1.5 (internal and external economies and diseconomies of scale)

Economies of scale

economies of scale refers to the reductions in average unit cost as a business increases in size. This refers to increasing the scale of operations and becoming more efficient.

diseconomies of scale

Sometimes a business experiences inefficiencies as it becomes larger, this is called diseconomies of scale, which refers to the increase in average unit cost as the business increases in size.

internal economies of scale (efficiencies that the business itself can make)

• Technical economies- bigger units of production can reduce costs because of the law of variable proportions- increase in variable costs spread against a set of fixed costs.

• Financial economies- large firms can borrow larger amounts of money at lower rates of inerest because large organizations are less risky.

• managerial economies- managerial roles lead to more efficiency in the business.

• specialization economies- dividing further, but in labor not in management roles

• marketing economies- large firms can benefit from lower average cost by selling in bulk, thus benefitting from time savings and transaction costs.

• purchasing economies- large firms can also lower their average costs by buying resources in bulk.

• Risk-bearing economies- firms with diversified portfolios of products in different markets can spread their fixed costs across a wide range of operations.

external economies of scale ( efficiencies that the business achieves because of something else)

• technological progress- leads to higher levels of productivity.

• improved transportation networks- allows for prompt deliveries and lesser chances of being late to work

• abundance of skilled labor in a specific area.

• regional specialization- a particular location or area highly regarded and trustworthy reputation for producing a good or service.

internal diseconomies of scale (inefficiencies that the business faces because of themselves)

• as a firm becomes larger, it lacks control and coordination as the span of control leads to communication problems

• poorer working relations- alienation and detachment between workers.

• Productive efficiency could fall due to workers becoming bored with performing the same repetitive tasks.

• Bureaucracy- likely to increase as a business grows. increases the decision-making time

• complacency, which can lead to reduced productivity levels.

external diseconomies of scale (inefficiencies that the business has no control of)

• too many business located in the same area, can lead to higher rents

• since workers have greater choice from a large number of employers, businesses might have to offer higher pay and financial rewards.

• traffic congestion results from too many businesses being located in an area. This leads to delayed deliveries and more staff being late to work.

Internal growth

Occurs when a business grows organically, using its own resources and capabilities to increase the scale of its operations and sales revenue.

Internal growth methods

• Changing the price of a product

• improved promotion

• improvement in product

• placement

• Buy now pay later schemes

• increased capital expenditure

• improved training and development

• better value for money due to internal growth

advantages of internal growth

1. better control and coordination → easier to rely on self than other

2. relatively inexpensive (compared to external growth)

3. maintains corporate culture

4. Less risky (compared to external growth)

Disadvantages of internal growth

1. Diseconomies of scale → higher average cost due to internal growth (added complexities in hierarchal structure)

2. The need to restructure → lots of time effort and money goes into this.

3. Dilution of control and owner ship → more owners = more conflicts and time in decision-making

4. Slower growth (in comparison to external growth)

External growth

Occurs through dealings with outside organizations rather than from an increase in the organizations own business operations.

examples→ M&A’s, takeovers, joint ventures, strategic alliances, or franchising.

advantages of external growth

1. quicker than organic growth → helps to diversify

2. synergies → benefit from more resources available

3. reduced competition → quick way to raise market share

4. economies of scale → allows businesses to gain access to larger markets

5. spreading of risks → due to diversification

disadvantages of external growth

1. more expensive (compared to internal growth)

2. more risk (compared to internal growth)

3. regulatory barriers → can be blocked by the government

4. potential diseconomies of scale → inefficiency=increased AC

5. organizational culture clash → culture clash among differing firms.

5 ways to measure size of a business

1. Market share

2. Total sales revenue

3. size of workforce

4. profit

5. capital employed

benefits of being a large business

1. economies of scale → bigger company = more cost-savings

2. lower prices → due to economies of scale

3. brand recognition → global brand recognition

4. brand reputation → more trusted

5. value-added services → larger firms have the resources to provide more services

6. greater choice → larger firms can provide more choice for their customer.

