Business Growth (3.1)

Why some firms tend to grow

• Profits: To generate higher total profits, providing shareholders with a better return on their investment

• Costs: Larger firms can benefit from economies of scale, resulting in lower C.O.P

• Market power: Larger firms have more dominant forces within the market, enabling them to keep out potential threats and control prices

• Reducing risk: Firms may want to diversify, ensuring they still generate sales, revenue and profit levels in another market if sales fall in the other

• Magerial motives: Senior managers may wish to grow in order to control a larger business

Why some firms tend to remain small

• Lack of finance for expansion

• Avoiding diseconomies of scale

• Providing niche products which have a low PED or high YED

• Offering a more personal service which requires you to get to know consumers and their needs

Divorce of ownership from control

Shareholders own the business and appoint directors and managers to run it on their behalf

The core conflict of objectives between shareholders and managers

Shareholders want to maximise profits to maximise their dividends, whereas managers might have different motives, such as increasing sales revenue at the expense of profits

The principal-agent problem

The principal is the shareholder and the agent is the manager. Their divergent aims can lead to the business growing larger than a profit-maximising firm would desire

How businesses grow

• Organic growth

• Horizontal integration

• Vertical integratin

Organic business growth

Growth achieved internally through reinvesting profits or borrowing

• Used to increase market share, produce innovative products, or expand production

Horizontal integration

A merger between two firms at the same stage of production in the same industry

• Motives: Increase range of products, increase market share, and achieve economies of scale

Vertical integration

A merger between two businesses at different stages of production in the same industry

• Motives: Increase barriers to entry, increase control over markets/suppliers, and to ensure a smoother production process

Forward vertical integration

Integration with a firm at a stage of production closer to the consumer

Backward vertical integration

Integration with a firm at a stage of production further away from the consumer, moving back down the supply chain

Conglomerate integration

A merger between two businesses in completely unrelated industries

Key benefits of vertical integration

• Greater control over the supply chain reduces costs and increases profits, which can be used to improve product quality.

• Greater access to raw materials, ensuring reliability and consistency of supply

Limitations of vertical integration

• Different corporate cultures and conflicting targets leading to diseconomies of scale

• Cost savings not being passed onto consumer via lower prices

• Increased barriers to entry limiting potential new entrants

Key benefits of horizontal integration

• Ability to exploit economies of scale and lower average costs

• Rationalisation to increase efficiency

• Spreading risk to minimise losses

• Reduced competition leading to higher market share and profit

Limitations of horizontal integration

• Culture clashes causing diseconomies of scale

• Higher market competition reducing consumer choice and increasing prices (worsening consumer welfare)

• Potential job cuts during operational rationalisation

Key benefits of conglomerate integration

• Risk reduction as losses in one market are offset by profits in another

• Ability to derive technical and managerial economies of scale by sharing knowledge across markets

Limitations of conglomerate integration

• Skill requirements across different industries can be costly to acquire

• Cultural differences can lead to significant diseconomies of scale