3.1 Business Growth
Agency problem- possible conflicts of interest that may result between the shareholders (principal) and the management
(agent) of a firm
Divorce of ownership from control - firms are owned by shareholders, who have little say in the day to day running of the
business, and controlled by managers; this leads to the principal-agent problem
Barriers to entry- ways to prevent profitable entry of competitors- may relate to differences in costs between existing san
new firms
Barriers to exit- the cots associated with a decision to leave a market/ industry e.g. lost goodwill with customers
Private sector- all privately owned businesses and organisations. These businesses usually aim to return a profit to the
owners
Public sector- Company owned by local or central government
Profit organisation- most private sector organisations aim to make a profit to maximise financial benefits
Not- for profit organisation- any profit they do make is used to support their aim of maximising social welfare and helping
individuals and groups, charities
Internal growth- growth as a result of a firms increasing the levels of factors of production it uses
Organic growth- internal growth without resort to takeovers and mergers, achieved through expanding a product range,
selling into new countries
Inorganic growth- external growth as a result of takeovers and mergers
Vertical integration- integration of firms in the same industry but at different stages in the production process
Backward vertical integration- acquiring a business operating earlier in the supply chain e.g. retailer buys a wholesaler
Forward vertical integration- acquiring a business further up the supply chain e.g. a vehicle manufacturer buys a car parts
distributor
Horizontal integration- when companies from the same industry amalgamate to form a larger company- firms at the same
stage of the production process
Conglomerate integration- combining firms which operate in completely different markets
Merger- two or more firms join under common ownership
Takeover- when one firm buys another.
Hostile takeover- a takeover that’s not supported by the management of the company being acquired
Synergy takeover- when the whole is greater than the sum of individual parts
De-merger- a business strategy in which a single business is broken into two or more components, either to operate on their
own, be sold or dissolved
Diseconomies of scale- a business may expand in the long run may expand beyond the optimal size in the long run and
experience diseconomies of scale. This leads to rising LRAC.
, Sizes and types of growth:
Firms grow for a number of reasons: to make more money, to gain monopoly power and for greater security.
Economies of scale relative to market size: Large firms might only experience small economies of scale compared to
their size, since the extent of economies of scale might be limited in that industry. This could make their costs higher
than firms which choose to stay smaller.
Diseconomies of scale: Larger firms could face high costs because they have grown too quickly. There could be poor
organisation, x-inefficiency or because firms in large, formal markets tend to have to pay higher wages.
Small firms as monopolists: Small firms could hold some degree of monopoly power, since they provide a more
personal, local service. Their opening hours might suit a small town, such as those of a corner shop, and some
consumer might prefer making smaller purchases, than the larger ones expected at bigger stores. Small firms might
also create a niche market, where they can use their relatively price inelastic demand to charge higher prices. An
example could be a small café over a multinational corporation.
Profit motive: By growing, firms get the opportunity to earn higher profits. Growing also allows firms to take
advantage of economies of scale, providing they do not grow so large that they experience diseconomies of scale.
Market power: large firms have more dominance over the market, which allows them to gain price setting powers and
discourage the entrance of new firms. They might also gain monopsony power, which can allow them to buy their
stock at a lower price
Diversification: By growing and expanding the product range, firms reduce their risk of making huge losses, since they
have areas of the market to fall back on.
Owners: Managers of the firm might have the motive of larger bonuses, more holidays or more leisure time, which
encourages them to expand the firm.
The principal agent problem: In many large firms, there is separation of ownership and control:
Firms are owned by their shareholders, who play no part in the day to day running of the business.
The chief executive and senior managers work for the company and control day-to-day decision making.
This separation causes problems due to the differing aims of the two stakeholders:
The owners - maximise the returns on their investment so will want to short run profit maximise. However, directors and
managers are unlikely to want the same thing: they will want to maximise their own benefits.
The principal-agent problem - theory of asymmetric information- agent makes decisions for the principal, but the agent
is inclined to act in their own interests, rather than those of the principal. For example, shareholders and managers
have different objectives which might conflict.
It comes about because owners of a firm often cannot observe directly, easily and accurately the key day-to-day
decisions of management – therefore problems can exist/be created with how the business is run and personal
objectives/targets
Managers might choose to make a personal gain, such as a bonus, rather than maximise the dividends of the
shareholders. When an owner of a firm sells shares, they lose some of the control they had over the firm. This could
result in conflicting objectives between different stakeholders in the firm.
External growth (inorganic growth) means combining firms:
Growth as a result of takeovers and mergers:
A takeover is when one firm buys another firm, which becomes part of the first firm
A merger is when two firms unite to form a new company
External growth can happen through horizontal integration, vertical integration, or conglomerate integration
Horizontal and vertical integration happen between firms in the same market
