Theme 3

• Firm


  Business enterprise that produces and sells goods/services; it turns factor inputs into output
• For-profit organisation


  A firm that aims to make profit
• Not-for-profit organisation


  Firm that operate commercially but aims to improve social welfare & environmental goals; profits are reinvested for social purposes
• Private sector business


  Firms owned by private investors rather than the state
• Public sector business


  Organisation owned and controlled by the state, e.g. the NHS, the Police, the Armed Forces
• Small firms


  • Selling to a niche (very small, specialist) market (low PED or high YED for goods)
  • May act as a supplier/subcontractor to larger businesses; produces a specific component in the overall production line
  • Focus on good customer service/product differentiation/USP/quality/more personalised service/better communication with customers
  • Enables more flexible response to changing market demand; allows more innovation
  • Lack of resources/access to finance for expansion
  • Low minimum efficient scale (link to economies of scale)
  • Lack of motivation/'easy life' option/ keep as a family business
  • To avoid higher business taxes
  • Allows access to informal/local labour markets
  • Operating within a competitive market structure i.e. monopolistic competition
  • May still benefit from external economies of scale
  • Avoids scrutiny from competition authorities e.g. the CMA
  • May avoid being taken over
  • Avoids internal diseconomies of scale
• Sole trader


  A business owned and operated by an individual who retains all profits
• Partnership


  A business structure where two or more individuals own and manage the business together, sharing the profits. Commonly found in professional services such as lawyers and doctors
• Private limited company


  A type of company whose shares are not publicly traded on a stock exchange. The ownership is limited to a specific number of shareholders, and shares are not available for public purchase
• Public limited company


  A company whose shares are listed on a public stock exchange, allowing them to be bought and sold by the general public. Shareholders have voting rights, typically exercised at the Annual General Meeting (AGM), but they are not directly involved in day-to-day business operations
• When there is a principal-agent problem


  The shareholders (the principals) have different objectives from the managers (the agents). This is a form of information failure
• Shareholder aim


  To earn profit from dividends and increase their shareholder value (capital gain)
• Managers


  Consider their own careers/job satisfaction; they may sacrifice short term profit from long term profit; profit-satisficing
• Internal growth


  • Also called organic growth – when a firm invests in new capacity to increase the business size
• External growth


  • Business grows by acquiring another business via merger or takeover
• Horizontal integration


  • A merger between two firms in the same industry at the same stage of production
• Vertical integration


  • A merger between two firms at different stages of production in the same industry
• Backwards vertical integration


  • Business buys one of its suppliers e.g. car maker buys up a tyre company
• Forwards vertical integration


  • Business supplying a good merges with one of its buyers, e.g. car maker buys up a car dealership
• Conglomerate merger


  • Merger between two firms producing unrelated products
• Lateral integration


  • Merger between two firms in industries that are somewhat related e.g. software company buying a games designer
• Friendly takeover


  • Board of Directors of the target company recommend shareholders accept takeover bid
• Hostile takeover


  • Board of Directors of target company recommend shareholders reject the bid; predator company has to buy 50% of shares in target company to take control
• Advantages of growth of firms


  • Increased control of markets/resources
  • Increase control of sales/customer base
  • Gain internal economies of scale
  • Helps ensure business survival/takeover competitors
  • For managerial reward
  • Helps gain expertise
  • Increased productive and dynamic efficiency
  • Synergy
  • Spreads risk; allows diversification
• Key constraints on business growth

  • Market size: a firm will not grow if the demand is not there
  • Access to finance: a growing firm may need enough retained profit or a business loan to expand; the cost of finance may also affect its decision to grow
  • The objectives of the business owners: may not be profit-maximisers
  • Regulation: large firms may gain monopoly power which could be investigated by the competition authorities
• Why some mergers & takeovers fail


  • High financial costs of during a takeover can leave a debt overhang
  • Integrating different technology systems can be expensive/near impossible
  • Share price may fall if fresh equity needs to be raised via a rights issue
  • Clash of corporate cultures/personalities
  • Loss of customers/poorer customer service
  • Possible loss of skilled workers
  • Businesses in competition to buy out a business may end up paying too much
  • Bad/unlucky timing if the economic cycle changes course
• Why some firms de-merge


  • To focus on its core business/core product
  • To provide better quality service
  • To become more specialised
  • To reduce the risk of diseconomies of scale
  • To raise money from the asset sale
  • To avoid the attention of the competition authorities
• Most businesses in the UK are small or medium-sized enterprises (SMEs)
• Developments in e-commerce has enabled the creation of more small businesses, with a relatively small online presence
• Successful businesses typically grow


  Because there is an increase in the market demand for the product they are selling
• Profit-maximisation


  Firm aim to make the maximum profit possible (occurs where MC = MR; this is also the loss-minimising condition)

  
• Revenue maximisation


  Firm aims to maximise total revenue (occurs where MR = 0)
• Sales (volume) maximisation


  Firm aims to have largest market share without running at a loss (occurs where AC = AR)
• Profit satisficing


  Managers aim to make enough profit to satisfy the shareholders
• Total revenue


  Quantity sold x price; TR = Q x P
• Average revenue


  Revenue per unit sold; AR = TR/Q
• Marginal revenue


  The change in TR when one more unit is sold; MR = change in TR/change in Q
• Price-maker


  A firm with some market power that can alter prices
• Price-taker


  A firm with no market power, selling at the market price only
• Profit-maximisation occurs at output Q1, where MC=MR