3.1.2 Business growth

Who are the CMA + what do they do?

An independent UK government department responsible for promoting competitive markets and enforcing consumer protection laws

What is X-inefficiency?

X-inefficiency is when a firm does not minimise its average costs, meaning it produces at a higher cost than technically possible due to a lack of competitive pressure

What is Dynamic Efficiency?

Dynamic efficiency when a firm invests in research and development (R&D), innovation, and new technology over time to improve products and reduce costs in the future

How do businesses grow?

• Organic growth 

• Forward and backwards vertical integration 

• Horizontal integration 

• Conglomerate integration

Define organic growth

Internal growth → increasing output by reinvesting profits, selling shares or borrowing loans from banks

What are the advantages of organic growth? (3)

• Less risk than inorganic growth

• No redundancy costs (e.g. duplicate roles)→ less wasted resources

• Less likely to receive CMA attention

What are the disadvantages of organic growth? (2)

• Very slow

• Might find it difficult to access finance (loans) if they do not have collateral → banks will see high risk

Define inorganic growth

External growth → increasing output via mergers or acquisitions

What are the 3 types of inorganic growth?

• Vertical integration

• Horizontal integration

• Conglomerate integration

Define Vertical Integration (2)

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

• Two types

  • Forward vertical integration

  • Backward vertical integration

What is the difference between forwards and backwards vertical integration? 

• Forwards vertical integration → Merger with a firm that is closer to the consumer

• Backwards vertical integration → Merging with a firm that is closer to the supplier (primary product)

What are the advantages of vertical integration? (4)

• Control of the supply chain → can prevent competitor firms from entering the market → increased market power

• Reduces intermediary costs

• Better access to consumers + raw materials

• Economies of scale → increased efficiency

What are the disadvantages of vertical integration? (3)

• Diseconomies of scale

• Control of suppliers = increased barriers to entry → could lead to a less efficient market since the firm has little incentive to reduce costs = x-inefficiency

• Lack expertise = inefficiency

Define Horizontal Integration

The integration of ​firms in the same industry at the same stage of production

What are the advantages of horizontal integration? (3)

• Increased market share → reduced competition as a competitor is taken out

• Internal economies of scale

• Increased expertise

What are the disadvantages of horizontal integration? (3)

• Could lead to diseconomies of scale due to 

  • Communication problems → difficult to maintain effective communication across a large organisation

  • Staff are demotivated, alienated and become difficult to manage

  • Corporate bureaucracy creates extra layers of management → average costs begin to rise at a faster rate

• Redundancy costs due to duplications 

• Could lead to CMA intervention if the firm is found to be too large → e.g. JD Sport and Footasylum were forced to demerge by the CMA

Define Conglomerate Integration

The integration of firms in different industries

What are the advantages of conglomerate integration? (3)

• Internal economies of scale → risk bearing economies of scale

• Knowledge transfers → dynamic efficiency

• Size of a conglomerate makes it easier to obtain finance

What are the disadvantages of conglomerate integration? (5)

• Firm is unlikely to have the expertise of a new market → reduced performance

• Hard to use technical or purchasing economies of scale when selling different products

• Ethos and culture may be different → E.g. Elon Musk purchasing Twitter

• Potential for asset stripping (when a company buys another business mainly to sell its valuable assets and make short-term profit from those sales, rather than invest in or develop the acquired firm)

• Diseconomies of scale

What are the 4 constraints on business growth?

• Size of the Market

• Access to Finance

• Owner Objectives

• Regulation

Explain “size of the market” as a constraint of business growth

Very difficult for firms to expand in small market due to a fixed amount of demand for a product, so economies of scale are virtually impossible to exploit

Explain “access to finance” as a constraint of business growth

Banks only lend to large companies with collateral → High-interest rates for small companies

Explain “owner objectives” as a constraint of business growth

Some owners may choose not to expand because they are satisfied with their current profit levels as growth often involves greater risk, increased workload, and more complex management, which owners may wish to avoid

Explain “regulation” as a constraint of business growth

CMA and licences → Business activity in Britain is tightly regulated to prevent too much growth

How does the CMA maintain competition when firms merge? (3)

• If one firm gains too much market share, they have more market power/ price inelastic demand → firms can raise prices and achieve higher revenues/profits, leading to lower consumer surplus

• Mergers and acquisitions which create 25% or more market share are investigated and can be blocked, e.g. Asda and Sainsbury’s

• Sometimes CMA allows → Virgin and O2

What are the problems faced by the CMA? (4)

• Time lag → investigation can take years 

• Asymmetrical information → The CMA may not have enough information to determine combined market share

• Regulatory capture → The CMA has limited resources to investigate

• Difficult to regulate companies based abroad