GROWTH OF FIRMS:

1. Internal Growth (Natural / Organic growth)

This comes about as a result of internal expansion e.g. through diversifying into other
products, opening new plants, increasing market for its current products.
2. External growth
This happens when two or more firms join together to form one. This can be through;
a) A merger – This is where two or more firms join together to form one enterprise.
b) A Takeover – This occurs when one firm buys 51% or more shares of another
company that gives it controlling rights over the business.
c) Acquisition – This occurs when one firm gains control of part of another
business.

Reasons why Firms May Wish to Grow in Size

 To reduce costs by benefiting from economies of scale
 To increase their market share
 To develop new and improved products to increase profits
 To expand their markets to other countries
 To become stronger and secure
 To increase the profitability of the firm

Internal Growth
This can occur from;
1. Reinvesting or ploughing back some of the profits made by the firm
2. Requesting owners/shareholders to put more money or capital into the firm for
expansion
3. Franchising where a larger firm allows another firm to use its business idea\name in
return for a share of the profits made
4. Opening new stores/ retail outlets to allow an online trading platform to expand the
market
5. Outsourcing to enable the firm contract out some of its services to another firm.

External Growth
This occurs through;
1. A merger with another firm to form a single business
2. Take over i.e. gaining 51% and above shares of another firm
3. Acquisition of part of another business
Advantages and Disadvantages of Internal Growth

Advantages Disadvantages
 It allows owners to keep control of the It is a slow process and takes a long time to
business be achieved

Advantages and Disadvantages of External Growth

Advantages Disadvantages

Allows more rapid growth Risky i.e. the firm may join another firm it
doesn’t know about necessarily
Firms gain skills and knowledge it may not
possess

Firm is associated with existing well-known

brands

Firms acquire new inventions and

technology

Firm is able to break into markets

MERGERS

Type Definition Advantages Disadvantages

Horizontal Merger Two or more Firms gain Diseconomies set in due to over expansion
firms at the economies of
scale Difficulty in merging the different
same
management structures of the integrating
level/stage of Firms increase firms
production join their market
together e.g. share
two banks
Firms exchange
ideas /
technology
Rationalisation
Vertical Backward A firm merges -Cheaper costs of Managing the firm at different stages may
Merger (Merging with / takes raw materials be too difficult
towards a source of raw over another
-Retail outlets
materials) firm in the same
 industry but at a hence more
stage of market
production
behind the
predator firm
e.g. tea factory
with tea
plantation

Vertical Forward Merger A firm merges Firm owns retail Management is hard at different levels
(Merging towards the with / takes outlet outlets to
market over another expand market
firm in the same
Helps in the
industry but at a
development and
stage of
marketing of new
production
products
ahead of the
predator firm
e.g. car
manufacturer
and retail outlet

Conglomerate Merger A merger A firm diversifies It is difficult to coordinate operations of

between firms its operations unrelated firms
producing hence reducing
different risks
products /
There could be a
different
transfer of ideas
industries e.g. a
travel company
and an
insurance
company

Economies and Diseconomies of scale

Economies of Scale:

Economies of scale are the advantages enjoyed by firms as a result of large scale production in the
form of reduced long run average costs.
Large scale firms incur lower costs per unit as they produce more output. This however is more
pronounced in the long run

Illustration

Economies of scale are divided into;

1. Internal economies of scale.

This refers to a reduction in long run average costs resulting from a firm growing in size e.g.
having more plants.
Types of internal economies of scale

Type Explanation

1. Technical economies The larger the output of a firm, the more

viable it is ti use large technologically
advanced machinery. This machinery is
likely to produce more output at lower
average costs.

2. Financial economies Larger firms find it cheaper and easier to

borrow from financial institutions since
they have the required collateral security

3. Managerial economies Large scale firms can afford to employ staff

in key positions which improves efficiency,
raises demand and revenue

4. Marketing economies (Buying and Large firms can buy raw materials in bulk at
 selling economies) cheapest prices and usually receive
discounts on large orders. Suppliers also
ensure high quality and speed delivery in
order to keep such large customers.
Transporting bulk purchases to consumers
is cheaper than bits of small purchases.
Large scale advertising is cheaper for it is
spread over the large output.

5. Risk spreading economies Large firms can spread risks by producing a

range of products. If the profits of one
products falls, it can shift its resources to
the more profitable product.

6. Research and development economies Large firms can afford to have a research
and development department which
develops new products and more efficient
methods of production

1. External economies of scale

This refers to lower long run average costs resulting from an industry growing in size.
Also called economies of concentration because they usually arise when firms in an industry are
located in one area e.g. Silicon Valley.

Type Explanation

1. Transport economies Improved transport network benefits all firms

e.g. roads, railways hence cheaper costs per
unit

2. Education Universities and colleges may provide tailor

made courses that benefit all firms

3. Suppliers Firms that provide raw materials and

components to the firms concentrated in the
area and benefit all firms

4. Amenities Improved housing and other social amenities

like entertainment attract more workers to
the area hence providing a pool of skilled
labour

5. Associated services The area is likely to attract banking and

insurance services that benefit all firms in an
industry

6. A skilled labour force A firm can recruit workers who have been
 trained by other firms in the industry

Internal diseconomies of scale

This refers to increasing long run average costs arising from a firm growing too large.

1) Difficulties controlling the firm Management of large firms is expensive and

complex. There are layers of management,
increased meetings and administrative costs

2) Communication problems The many workers in the firm may not get the
opportunity to express their views and ideas to
management. Information flow about duties and
opportunities is constraines.

3) Poor industrial relations