1.5: Growth and Evolution

Economy of Scale:

Lower costs of production as the firm operates on a larger scale because of improvement in their efficiency 

• Cost advantage: Lower avg cost - lower prices for customers and higher profit margin 

Average Cost (AC)

 = Total costs (TC) / Quantity of output (Q)

Optimal level of output

• reached when average cost is minimized 

  • Any more increase brings diseconomies of scale

Internal economies of Scale

Within the individual FIRMS and are within its control

• Technical Economies

• FInancial Economies

• Managerial Economies

• Specialization Economies

• Marketing Economies

• Purchasing Economies

• Risk-Bearing Economies

Technical Economies

• Use capital technology to mass produce products

  • Allows for more efficient production

Financial Economies

• Have more ability to borrow large sums of money at lower interest rates

  • They will be seen as less risky and more likely to return the loan

  • Smaller business may struggle to get external finance and will be charged more due to higher risks 

Managerial Economies

• Having multiple people working on roles they’re better at rather than one person who does it all and isn’t good at it

  • Specialization leads to higher productivity - having special managers organizing these different zones

  • Helps avoid the duplication of works - everyone has their own unique role

Specialization Economies

• SImilar to managerial but its the division of labor rather than management 

  • More access to highly trained and specialized workers 

Marketing Economies:

• Large firms can benefit from lower costs by selling in bulk 

  • Save time and transactional costs

Purchasing Economies

• Lower their avg cost by buying in bulk

  • Normally get discounts from warehouses for bulk buys 

Risk-Bearing Economies

Don’t have as much risk and can use their savings rather than keeping them for emergencies

• Can spread their costs on advertising, research and development

Conglomerates

• Firms with a diversified portfolio of products

  • Eg, Reliance Industries 

External Economies of Scale

Within the industry and are out of the control of the individual firms

• Technological Progress: 

• Improved Transportation Networks

• Regional Specialization

Technological Progress

• Increases the productivity level of industry 

  • Do not need to be located in central business districts - rent cost

Improved Transportation Networks:

• Helps to ensure quick deliveries 

  • Bad transportation can cause issues to the business 

  • Convenience

  • Area could have skilled labor

Regional Specialization

• Certain locations or countries have highly regarded reputations for producing goods 

  • Eg european countries

Diseconomies of scale:

When a business becomes to large it is no longer beneficial to them

Internal Diseconomies of Scale

Higher unit costs as the firm continues to increase in size - outsized and inefficient

Problems in mismanagement

Internal problems in diseconomies of scale

• Managers lack control and coordination → Slow decision making 

• Poorer working relationship → Damages communication flow

• Specialized tasks become repetitive and boring → lack of productivity and more procrastination 

  • Lower productive efficiency

• Excessive Bureaucracy and paperwork/administration 

  • Decisions-making are more time consuming and add to the productions costs but doesn’t give a proportional rise in the output 

  • Bad communication continues 

Complacency

Lack of understanding and awareness of possible risks or deficiencies in their business

External Diseconomies of Scale:

Occurs when there is an increase in avg cost and they are growing due to factors out of their control 

• Higher rents: When there are too many business in the area 

• Higher pay and financial Rewards:

• Traffic Congestion

Internal Growth

 Using its own resources (personal Funds) 

• Changing prices: More customers buy at lower prices 

• Improved Promotion: Given information on benefits of the product 

• Producing Improved or Better Products:

• Selling through a greate distribution network (Placement): If the product is widely available they’ll be more likely to buy

• Offer preferential Credit

• Increased capital expenditures (investment spending): Internal expansion of the business to new locations 

• Improved training and development

• Providing overall value for money: Product quality is a selling point for customers

Elasticity of price based on demand

• Price inelastic when it's in demand - can raise the price alot to make more revenue

• Not in demand - price elastic - must lower prices to make revenue

Advantages of internal growth

• Control and coordination

• Relatively inexpensive

• Maintains the corporate culture

• Less risky

Disadvantages of internal growth

• Diseconomies of scale

• A need to restructure 

• Dilution of control and ownership

• Slower growth

External Growth:

• Dealings with outside organizations rather their own increase in operations 

  • Through the use of mergers, acquisitions, takeovers, joint ventures, strategic alliances or franchising 

Amalgamation or Integration

•  the action, process, or result of combining or uniting.

Advantages of external growt

• Quicker than organic growth 

• Synergies: Greater pool of skills 

• Reduced competition 

• Economies of scale 

• Spreading of risks

Disadvantages of external growth

• More expensive than internal growth 

• Greater risks

• Regulatory barriers: Acquisitions and takeovers can be blocked by government if it is anti competitive 

• Potential diseconomies of scale 

• Organizational culture clash

Ways to measure the business:

• Market share

• Total sales revenue

• Size of workforce 

• Profit 

• Capital employed

Advantages of being a larger business 

• Economies of scale

• Lower prices

• Brand Recognition

• Value-added services

• Greater choice

• Customer loyalty

Disadvantages of being a large business

• loss of control over operations and cost

• financial risks

• lack of government aid

• lack of local monopoly power if franchising

• no personalized services

• less flexibility

Methods of external Growth (11)

1. Mergers

2. Acquisition

3. Synergy

4. Horizontal integration

5. Vertical Integration

6. Lateral Integration

7. Conglomerate MandA

8. Takeover

9. Joint Ventures

10. Strategic Alliances

11. Franchising

Mergers

two or more firms create a new company with its own legal identity

Acquisition

a company buys a controlling interest in another firm (buying enough shares to hold a majority stake) with the agreement of the company’s BOD

Synergy

they generate greater output and efficiency together than they did apart

Horizontal integration

amalgamation of firms operating in the same industry

Vertical Integration

• businesses at different stages of production

  • forward: head towards final stage of production

  • backward:  toward an earlier stage of production

Lateral Integration

firms that have similar operations but do not directly compete

Conglomerate MandA:

amalgamation of businesses in completely different markets

Takeover

A company buys a controlling interest in another firm without the agreement of the company’s BOD

Joint Ventures

two or more businesses split the costs, risks, control and rewards of a project, setting up a new legal entity

Demerging reasons:

• Offloading unprofitable sections of business 

• Avoiding rising average costs and inefficiencies by being too large 

• Raising cash to sustain operations in other parts of the business that are more profitable

• Having a clear corporate focus by concentrating efforts on a smaller range of products or business operations 

Strategic Alliances

• similar to a joint venture, but without a new legal entity

  • Stages of Formation 

1. feasibility study

2. partnership assessment

3. contract negotiations

4. implementation

Franchising

• company buys a license to trade using another company’s products, logos, brands, etc. in return, the franchisee pays a license fee to the franchisor (parent company), as well as a royalty payment

  • Franchisor: Parent company 

  • Franchisee: Purchase a part of the franchise 

  • Royalty Payment: Similar to commission 

• Diseconomies of scale can cause issues so businesses make franchise instead so they can expand and grow without reaching that point