Theme 3 Topic 1

Question 1

Why do firms want to grow ? (5)

Answer 1

1. To increase Profits - to give shareholders a better return (dividends)
2. To lower average Costs - to benefit from economies of scale, lower average unit costs of production.
3. To increase Market Share - leads to greater influence over price and brand image
4. To Reduce risk - firms might want to diversify so that if sales drop in one market they have another market to generate sales. Risk is spread
5. Managerial motives - senior managers may wish to grow in order to control a larger business.

Question 2

how many businesses are there

Answer 2

115 million, Amazon and Walmart amongst them

Question 3

Context points for reasons for growth

Answer 3

Apple started in 1976, making 50 computers with 400 dollar profits, now they make 53 billion dollars

CMA (corporate market authorisation) stopped O2 and 3 from merging in 2016.

Question 4

Reasons for remaining small (5)

Answer 4

1. Limited market size - for niche or luxury markets they may want personalised experiences for consumers
2. Limited access to finance - retained profits or loans needed (banks may not be willing to lend)
3. Owner objectives - they may want to prioritise satisfaction over growth, or may be happy where they are now (profit satisfice)
4. Govern,ent regulations - restrict expansion to prevent monopolies or consumer exploitation
5. Diseconomies of scale - if firms grow too fast they reach DOS above optimum level, leading to alienation, bureaucracy, communication issues.

Question 5

Divorce of ownership and control

Answer 5

Shareholders own the firm but delegate daily decisions to directors and managers.
They have different aims.
Owners may want to maximise returns for dividends while managers may prioritise their own benefits (higher salaries and bonuses)

Question 6

Principal agent problem

Answer 6

Agents (managers) make decisions on behalf of principals (owners), but interests may nor align.

Solution may be to give managers shares or link bonuses to profits to align their interests with those of owners.

Question 7

Example of principal agent problem (context)

Answer 7

The Enron Scandal.

Executives hid debt, harming shareholders

Question 8

Public sector

Answer 8

Owned and controlled by government rather than firms, aiming to provide services for citizens.
Profit making isn’t the primary goal.

E.g. NHS, state education, army, TFL (transport for London)

Question 9

Private sector

Answer 9

Owned and ran by individuals or groups.
Main goal is to make a profit

E.g. sole traders, PLCs

Question 10

For profit organisations

Answer 10

Aim to maximise financial benefits for shareholders, although they may not always strictly profit maximise

Question 11

Not for profit organisations

Answer 11

Use any profits to support their aims of maximising social welfare

E.g. charities

Question 12

Organic growth

Answer 12

Internal growth by increasing output and sales from within the resources of the business.

Usually by reinvesting profits into the business.

Question 13

Inorganic growth

Answer 13

External growth achieved by mergers or takeovers

Question 14

Examples of organic growth

Answer 14

Develop product range

Invest in machinery or technology

Expand internationally

Question 15

Examples of inorganic growth

Answer 15

Mergers

Takeovers (acquisitions)

E.g. YouTube takes over Google for 1.65 billion dollars in 2006.

Question 16

Mergers definition

Answer 16

2 businesses of similar size and scale of operations combine into 1 new company

Question 17

Acquisitions definition

Answer 17

One business buys another smaller one

Question 18

Context points of inorganic growth

Answer 18

Facebook buys WhatsApp for 22 billion dollars in 2014

Vodaphone buys Mannesmann for 202 billion dollars in 1999

Question 19

3 sectors of a business

Answer 19

1. Primary (extracting raw materials)
2. Secondary (manufacturing process, buying and selling goods)
3. Tertiary (services provided)

Question 20

Integration definition

Answer 20

Growing through amalgamation, merger, or takeover.

Question 21

Context for organic growth

Answer 21

LEGO grew through organic growth.
they introduced new products (e.g. Lego friends) and board games to expand their customer base.

Question 22

3 advantages of organic growth

Answer 22

1. Less risky than integration as firms often pay too much for takeovers, and integration is often poorly managed with lang key workers tending to leave after the change, it’s also very time consuming.
2. Owners can have more control on the vision and direction of the business.
3. Often paid from retained profit which reduced chances of paying interest and losing control of the business by selling shares.

Question 23

3 disadvantages of organic growth

Answer 23

1. Can be very slow, can take years to double the size of the firm yet external growth can achieve this overnight.
2. Market share could fall if other businesses expand more quickly.
3. No gains from integration, so may be more difficult to generate new ideas.

Question 24

3 advantages of inorganic growth

Answer 24

1. Quick + easy to expand as capacity already exists
2. Share expertise with other successful firms
3. Market share is instantly boosted by the brand name and sales of the other firm

Question 25

2 disadvantages of inorganic growth

Answer 25

1. Can be costly to purchase successful firms. Interest on any loans taken out to pay for the merger (opportunity cost) 2. There are problems with managing and controlling a much larger firm

Question 26

Vertical integration

Answer 26

Integration of firms in the same industry but at different stages of production

Question 27

Forward vertical integration

Answer 27

Moving towards the consumer

Question 28

Backward vertical integration

Answer 28

Moving towards the supplier

Question 29

Horizontal integration

Answer 29

Integration of firms in the same industry at the same stage of production

Question 30

Conglomerate integration

Answer 30

Firms in different industries with no obvious connections integrate Can sometimes be linked by common raw materials or technology E.g. tobacco company buys insurance company

Question 31

SMEs

Answer 31

Small and medium sized enterprises

Question 32

SMEs features

Answer 32

Small : less than 50 employees Medium : less than 250 employees owner managed and flexible operate locally and regionally lower revenue and capital

