Chapter 36, growth and survival of firms

• About 90% of businesses are small firms employing fewer than 10 people
• Small firms are commonly found in the service sector, in retail, food production, automotive, personal, and business services
• • Small businesses receive financial help under government enterprise schemes
  • Increased access to technology through the internet and electronic devices has made small businesses more efficient and competitive
• Reasons for the existence of many small firms in the world:

  • Economic activities where the market size is too small to support large firms
  • Specialist skills possessed by very few people
  • Small firms offer personal attention to customers in service industries like lawyers, accountants, dentists
  • Small firms may become big in the future, but only a small percentage do
  • Entrepreneurs may not want the firm to grow bigger due to reasons other than extra profit
  • Recession and increasing unemployment can lead to new business startups
• Motives behind large firm's growth:

  • Desire to achieve a reduction in long-run average costs through economies of scale
  • Monopoly and defensive strategies to increase market share and profit
  • Economies of scope by producing a variety of products
  • Capturing the resources of another business through takeovers and mergers
• Internal growth (organic growth) strategies:

  • Develop new product ranges
  • Sell existing products in new international markets
  • Open businesses in new locations
  • Invest in new technology
  • Borrow funds for investments
  • Product diversification
  • Non-price competition strategies
  • Offer free and subsidized services to encourage customers with cheap prices and free services
• Expenses for internal growth:

  • Firms use retained profits to implement various strategies for internal growth
  • Retained profits are often invested to increase capital-intensive activities
• Advantages of internal growth:

  • Less risky than external growth
  • Can be financed through internal funds like retained profits
  • Builds on a business's existing strengths
  • Allows the business to grow at a more sensible rate in the long run
• External growth (inorganic growth) reasons:

  • More speed compared to internal growth
  • Increases market share and market power
  • Achieves economies of scale
  • Secures better distribution channels
  • Controls supplies
  • Acquires intangible assets like brand names, patents, trademarks
• Diversification:

  • Firms grow through diversification by producing or selling a range of different products to spread risk or exploit market opportunities
• Integration:

  • Business integration is the process of acquiring another company and merging its operations through acquisitions or mergers
• Methods of Integration:

  • Horizontal integration (horizontal merger) involves acquiring a business in the same sector of an industry
  • Benefits of horizontal integration include expanding the firm's size, increasing economies of scale, reducing costs, and achieving synergies
• Horizontal Integration:

  • Rationalization: One large firm needs fewer managers, workers, and premises than two firms, reducing costs
  • Synergies: Combined value and performance of two companies will be greater than the sum of separate parts
  • Product diversification: Opportunity for economies of scope by producing diversified products
  • Research and development costs can be pooled
  • Leads to access to new markets
  • Increases market power by reducing competition
  • Opportunity to make abnormal profits
• • Disadvantages include regulatory inquiry, blocked integrations by governments, reduced flexibility, cultural clashes, and diseconomies of scale
• • Disadvantages include increased costs if not effectively integrated, limited scope for technical economies of scale, more monopoly power, lower prices to suppliers, higher cost of investment, reduced flexibility, difficulty in controlling the business, and less choice for consumers
• Vertical Integration:

  • Acquiring businesses in the same industry but at a different stage of the supply chain
  • Two main kinds: forward and backward integration
  • Benefits include improved security and quality of supplies, reduced supply chain costs, economies of scale, greater control over supply, overcoming monopsony power, lower transaction costs, and more competitive advantages
• Conglomerate Integration:

  • Expanding business into unrelated business areas or industries
  • Advantages include diversification, covering the loss of some subsidiary, increased revenue, economies of scale, cross-selling opportunities, flexibility, and gaining synergy
  • Disadvantages include difficulty in strategic management, lack of past experience, shift in focus, complications in human relationships and behaviors
• Cartels:

  • Formal agreement between member firms in an industry to limit competition
  • Involves fixing quantity produced or price for the product
  • Maximizes profits like a monopolist
  • Example: OPEC (organization of petroleum exporting countries)
  • Threats include a price war, fewer profits due to agreed fixed price, lack of dominant member to control others, and legal obstacles
• Principle-Agent Problem:

  • Occurs when decisions are made by management who are not the owners of the firm
  • Asymmetric information and moral hazard between management (agent) and ownership (principal)
  • Agency cost arises when the agent acts in their own interest without the principal's knowledge
  • Leads to market failure due to information asymmetry