Costs and Revenue
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- Average cost (AC) is the cost per unit of output. It’s calculated by dividing total cost (TC) by the quantity of output (Q): AC = TC / Q.
- Average cost is composed of two parts: average fixed cost (AFC) and average variable cost (AVC).
- AFC is calculated by dividing total fixed cost (TFC) by the level of output: AFC = TFC / Q.
- Similarly, AVC is calculated by dividing total variable cost (TVC) by the level of output: AVC = TVC / Q.
Economies of Scale
- Technical economies: They can use advanced machinery to mass-produce goods, spreading high equipment costs over a larger output. This reduces the cost per unit.
- Financial economies: They can borrow money at lower interest rates due to lower perceived risk.
- Managerial economies: Employing specialized managers for different functions (like marketing, accounting, and production) leads to increased efficiency and productivity.
- Specialization economies: Dividing labor among specialized workers (designers, production staff, engineers) boosts productivity.
- Marketing economies: Selling products in bulk to larger customers and spreading advertising costs over wider markets reduces costs.
- Purchasing economies: Buying resources in bulk results in lower prices.
- Risk-bearing economies: Diversified companies can spread risks and costs across different products or industries.
Diseconomies of Scale
- As a business grows larger, it faces increasing challenges that can lead to higher costs. These issues include:
- Management difficulties: Coordinating a larger workforce becomes harder, leading to slower decision-making and communication problems.
- Employee morale: Workers may feel alienated, reducing motivation and productivity.
- Inefficiencies: Specialization and division of labor can lead to boredom, decreased productivity, and increased bureaucracy.
- Complacency: Large, successful firms may become complacent, leading to decreased productivity.
External Economies of Scale
- Technology: Technological progress, such as the internet, can reduce costs by enabling efficient operations like e-commerce.
- Infrastructure: Improved transportation networks enhance delivery speed and reduce employee tardiness, ultimately benefiting the business.
- Labor: Access to skilled labor through local training programs or regional specialization can lower recruitment and training costs while boosting productivity.
External Diseconomies of Scale
- Increased land costs: As more businesses compete for space, land prices rise, increasing fixed costs for all.
- Higher labor costs: With more firms competing for workers, wages increase, raising operating costs.
- Traffic congestion: Increased business activity leads to traffic congestion, which raises transportation costs.
How to Achieve Internal Growth?
- Pricing: Businesses can adjust prices based on demand. Lower prices can attract more customers (elastic demand), while raising prices can increase revenue (inelastic demand).
- Promotion: Increased marketing and advertising efforts can raise brand awareness and sales.
- Product Development: Creating new or improved products that appeal to customers can attract new buyers and boost sales.
- Distribution: Expanding sales channels (e.g., more stores) makes products more accessible and increases sales potential.
- Credit Options: Offering financing options like installments attracts customers and increases sales.
- Investment: Investing in new facilities, technology, or processes can improve efficiency and lead to higher sales.
Advantages and Disadvantages of Internal Growth
Advantages
- Control: Businesses maintain full control over their growth process.
- Lower cost: Typically, less expensive than external growth methods.
- Preserved culture: Maintains existing company culture.
- Lower risk: Less risky compared to external growth options.
Disadvantages
- Slower growth: Often results in a slower growth rate compared to external methods.
- Diseconomies of scale: Can lead to increased costs as the business grows.
- Restructuring: Requires changes in organizational structure as the business expands.
- Dilution of ownership: For businesses transitioning to public ownership, control is shared with shareholders.
External Growth
- External growth is a way for a company to expand its operations by working with other businesses, rather than relying solely on its resources.
- This involves strategies like mergers, acquisitions, takeovers, joint ventures, strategic alliances, and franchising
- Essentially, it’s about combining forces with other companies to achieve growth.
Advantages and Disadvantages of External Growth
Advantages
- Faster growth: Achieved through acquiring existing resources and markets.
- Synergies: Combines the strengths of different companies.
- Reduced competition: Can lead to increased market share.
- Economies of scale: Benefits from larger-scale operations.
- Risk diversification: Spreads business risks across different areas.
Disadvantages
- Higher costs: Often involves significant financial investments.
- Increased risk: Involves uncertainties and potential failures.
- Regulatory hurdles: May face government restrictions.
- Diseconomies of scale: Can occur if the merged company becomes too large.
- Cultural clashes: Integrating different company cultures can be challenging.
Reasons for Businesses to Grow Large
- Market share: Percentage of total industry sales.
- Sales revenue: Total income from sales.
- Number of employees: Workforce size.
- Profit: Earnings.