Question 33

pros of SMEs

Answer 33

Quick to adapt closer consumer relationships encourages innovation

Question 34

cons of SMEs

Answer 34

limited access to finance harder to compete on price higher failure risk

Question 35

large corporations features

Answer 35

large scale operations over 250 employees (high turnover) same features as SMEs

Question 36

pros of large corporations

Answer 36

market power and brand strength economies of scale can hire specialist

Question 37

cons of large corporations

Answer 37

slower decisions risk of monopolistic behaviour

Question 38

positive impact of growth on workers

Answer 38

• More job opportunities • Higher wages (especially in high-skilled sectors) • Training and development programs • Job security in large, stable firms

Question 39

negative impact of growth on workers

Answer 39

* Redundancies: After mergers or automation • Alienation: In large, impersonal organizations

Question 40

positive impact of growth on consumers

Answer 40

* Lower prices due to economies of scale • Wider product range • Innovation and R&D (especially by large firms) • Improved product quality

Question 41

negative impact of growth on consumers

Answer 41

* Less choice in monopolistic markets • Higher prices if firms gain monopoly power • Consumer exploitation (e.g. misleading advertising) • Reduced local services if small businesses are crowded out

Question 42

4 advantages of vertical integration

Answer 42

1. There is increased potential for profit ​as the firm takes the potential profit from a larger part of the chain of production. 2. There will be less risks as suppliers do not have to worry about buyers not buying their goods and buyers do not have to worry about suppliers not supplying the goods. 3. With backward integration, businesses can ​control the quality of supplies and ensure delivery is reliable​. they don’t have to worry about being charged high prices for supplies, keeping ​costs low and allowing lower prices for consumers. This can increase competitiveness and sales. 4. Forward integration secures ​retail outlets and can restrict access to these outlets for competitors.

Question 43

2 disadvantages of vertical integration

Answer 43

1. Forms may have no expertise in the industry they took over 2. Clash of cultures which could lead to employee demotivation and diseconomies of scale

Question 44

4 advantages of horizontal integration

Answer 44

1. This helps to ​reduce competition as a competitor is taken out and ​increases market share​, giving firms more power to influence markets. 2. Firms will be able to ​specialise and rationalise​, reducing the areas of the businesses which are duplicated. 3. The business is able to grow in a market where it ​already has expertise​, which is more likely to make the merger successful. 4. Economies of scale can be achieved if lower average costs occur, so lower prices for consumers

Question 45

2 disadvantages of horizontal integration

Answer 45

1. increase risk for the business as if that particular market fails, they have nothing to fall back on and will have invested a lot of money into that area. 2. Clash of cultures and diseconomies of scale

Question 46

3 advantages of conglomerate integration

Answer 46

1. It is useful for firms where there may be ​no room for growth in the present market​. 2. The range of products ​reduces the risk ​for firms and if a whole industry fails, they will still survive due to the other parts of the business, + increased knowledge 3. It will make it ​easier for each individual part ​of the business to expand than if they were on their own as finance can be easily obtained and managers can be transferred from company to company within the firm.

Question 47

2 disadvantages of conglomerate integration

Answer 47

1. firms are going into markets in which they have ​no expertise​. It can often be ​damaging​ for the business. 2. Risk of culture clashes and diseconomies of scale

Question 48

What is a demerger ?

Answer 48

When a firm sells off at least 1 of the businesses it owns, or splits itself into separate parts to create 2 or more firms.

Question 49

Pepsi demerger

Answer 49

In 1997, Pepsi announced a demerger of its Pizza Hut, KFC, and Taco Bell restaurants to focus on competition with Coca Cola. This was welcomed by shareholders as the restaurants had failed to live up to expectations.

Question 50

Reasons for demergers (5)

Answer 50

1. Reducing diseconomies of scale 2. Specialisation 3. Value of company/ share price 4. Cultural differences 5. Comply with the demands of the competition commission

Question 51

Lloyds TSB baking group demerger

Answer 51

Demerger to create 2 separate banks, TSB and Lloyds bank.

Question 52

Reason for demerger - reducing diseconomies of scale

Answer 52

Decreasing size of the firm can reduce diseconomies by lowering output, which lowers LRAC, increasing profitability.

Question 53

Reason for demerger - specialisation

Answer 53

If the compact is focused on 1 individual market they become more efficient and successful, as productivity increases, LRAC falls, and profits increase. Managers can improve skills and knowledge and become more successful.

Question 54

Reason for demerger - value of the company / share price

Answer 54

The value of the separate parts of the company is worth more than the company combined. Due to some parts of the business operating well and have potential to grow, but the overall value is brought down due to the lack of success in other parts. Financial markets talk about ‘creating value’ by splitting up companies like this.

Question 55

Reason for demerger - cultural differences

Answer 55

The most common reason for failures of mergers is cultural differences. (A conflict that arises between workers due to different working norms or value systems). Sometimes, these differences are irreconcilable and not worth the expense to change.

Question 56

Reason for demerger - comply with the demands of the competition commission

Answer 56

Firms can be forced to demerge by the competition regulator due to concerns about the high level of market share they may have, which is considered to be anti- competitive and bad for consumers.

Question 57

Impact of demergers on WORKERS

Answer 57

workers could gain or lose through a demerger. separate firms may need their own managers + leaders so people could get a promotion. but the goal of making the firm more efficient may led to job losses. also, reduces friction cultural differences to help build better team dynamics.

Question 58

impact of demergers on BUSINESSES

Answer 58

concentrating on a smaller core business may allow it to be more efficient and concentration may lead to more innovation, surviving higher competition. however, the smaller size of the business may lead to a loss of economies of scale + reduced efficiency.

Question 59

impact of demergers on CONSUMERS

Answer 59

they may gain from innovation and efficiency, leading to better products and cheaper prices. however, demerged firms may be less efficient through loss of economies of scale or raised prices and reduced quality/range of goods as they become motivated by profits.