Edexcel Economics 3.1

Firm

A business organisation that produces and sells goods or services in markets.

Why do small firms survive? (3)

1. Small firms keep their head-over costs low.

2. Small businesses are often flexible and innovative in responding to changes in market demand.

3. Many smaller businesses act as a supplier to larger industries.

Reasons for firms to stay small. (3)

1. Product differentiation and having a USP (unique selling point).

2. Flexibility in meeting customer needs.

3. Deliver a high standard of customer service

Stakeholder

Any individual or organisation who has vested interest in the activities and decision making of a business.

Shareholder

Any individual or organisation who owns at least one share of stock in a limited company, making them a legal part-owner of the business.

The principal agent problem

It is an asymmetric information problem. It occurs when a business owners and its hired managers have different objectives, and the owners cannot easily monitor the daily decisions of management.

How to overcome the principal agent problem. (3)

1. Employee share ownership schemes - incentivises interest of business

2. Long term stock commitment

3. Long term employment contracts for senior management

Privatisation

The transfer of assets from the public sector to the private sector of an economy, there is a change in ownership.

Organic growth

Internal growth that happens when a business expands their own operation rather than takeovers and mergers.

How can organic growth happen?(4)

1. Increasing existing production capacity through investment in capital and technology.

2. Development and launch of new products.

3. Finding new markets by exporting into emerging countries.

4. Growing a customer base through marketing.

Advantages of organic growth. (3)

1. Can be financed through internal funds.

2. Builds on a business’ strengths.

3. Much less risk than external growth.

Disadvantages of organic growth. (3)

1. Slow growth - shareholders may want quicker growth.

2. Hard to build extra market share if business is already top of their competition

3. Growth achieved may be dependent on the growth of the overall market.

Horizontal integration

When two firms in the same industry at the same stage of production merge or take one over.

Advantages of horizontal integration. (3)

1. Exploitation of internal economies of scale.

2. Cost savings from the rationalisation of the businesses.

3. Reduces competition by removing key rivals, increasing market share.

Disadvantages of horizontal integration. (2)

1. Risks of diseconomies of scale if there are clashes between how the two businesses operate.

2. Destroys shareholder value rather than creating it.

Vertical integration

The merger of two firms at a different stage of the same industry or process of production or same final product.

Forward and backward vertical integration

Forward vertical is an integration of a business that is closer to final consumers.

Backward vertical is an integration of a business that is closer to the raw materials in the supply chain.

Advantages of vertical integration. (3)

1. Control of the supply chain - reduces unit costs and improves the production process.

2. Improved access to key raw materials.

3. Increases a firms market power if suppliers are taken out of the market.

Disadvantages of vertical integration. (2)

1. There wont be economies of scale because most of the production is at different stages.

2. Mergers can often create new problems of communication and coordination.

Conglomerate integration

When two firms operating in completely unrelated markets or industries join through a merger or takeover.

Why mergers and takeovers fail. (4)

1. Huge financial costs of funding takeovers which often leave a large debt.

2. The businesses may suffer a loss of customers and skilled workers

3. Companies may have different technology systems which are unable to combine.

4. They may over pay for the merge or takeover.

Constraints on business growth. (4)

1. Regulation - The competition and market authority(CMA) may decide to block a merger or takeover if they think it would lead to big decrease in competition.

2. Competition - There is always threat of entry from rival forms.

3. Finance - Many small firms struggle to have loans

4. Size of the market - Businesses in niche markets may find there is not consumer spending.

Demerger

When a firm decides to split into separate firms or sells off a business unit.

Reasons for demergers (4)

1. To raise money from asset sales.

2. To avoid the attention of competition authorities.

3. Reduce the risk of diseconomies of scale and diseconomies of scope.

4. To focus on core businesses to cut costs and improve profit margins.

Impacts of demergers on stakeholders

Businesses - Long term gain of higher returns And short term cost of selling a part of their business.

Employees - expected job losses if demerger is driven by a desire to cut costs, although new jobs may be created.

Consumers - impact on the prices of goods and services.