1.5. Growth and evolution

Economies of scale

Fall in cost per unit at each and every level of output as the scale of a business's operation expands

Diseconomies of scale

Rise in cost per unit at each and every level of output when the scale of a business's operation expands

Internal economies of scale

Fall in cost per unit at each and every level of output when the scale of a business's operation expands within the firm's control inside the firm

Types of internal economies of scale

- Technical

- Financial

- Purchasing

- Marketing

- Managerial

- Specialization

- Risk bearing

Technical economies of scale

The fall in cost for sophisticated machinery or different technologies per unit of a product as the scale of outputs increases.

The machinery provides efficiency, productivity and quality to the product while spreading the high fix cost over the huge scale of output, affordable with expanded operation.

Specialization economies of scale

Falls in cost for hiring specialized human workforces for each unit of product as the scale of operation expands. The high fixed cost to hire workforces specialized to each stages of production process is spread over the huge scale of production. This increases productivity of the production and quality of the product

Purchasing economies of scale

Falls in cost for purchasing resources for each unit of product that occurs as the scale of production grows. Purchasing materials in bulk from suppliers allow to get a discount. While the cost is already spread over the huge scale of production, the discount lowers the total cost too.

Financial economies of scale

Large firms can borrow large sums of money at lower interest rates because they are seen as less risky financiers, resulting in the reduction of the costs of borrowing finance

Managerial economies of scale

Large firms divide managerial roles by employing specialist managers

Small firms are less able to do so. This results in a fall in average costs due to higher productivity

Marketing economies of scale

A situation where larger firms can lower the average unit cost of advertising and promotion, perhaps through access to more effective marketing media and increased scale of sales

Internal diseconomies of scale

Inefficient loss when a firm expands its capacity as the cost per unit increases, usually due to internal problems of mismanagement.

Types of internal diseconomies of scale

- Communication

- Coordination

- Motivation problems

External economies of scale

When the unit cost falls at each and every level of output as the factors outside of the business suggest efficiency

Types of external economies of scale

- Technical progress

- Improved transportation networks

- Abundance of skilled labor

- Regional specialization

Technical progress

Technological innovations increase productivity within an industry with significant cost savings.

e.g.) The internet has revolutionized business by offering e-commerce.

This offers cost savings as the location of premises can be in more affordable areas

Improved transportation networks

- Globalized transportation networks have enabled firms to import raw materials and finished goods that have been manufactured at much lower costs.

- Increased convenience from an improved logistical network allows for faster deliveries at lower costs.

Abundance of skilled labour

Falls in cost for recruitment and training for employees who directly/indirectly participate in product production by having a suitable pool of educated and trained labor by particularly reputable education in the region/local market/regional industry.

Regional specialisation

Fall in cost for recruitment and training to employees who directly/indirectly participates in product production by specialization in specific product production or raw materials, etc.

+ can also sell the products at a higher premium price

External diseconomies of scale

This occurs when an individual firm has a higher cost per unit of output due to factors beyond its control as the industry grows.

Types of external diseconomies of scale

Higher rents

Local market conditions for pay and financial rewards

Traffic congestion

Context-specific problems

Internal growth

To grow the business (increasing the scale of its operations and sales revenue) by expanding its existing operations, using their capabilities and resources.

To do this, a business may:

- Try to grow sales of its existing products in its existing markets

- Develop new products for its customers

External growth

This occurs through dealing with outside organizations. Such growth usually comes in the form of alliances or mergers with other firms or through the acquisition of other businesses.

Pros of internal growth

Better control and coordination

Relatively inexpensive

Maintains corporate culture

Generally less risky

Cons of internal growth

- Diseconomies of scale

- Restructuring of the form of ownership may be needed

- This may lead to dilution of control and ownership

- Slow

Pros of external growth

+ Quicker than organic growth

+ Synergies

+ Reduced competition

+ Economies of scale

+ Spreading of risks

Cons of external growth

- More expensive than internal growth

- Greater risks

- Regulatory barriers

- Potential diseconomies of scale

- Organizational culture clash

Mergers

One new company with its own legal identity created from a union of two existing companies under an agreement

Acquisition

Consolidation or merger after a transaction in which one business buys a controlling share in another firm with the permission and agreements of its board of directors

Takeover

Consolidation or mergers that are caused when a company purchases a controlling stake in another company without the permission and agreement of the company or board of directors

Joint venture

A commercial enterprise with a separate legal entity that occurs when two or more businesses agree to accomplish a specific task.

The costs, risks, control, and rewards of its business projects are split.

Strategic Alliance

An arrangement between two or more businesses to undertake a mutually beneficial project while each retains its independence.

The costs and profits are shared as agreed

Franchising

Franchising is a form of business ownership whereby a person or business buys a license to trade using another firm's name, logos, brands, and trademarks

Reasons to grow the business

+ Less susceptible to changes with trends in the market

+ Internal economies of scale

+ Products provided at lower prices

+ Capable of reaching more customers

+ Possibility of more profit and sales

+ Additional earnings that cannot be bought e.g. reputation

+ brand recognition, brand identity

+ A sense of achievement for the owners

+ Raise its profit

+ Value-added services e.g. tech support

Reasons to stay small

- Cost control

- Operational control

- Financial risks

- Attracts less attention

- Government aid

- Local monopoly power

- Personalized services

- Flexibility