7. customer loyalty → more customer loyalty (due to size and workforce)

benefits of being a small business

1. cost control → diseconomies of scale can form due to lack of control from being too big.

2. loss of control → external growth could result in loss of ownership

3. financial risks → large businesses take on more risks

4. government aid → financial support is given to small companies

5. local monopoly power → advantage of being the only business in a certain location.

6. Personalized services → smaller firms have more time to devote to customers

7. flexibility → small businesses tend to be more responsive and adaptive to change

8. small market size → some businesses are unlikely to attract the attention of large firms.

5 External growth methods

1. Mergers and acquisitions

2. takeovers

3. joint ventures

4. strategic alliances

5. franchising

Mergers and acquisitions

refers to the integration of two or more businesses to form a single company

Mergers

this takes place when two or more firms agree to create a new company with its own legal identity

acquisition

occurs when a company buys a controlling interest in another firm. this means that the acquiring company buys enough shares in the target company to hold a majority stake.

4 different types of integration from M&A activity

1. Horizontal integration → integrating with a company in the same industry

2. vertical integration → forward vertical integration is integration with businesses that head towards the customer
   Backward vertical integration is integration with businesses towards the supplier.
   Same industry different stages of production.

3. Lateral integration → integration between firms with similar operations but in different industries.

4. conglomerate→ diversification (businesses in different markets and production processes)

6 Advantages of M&A activity

• Greater market share → integrated company to benefit from market power

• Economies of scale → larger scale operations

• Synergy → The use of combined resources to increase productivity, sales revenue and profits

• survival → stronger position to compete with rivals

• gain entry into new markets → only achieved if companies in the deal operate in different markets.

• diversification → allows to diversify product portfolio and adhere to larger customer base

6 disadvantages of M&A activity

• redundancies → job losses due to cost savings in M&A’s

• conflict → conflict is inevitable

• culture clash → need to adapt to new settings

• loss of control → restructuring and loss of power for old BOD

• diseconomies of scale → increased bureaucracy may lead to inefficiencies.

• regulatory problems → governments may prevent M&A (if too much market power)

Takeovers/hostile takeovers

Occurs when a company buys a controlling stake in another company without the permission of the company or BOD.

reasons why businesses takeover other businesses

• They see potential for growth through funding

• seen as a small rival with potential growth

• widely recognised name but face liquidity or financial crisis.

• vulnerable due to drop in profits.

Joint ventures

occurs when two or more businesses split the costs, risks, control and rewards of a project.

7 advantages of joint ventures

1. synergy → the pooling of experience create synergies.

2. spreading of costs and risk → financial costs are shared in a JV, reducing financial burden

3. entry to foreign markets → JV allows companies to enter foreign markets by forming an agreement with local firms

4. relatively cheap → cheaper to establish and easier to pull out of

5. competitive advantages → competition is reduced, make them stronger against other competitions

6. exploration of local knowledge → firms that expand internationally can take advantage of each other’s local knowledge

7. high success rates → tend to be friendly and well received by key stakeholders.

disadvantages

heavy reliance on couterparts.

culture clashes

strategic alliance

two or more businesses cooperate in a business venture for mutual benefit. They operate as independent organizations.

steps to form a strategic alliance

1. feasibility study

2. partnership assessment

3. contract negotiations

4. implementation

Franchising

a form of business ownership whereby an individual or business buys a license to trade using another company’s products, name, logos, brands and trademark.

benefits for the franchisor

• rapid growth without large risk

• allows to have national or international presence without too many additional costs

• growth without running costs

• receive royalty payments

• Franchisee’s have more incentives to do better

benefits for the franchisee

• there are relatively low start-up costs

• low risk due to tried and tested method

• the franchisor will support the franchisee

• benefits from large-scale advertising used by franchisors

• their own bosses.

drawback for franchisor

• franchisees can damage the reputation of the business

• difficult to control the operations

• not as quick as other external growth methods

drawback for franchisee

• Restricted by the franchisor’s ideas.

• very expensive to buy a franchise

• lot of money paid on royalty.