3.1) Business Growth

Reasons for Growth

• By growing, a firm will be able to experience economies of scale which helps them decrease their cost of production - can sell more goods and thus make more revenue, generating a larger profit (incentive)

• Growth = greater market share, therefore can influence prices and restrict entries into the market, boosting profits in 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

• Increased security as they will be able to build up assets and cash which can be used in financial difficulties + likely to sell a bigger range of goods in more than one local/ national market so will be less affected by changes to individual products or places

Reasons firms Stay Small

• Offer a more personalised service and focus on building relationships with their customers

• Provide a product that is in a niche market - smaller market size but can be very profitable

• High ability to respond quickly to changing customer needs/ preferences

• Rapid growth can cause diseconomies of scale, which can be difficult to deal with and so many owners choose to avoid these

• Owner’s goal is not profit maximisation but rather an acceptable quality of life (satisficing)

• Modern technology can work in favour of small-scale and personalised firms as the internet offers low cost access to the market and reduces the cost differential between mass produced and niche products

Principal Agent Problem

• Separation of ownership and control - firms are owned by shareholders and run by chief executive and senior managers (day to day decision making)

• Separation causes problems due to differing aims of the stakeholders - owners will want to maximise returns on their investment so will want to short-run profit maximise

• However, directors and managers are likely to aim to maximise their own benefits

• Hence, many firms run to profit satisfice

Public Sector

• The part of the economy which is owned or controlled by local or central government

• Purpose of these organisations is to provide a service for UK citizens and profit making is not the main aim - some may even make a loss which is funded by the taxpayer

Private Sector

• The part of the economy that is owned and run by individuals or groups of individuals, including sole traders and PLCs

• Self-interested - often profit maximising motif

Profit Organisations

• Almost all private sector organisations are run to make a profit and maximise the financial benefits for their shareholders

Not-for-profit Organisations

• Any profit made is used to support their aim of maximising social welfare and helping individuals/ groups

• Includes charities and smaller organisations who aren’t large enough to be classified as charities

Organic Growth

• Where firms grow by increasing their output, e.g. increased investment or more labour

• May open new stores, increase their range of products etc.

• E.g LEGO - introduce new products and ranges to expand their customer base

Advantages of Organic Growth

• Integration is expensive, time-consuming and high risk. Firms often pay too much for takeovers and integration is often poorly managed with many key workers tending to leave - hence organic growth is more attractive

• The firm is able to keep control over their business

Disadvantages of Organic Growth

• Sometimes another firm has a market or an asset which the company would be unable to gain through organic growth, e.g. 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

Integration

• Growth through amalgamation, merger or takeover

• Merger/ amalgamation is where two or more firms join under common ownership

• Takeover/ acquisition is when one firm buys another

Vertical Integration

• Integration of firms in the same industry but at different stages in the production process

Backwards Integration

• Integration with suppliers or producers (going backwards in the supply chain/ production process)

Forward Integration

• When the firm is moving towards the eventual consumer of a good (moving up the production process/ supply chain)

Advantages - Vertical Integration

• Increased potential for profit as the firm takes the potential profit from a larger part of the chain of production

• Less risks as suppliers do not have to worry about buyers not buying their goods and buyers don’t have to worry about suppliers supplying the goods

• With backwards integration, businesses can control the quality of supplies and ensure delivery is reliable + don’t have to worry about being charged high prices for suppliers, keeping costs low and allowing lower prices for consumers - increases competitiveness and sales

• Forward integration secures retail outlets and can restrict access to these outlets for competitors

Disadvantages - Vertical Integration

• Firms may have no expertise in the industry they took over, e.g. a car manufacturing company would have deep knowledge of car manufacturing but little knowledge of selling cars and vice versa

Horizontal Integration

• The merger of two firms in the same industry and the same stage of production

• E.g. AstraZeneca’s acquisition of ZS Pharma

Advantages - Horizontal Integration

• Helps reduce competition as a competitor is taken out and increases market share, giving firms more power to influence markets

