Business Economics

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Business Economics

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Business Economics

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The Growth of Firms

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The Growth of Firms Internal Growth: • Generated through increasing sales • To increase sales firms need to: – Market effectively – Invest in new equipment and capital – Invest in labour

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The Growth of Firms External Growth: • Through amalgamation, merger or takeover (acquisitions) • Mergers – agreed amalgamation between two firms • Takeover – One firm seeking control over another – Could be ‘friendly’ or ‘hostile’ Copyright 2006 – Biz/ed

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External Growth • Vertical Integration • Horizontal Integration • Conglomerate Merger

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The Growth of Firms External growth – types of acquisition: • Vertical integration – amalgamation, merger or takeover at different stages of the productive process

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Vertical Integration Primary

Secondary

Manufacturer

Tertiary

Retail Stores

Vertical Integration Backwards – acquisition takes place towards the source

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Vertical Integration Primary

Dairy Farming Cooperative

Secondary

Cheese Processing Plant

Vertical Integration Forwards – acquisition takes place towards the market

Tertiary

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Horizontal Integration • Amalgamation, merger or takeover at the same stage of the productive process

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Horizontal Integration Primary

Confectionery Secondary Manufacturer

Soft Drinks Manufacturer

Tertiary

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Conglomerate Acquisition • Amalgamation, merger or takeover of firms in different lines of business.

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Motives • Cost Savings – External growth may be cheaper than internal growth – acquiring an underperforming or young firm may represent a cost effective method of growth

• Managerial Rewards – External growth may satisfy managerial objectives – power, influence, status

• Shareholder Value – Improve the value of the overall business for shareholders

• Asset Stripping – Selling off valuable parts of the business

• Economies of Scale – The advantages of large scale production that lead to lower unit costs

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Motives • Efficiency – Improve technical, productive or allocative efficiency

• Synergy – The whole is more efficient than the sum of the parts (2 + 2 = 5!)

• Control of Markets – Gain some form of monopoly power – Control supply – Secure outlets

• Risk Bearing – Diversification to spread risks

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Key Issues

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Key Issues • Divorce between ownership and control – who runs the business? – Shareholders? – Board of Directors?

• Principal-Agent Relationship: – Shareholders act as principals, Board as agents – principals expect agents to act in their interest – Sub-contracting work operates on a similar basis – Contracts and compensation procedures to ensure agents act on behalf of principals

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Key Issues • The Law of Diminishing Returns: – Increasing successive units of a variable factor to a fixed factor will increase output but eventually the addition to output will start to slow down and would eventually become negative • To prevent diminishing returns setting in, all factors need to be increased – returns to scale Copyright 2006 – Biz/ed

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Key Issues Diminishing Returns – assume the amount of land/plant was fixed. Adding labour and capital units would initially increase output but the rate at which output would rise will start to decline and eventually would become negative unless the amount of land/plant was increased to accommodate the increase in variable factors.

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Diminishing Returns – Graphical representation Output

Total Product (TP)

Quantity of the variable factor Copyright 2006 – Biz/ed

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Efficiency

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Productive • Lowest Cost – Productive efficiency can be achieved where the same output could be produced at lower total cost – Achieved through re-organisation (e.g. to cell production), investment in new technology, training for staff and so on Copyright 2006 – Biz/ed

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Technical • Minimum inputs – Technical efficiency can be achieved if the same output can be produced using fewer inputs – Can be achieved using labour saving devices, more efficient machinery, more effective re-organisation of restructuring and so on

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Allocative • Needs of Consumers (P = MC) • Allocative efficiency occurs where the goods and services being produced match the demand by consumers • P = MC – the value placed on the product by the buyer (the price) = the cost of the resources used to generate the good/service

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Social • MSC = MSB • Social efficiency occurs where the private and social cost of production is equal to the private and social benefits derived from their consumption • A measure of social welfare

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Motives of Firms

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Profit Maximisation • Profit maximisation – assumed to be the standard motive of firms in the private sector • Profit maximisation occurs where Marginal Cost = Marginal Revenue • MC = MR • The firm will continue to increase output up to the point where the cost of producing one extra unit of output = the revenue received from selling that last unit of output • This assumes that firms seek to operate at maximum efficiency Copyright 2006 – Biz/ed

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Profit Maximisation – Diagrammatic Representation Cost/Revenue

MC

150 145 140

Reduces total profit by this amount

Total added to profit 120

Added to total profit

Added to total profit

40 30 20 18

100

101

102 103

104

Assume output is at the process firm were continues to 100 units. The MC IfIfThe the MR firm – decides addition toof MC –the The cost th th produce for each the successive 104100 unit, producing the produce to total one revenue more unit as– of producing this unit produced. unit cost unit isst 20. the 101 alast result – the ofwould addition ONE extra unit more Provided tocost produce the MCthan is18, it to total producing is now one The MR received from earns less than in revenue the MR (-105) it the addition more unit to of total of production th selling that 100 total unit this willoutput would be is worth reduce revenue 140 – the – the price firm is 150. The firm can profit expanding and soto output would as not will add received 128 from profit – it add the difference of the worth difference producing. isbe worth selling expanding thatthe extra the cost and between the two is output. unit. The profit received maximising revenue from ADDED to total profit. th output is where MR = that 100 unit to MC. profit (130). MR Output

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Revenue Maximisation • • • •

Total Revenue Average Revenue Marginal Revenue In this model the policies to achieve revenue maximisation may be different to those adopted to maximise profits

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Other Objectives of Firms • Sales maximisation: – Attempts to maximise the volume of sales rather than the revenue gained from them

• Share Price Maximisation: – Pursuing policies aimed at increasing the share price

• Profit Satisficing: – Generating sufficient profits to satisfy shareholders but maximising the rewards to the managers/board and avoiding attention from rivals or regulatory authorities Copyright 2006 – Biz/ed

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Behavioural Objectives • Modern firms have to attempt to match competing stakeholder needs: – – – – – – –

Shareholders Employees Consumers Suppliers Government Local communities Environment Copyright 2006 – Biz/ed

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Behavioural Objectives • Firms may have to balance out their responsibilities: – – – – – – –

‘Fat cat pay’ Management rewards – bonuses, etc. Social and environmental audits Employee welfare Meeting consumer needs Paying suppliers on time Satisfying shareholders and ‘The City’ about its policies, plans and actions Copyright 2006 – Biz/ed