneficial impact in terms of its effect on the more efficient and profitable running of another part of the firm
Why does a demerger occur in terms of diseconomies of scale?
Management could struggle to run different parts of the firm with little in common
Why does a demerger occur in terms of price?
It is possible that the price of a demerged firm may be higher than that of a single bigger merged firm as a relatively inefficient part of one firm could drag down the share price of the whole company
Why does a demerger occur in terms of focused companies?
High profits might be obtained by increased knowledge and exploitation of a limited range of markets, big profits are more likely to be made if you are the market leader so it might be advantageous to divest (sell off) those bits of the company that don’t fit in with the other core activities, those parts sold off could then become more successful than they were previously as management could now have time and expertise to nurture them
How can firms grow?
Selling more to their existing customers (market penetration) and selling to new customers in new markets: geographical and product (diversification)
What is internal growth?
Also known as organic growth, where the firm increases the sales and total revenue of its existing business
How can internal growth be achieved?
Increasing investment or taking on more workers as this leads to an expansion of output; ploughing profits back into the firm to increase capacity; borrowing money from banks (debt), issuing shares (equity); product development: increasing the product portfolio by selling new products or services to existing markets; diversification: selling new products or services to new markets
What are the benefits of internal growth?
It is a long term strategy and it is a lower risk strategy than inorganic growth as it is building on the company’s strength to increase sales
What is external growth?
Also known as inorganic growth, it is a faster route to take an increasing share of a market through external methods or integration i.e. through mergers or takeovers
What are mergers?
Two firms agreeing to join together
What are acquisitions?
One firm buying another - may be amicable or hostile
Why are there no pure monopolies?
There is no market where a firm can achieve a minimum efficient scale that meets 100% of its demand, creating a monopoly position would be too expensive due to the diseconomies of scale that would result
Why do some firms grow large in terms of economies of scale?
Average costs fall only as firms grow large so growth is required in order to be price-competitive and beat your rivals
Why might a firm feel a pull towards expansion?
Due to the pressures of competition, the need to achieve economies of scale and the effects of mergers and takeovers across many industries
Why do some firms grow large in terms of entry barriers?
These prevent new firms entering the market and it enables existing firms to grow and take all market share
Why do some firms remain small in terms of economies of scale?
Economies of scale may be small relative to the market size (especially with the internet) and it allows smaller firms to have the same cost advantage as large firms in reaching out to customers
What are small firms important for?
Employment, innovation and exports
Why do some firms remain small in terms of diseconomies of scale?
Diseconomies of scale suffered by large firms e.g. poorly organised firm leading to organisational slack and X-inefficiency
Why do some firms remain small in terms of the market structure?
The fall in performance associated with expanding production due to economies of scale
Why do some firms remain small in terms of informal labour markets?
Small firms often use informal labour markets e.g. hiring non-unionised workers - less likely to demand pay rises and paying cash in hand to avoid income taxes makes lower wages possible
Why do some firms remain small in terms of entry barriers?
Entry barriers may be low
Why do some firms remain small in terms of personal services?
Customers may prefer a more personal service which can only be provided by a small owner-managed firm, customers value staff who can remember them and their individual preferences
Why do some firms remain small in terms of niche industries?
They are very specialised markets and can perform better than bigger firms, small firms produce vital components for larger firms as well as meeting the needs of niche markets
How is the competition commission involved in a takeover?
If a takeover is really large then it will need to be cleared by the competition commission
What are the characteristics of a sole trader?
The owner has unlimited liability; personally liable for all debt
What are the characteristics of a partnership?
Partners draw up legal documents - Memorandum of Association and Articles of association; outlines responsibilities and liabilities of all partners
What are the characteristics of a private limited company?
Owners have limited liability; registered with Companies House and receive a certificate of corporation; issue shares to raise capital but only to private individuals in return for a share of the profits
What are the characteristics of a public limited company?
Have limited liability; issue shares to any member of the public in order to raise capital; “float” shares on the stock market; more accountable as must publish all financial accounts and hold AGMs where any shareholder can attend; can exist a divorce of ownership and management which can lead to conflicting objectives and potential issues with asymmetric information
What is the cost motive for growth?
Economies of scale have the effect of increasing the productive capacity of the business and they help to raise profit margins through the lowering of long run average costs, also gives a business a competitive edge
What is the profit motive for growth?
Larger scale enterprises grow to expand output and achieve a higher level of profit; stimulus is provided by the demands and expectations placed on a business by the capital (stock) markets, valuation is influenced by profit streams and expectation of future sales; falling share prices increases the risk of a hostile takeover and makes it harder and more expensive for a company to raise financial capital by issuing new shares onto the market
What can be reflected in a company’s market capitalisation?
If a company achieves disappointing growth figures
What is the market power motive for growth?
Increase market dominance therefore increasing pricing power; monopolies can engage in price discrimination
What is the risk motive for growth?
Diversify production; falling sales in one market may be compensated by healthier demand and output in another market
What is the managerial motive for growth?
Decisions and strategies of managers may be different to what those who have an equity stake in the business want
What is the brand motive for growth?
The importance of a brand can stimulate a firm to seek growth
What is an evaluation of mergers in terms of efficiency?
If average cost falls, then productive efficiency has been gained and if better quality goods are produced then allocative efficiency has increased, however competition may have reduced
What is an evaluation of mergers in terms of cost?
Often huge financial costs of funding takeovers including the burden of deals that have relied heavily on loan finance
What is an evaluation of mergers in terms of bad timing?
Mergers that take place towards the end of an economic boom
What is an evaluation of mergers in terms of asset-stripping?
Mergers resulting from asset-stripping have often been controversial since a company’s market price might not be an accurate reflection of true social value and short run profit maximisation by one company may well not lead to an economically efficient outcome for society
What is outsourcing?
The transfer of significant parts of a company’s production operations overseas
Why do firms outsource in terms of technological change?
Information, communication and telecommunication costs are falling which makes it easier for outsourcing to happen
Why do firms outsource in terms of increased competition?
Increased competition in a low inflation environment increases pressure on businesses to achieve lower unit costs as a means of maintaining market share
Why do firms outsource in terms of profitability?
Pressure from financial markets for businesses to improve their profitability - clear cost advantages to have call centres located abroad
Why do manufacturing businesses outsource?
It reduces costs; provides greater flexibility of production levels at times of volatile demand and also in speeding up the time it takes to get their goods to the market (especially if new); businesses can then concentrate on marketing their products and investing in research and development to develop new products through product innovation; contractors in manufacturing can exploit much greater economies of scale because they make similar products for other customers and can order components in larger numbers to achieve financial economies of scale; however businesses must be confident that contractors can guarantee to meet required production levels
