Growth and Evolution

1.5 Oxford Textbook

Average Cost

Average Cost

the ratio of total cost of production to the number of items produced. 

Economies of scale

Economies of scale enables a business to benefit from lower average costs by increasing the size of its operations.

Optimal output level

Optimal output level is when the average cost of production is at its lowest level and profits are maximised. 

Risk economies

A large company can diversify its product lines to lower the average risk it faces. Not all product lines are likely to experience losses at the same time. 

Advertising

Raise awareness to consumers of products that are going to be sold.

Internal economies of scale

Internal economies of scale assist businesses in reducing minor expenses or lowering the average cost per unit: 

• Managerial economies

• Financial economies

• By products

• Technical economies

• Economies of inventory management

• Marketing economies

Managerial economies

Employing better qualified employees and managers who can make quicker and more profitable decisions. 

Financial economies

Creditworthiness of the borrower is considered by lenders when determining the rate of interest. 

By products

If waste production exceeds a certain threshold, a business may be able to manufacture specific by-products to increase revenue. 

External economies of scale

External economies of scale occur when the firm’s average cost of production falls as the industry as a whole grows. All firms benefit. Examples, location, connectivity of infrastructure, business regulation laws.

Diseconomies of scale

Diseconomies of scale occur when a firm grows beyond its ability to operate efficiently. 

Internal diseconomies of scale

Internal diseconomies of scale occur due to problems within the organisation. Can occur due to larger businesses having communication and coordination more difficult.

• Bureaucracy

• Organisational diseconomies

• Technical diseconomies

Bureaucracy

Bureaucracy refers to any combination of excessive corporate policies, procedures and paperwork. Gets in the way of doing things due to the rules, policies and procedures. 

Organisational diseconomies

Managing a large workforce may decline effective communication. Larger organisations risk isolating stuff making them feel demotivated which means lack of productivity. 

Technical diseconomies

• Inefficiencies in the production process. 

• Overcrowding can result in poor work conditions and reduces productivity.

• Lack of equipment and resources 

• New facilities have a less efficient production process with employees needing training and time to familiarise themselves with tools and equipment.

External diseconomies of scale

Raises the average costs of production of all businesses in the industry. Includes higher levels of rent, competition for scarce resources and traffic congestion/delays.

Reasons for a business to grow

• Survival

• Economies of scale

• Higher status

• Market leader status

• Increased market share.

Reasons for a business to stay small

• Greater focus

• Greater prestige (more profit, can charge more)

• Greater motivation

• Competitive advantage (provide a more personalised experience). 

• Less competition

Internal growth (organic growth)

• It happens slowly and steadily. 

• Can grow without taking too many risks. 

• Expands by selling more products or by developing its product range. 

• Most expansion is self financed from retaining profits.

External growth (fast track growth)

• Quicker and riskier method of growth. 

• The business expands by entering into some type of arrangement to work with another business. 

• Requires significant external financing. 

• Potential rewards increase market share and can decrease competition greatly.

Merger and acquisition (M & A)

• Merger is when two companies that are theoretically “equal” legally become one company. 

• Acquisition is when one company purchases a majority or all the shares of another company, taking it over. 

Both result in a bigger business

Takeover

An unwanted acquisition by a company.

Happens to publicly held companies.

Horizontal integration

Occurs when two businesses being integrated are not merely in the same broad industry, but in the same chain of production. For example, two supermarkets.

Vertical integration

Occurs when one business integrates with another at a different stage in the chain of production or when a business begins operations in an earlier stage through internal growth. 

Allows for reliable supply and reduce transaction costs

Backwards vertical integration

when a business gets involved in an earlier stage in the chain of production. Example, Apple buying a chip company.

Forwards vertical integration

occurs when one business integrates further forward in the chain of production. Example, a farmer opening a retail store.

Conglomeration

Occurs when two businesses in unrelated lines merge. Known as diversification and reduces overall corporate risk.

Joint venture

• Two businesses agree to combine resources for a specific goal and over a finite period of time.

• A separate business is created funded by two parent businesses. Once time is finished it may be gone or in one of the parents' business

• Good that two firms enjoy greater sales by still having their separate legal existence and different workskills. 

• Disagreement may arise. 

Strategic alliance

Similar to joint venture except may be multiple business, no new business is created but it lacks stability.

Franchises

An original business sells their concept and makes it more well known.

Franchisor

Original business

Franchisee

Right to offer the concept and sell the goods or services. Pay royalties to the franchisor.