- Capital employed: Investment in the business.
Reasons for Businesses to Remain Small
- Lower costs: Smaller-scale operations often lead to lower costs due to avoiding diseconomies of scale and lower borrowing costs.
- Control: Owners maintain greater control over their business.
- Lower financial risk: Smaller businesses typically have lower financial stakes.
- Government support: Small businesses often qualify for government grants and subsidies.
- Local monopoly power: Can operate without direct competition in certain areas.
- Personalized service: Ability to build strong customer relationships.
- Flexibility: Can adapt to market changes more quickly.
- Niche markets: Can focus on specific, smaller markets without attracting large competitors
What are Mergers and Acquisitions?
- Merger: Two or more companies combine to form a new legal entity. (e.g., BP Amoco)
- Acquisition: One company purchases a controlling interest in another company. (e.g., Google acquiring YouTube)
- Examples:
- Daimler Benz & Chrysler (1998)
- GlaxoWellcome & SmithKline Beecham (2000)
- American Airlines & US Airways (2013)
- Amazon & Whole Foods (2017)
Types of Mergers and Acquisitions
- Horizontal integration: Combining companies in the same industry to increase market share. (e.g., Nike acquiring Umbro)
- Vertical integration: Merging with companies involved in different stages of production. Can be forward (towards the consumer) or backward (towards raw materials).
- Lateral integration: Combining companies with similar but not competing operations. (e.g., Tata Motors acquiring Jaguar and Land Rover)
- Conglomerate integration: Merging companies in unrelated industries. (e.g., Berkshire Hathaway)
Benefits and Drawbacks of Mergers
Benefits
- Increased market share and power
- Economies of scale (lower production costs)
- Synergy (combined strengths for greater output)
- Survival (defensive strategy to compete better)
Drawbacks
- Job losses due to redundancies
- Conflicts and disputes between companies
- Loss of control for original owners
What are Takeovers?
- A takeover is the acquisition of a controlling interest in a company without the target company’s approval. This is often done by offering shareholders a price higher than the current market value.
- Examples of takeovers:
- Heineken’s dominance in the Dutch brewing industry
- Kraft’s acquisition of Cadbury
- Walt Disney’s purchase of 21st Century Fox
What are Joint Ventures?
- A joint venture is a partnership between two or more companies to create a new business entity. They share costs, risks, control, and profits.
Advantages and Disadvantages of Joint Ventures
Advantages
- Synergy: Combining strengths for mutual benefit.
- Shared costs and risks: Reducing financial burden on individual companies.
- Exploitation of local knowledge: Accessing expertise in foreign markets.
- Market entry: Facilitating entry into new markets, especially with legal restrictions.
Disadvantages
- Dilution of brands: Potential weakening of individual brand identities.
- Culture clashes: Differences in company cultures can hinder collaboration.
- Dependency on partners: Reliance on the performance and cooperation of other companies.
- Potential conflicts: Disagreements between partners can arise.
Strategic Alliances
- A strategic alliance is a cooperative agreement between two or more independent businesses to achieve a common goal. Unlike joint ventures, strategic alliances do not involve creating a new legal entity. Partners share costs, risks, and benefits while maintaining their individual identities.
- Stages of forming a strategic alliance:
- Feasibility study: Assessing the potential benefits and viability of the alliance.
- Partnership assessment: Identifying suitable partners and their strengths.
- Contract negotiation: Establishing terms and conditions for the alliance.
- Implementation: Initiating the alliance and fulfilling contractual obligations.
Franchising
- Franchising is a business arrangement where a company (franchisor) licenses its brand, products, and business model to an individual or another company (franchisee).
- The franchisee pays a fee to the franchisor and typically a percentage of sales (royalty) in exchange for the right to operate the business. Examples of well-known franchises include McDonald’s, Subway, and The Body Shop.
Advantages and Disadvantages of Franchising
Benefits to Franchisor
- Rapid expansion with minimal financial risk
- National and international reach without high costs
- Reduced operational burdens (recruitment, training, etc.)
- Steady income through franchise fees and royalties
Benefits to the Franchise
- Lower start-up costs due to an established business model
- Reduced business risk due to proven concept
- Support and training from the franchisor
- Benefit from the franchisor’s advertising and brand recognition
Limitations to the Franchisor
- Risk of reputational damage from unsuccessful franchisees
- Difficulty in maintaining quality control across franchises
- Slower growth compared to some other external growth methods
Limitations of Franchise
- Limited autonomy due to the franchisor’s rules and regulations
- High initial investment with uncertain return
- Ongoing royalty payments reduce profit margin