• Firms will be able to specialise and rationalise, reducing the areas of the business which are duplicated

• The business is able to grow in a market where it already has expertise, which is more likely to make the merger successful

Disadvantages - Horizontal Integration

• Increase risk for business as if that particular market fails, they have nothing to fall back on and a lot of money to lose

Conglomerate Integration

• Where firms in different industries with no obvious connections integration

• They can sometimes be linked by common raw materials/ technology/ outlets

• E.g. Amazon and Whole Foods’ merger

• General Electric

Advantages - Conglomerate Integration

• Useful for firms where there may be no room for growth in the present market

• The range of products reduces the risk for firms and if a whole industry fails, they will still survive due to the other parts of the business

• Makes it easier for each individual part of the business to expand than if they were on their own as finance can be easily obtained and managers can be transferred from company to company within the firm

Disadvantages - Conglomerate Integration

• Firms are going into markets in which they have no expertise - can often be damaging for the business

Constraints of Business Growth - Size of the Market

• A market is limited to a certain size and so not all businesses are able to mass produce because their goods would not be bought by consumers (lack of demand)

• This can happen no matter how big the market is, and there will always be limits on growth

• In particular, niche markets and markets for luxury items or restricted prestige markets make it difficult for businesses to grow

Constraints of Business Growth - Access to Finance

• Firms use two main ways to finance growth - retained profits and loans

• If firms do not make enough profit or have to give out too much to shareholders, they will not be able to use retained profits to grow

• Banks may be unwilling to lend firms money, particularly smaller businesses that they see as high risk

• As a result, firms will be unable to grow as they can’t finance growth

Constraints - Owner Objectives

• Some owners may not want their business to grow any further as they are happy with their current profits and do not want the extra risk or work that comes with growth

Constraints - Regulation

• In some markets, the government may introduce regulation which prevents businesses from growing

• E.g. the UK gov. regulates the number of pharmacies in a local area and an existing pharmacy can only expand by buying another company. Competition law, which prevents monopolies, can restrict growth as any merger which creates a company with more than a 25% market share can be forbidden from taking place

Demergers

• A business strategy, in which a single business is broken into two or more components, either to operate on their own, or to be sold or to be dissolved

• E.g. Pepsi’s demerger of its Pizza Hut, KFC and Taco Bell restaurants to focus on competition with Coca Cola in 1997

Reasons for Demergers - Lack of Synergies

• This is when the different parts of the company have no real impact on each other and fail to make each other more efficient

• Lack of synergy means that managers are splitting their time between areas which are so different it could lead to diseconomies of scale; firms may split in order to avoid these diseconomies

Reasons for Demergers - Value of the Company/ Share Price

• Some companies demerge because the value of the separate parts of the company is worth more than the company combined

• This is because some parts of the business are operating well and have potential to grow but the overall value is brought down because of the lack of success or lack of potential for growth of other parts of the business

• Financial markets talk about ‘creating value’ by splitting up companies like this

Reasons for Demergers - Focussed Companies

• Some believe if the company and the management are more focussed on individual markets they become more efficient and successful, and make higher profits

• Management have limited time and skills and they are unable to spend the required time to make all areas of a huge diverse business successful

• By focusing on one area, managers can improve their skills and knowledge and become more successful

• They may also want to avoid attention from the competition authorities

Impacts of Demergers - Workers

• Workers could gain or lose through a demerger

• Separate firms may need their own managers and leaders, so people could get a promotion

• However, the goal of making the firm more efficient may result in job losses

Impacts of Demergers - Businesses

• Concentrating on a smaller core business may enable it to be more efficient and concentration may lead to more innovation and surviving higher competition

• However, the smaller size of the business could lead to a loss of economies of scale and reduce inefficiency

Impacts of Demergers - Consumers

• Again, consumers could gain or lose

• They may gain from innovation and efficiency, leading to better products and cheaper prices

• However, demerged firms may be less efficient through loss of economies of scale or raise prices/ reduce quality or range of goods as they become motivated by profits