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Size of business
Activity 3.1 (page 44): Problem of deﬁning size
Which business is largest, using the following measures of size:
• • • • •
employees capital employed sales turnover selling space number of outlets? 
Measure employees capital employed sales turnover selling space number of outlets Largest business Z Y X Y Z
What do your results tell you about your attempt to measure business size?  Business size is not easy to measure objectively. Many factors contribute to an assessment of size when comparing one firm with another, such as their degrees of capital intensity and the markets within which they operate.
Explain which would be the preferred measure of size in the following circumstances:
• • •
the government wishes to identify the supermarket with the greatest degree of monopoly power a bank wishes to lend money to the business with the largest capital base a shareholder wishes to invest in the business with the greatest sales potential. 
There is no definitive answer to this question; the examiner would be looking for the quality of the candidate’s justification in choosing between different measures.
the government wishes to identify the supermarket with the greatest degree of monopoly power
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Selling space will be particularly relevant in determining sales potential as this determines the amount of stock that can be displayed for customer purchase and the number of different product lines that can be sold.57 10 Efficiency relates to the ability to turn inputs into outputs. this is best measured by turnover. • Even though supermarket W.000 2. Activity 3.27 Sales per outlet (£m) 16. based on a number of different measures. 4 What can you conclude about the levels of efficiency of these four businesses?  Calculation of various measures of efficiency is necessary to answer this question.83 0.4 1.The government might focus on sales turnover in assessing monopoly power.67 60 28.3 − answer provided on Student’s CD-ROM. • a bank wishes to lend money to the business with the largest capital base Capital employed gives an indication of the capital base of a business. Chapter 3 © Cambridge University Press 2010 2 . supermarket X achieves £4. • Supermarket X appears to be more efficient. which is the smallest supermarket on all measures. The sales turnover it generates per unit of capital is greater than the other three supermarkets.83 1.000 per square metre compared to £2.67 2.2 − research activity. generates the highest level of sales per square metre of selling space.5 0.43 1 Sales per square metre of selling space (£) 4. it is much less efficient in terms of sales per employee and sales per unit of capital employed.667 for Z.500 2. Activity 3. Capital employed measures the total value of all the long-term finance invested in the business. These are summarised in the table below: Sales per unit of capital employed (£) 1.500 for Y and £2. • a shareholder wishes to invest in the business with the greatest sales potential. Competition legislation usually defines monopoly in terms of market share. • This is also reflected in its ability to generate sales from the available selling space.545 4.667 Supermarket W X Y Z Sales per employee (£m) 0.
in a more secure trading position.A Activity 3. it would gain competitive advantage by ensuring that new aircraft from the manufacturer are not sold to competitors ahead of Jet Airways. 3 Assess the likely impact of the Jet Airways takeover of Air Sahara on any two stakeholder groups. Thus. • Employees may have better job security as Jet Airways now faces less competition and is. Jet Airways and Air Sahara are both airlines.4 (page 50): Jet Airways takes over Air Sahara and Daimler sells Chrysler after failed merger 1 How would you classify the type of integration used in both of these case studies? Explain your answer. This will mean that some employees will be made redundant.  Two potential benefits would be: It would give Jet Airways control over the quality and price of aircraft as well as ensuring an adequate supply of aircraft to meet its needs.  Both of these case studies relate to horizontal integration. Jet Airways would be able to absorb the profit margin of the aircraft manufacturer and this would help make the airline more price competitive in the market. Jet Airways would be able to control supply of aircraft to other airlines. therefore. (Continued) Chapter 3 © Cambridge University Press 2010 3 . Daimler and Chrysler are both car manufacturers. A horizontal merger occurs when two firms in the same industry at the same stage of production come together. • The combined airline may decide to cut flights where there is a duplication of services. • analyse two potential benefits to Jet Airways of this merger.  Stakeholder Employees Impact of Jet Airways takeover of Air Sahara • A motivation for the takeover is to streamline the two head offices. 2 If Jet Airways were now to merge with an aircraft manufacturer: • how would this merger be classified? Explain your answer  Merging with an aircraft manufacturer would be an example of vertical integration as it would involve two firms in the same industry but at different stages of production merging. This could also result in redundancy.
A Stakeholder Customers Impact of Jet Airways takeover of Air Sahara • Better customer service as the ‘inter-linking of . streamlining the two head offices and better deals from aircraft manufacturers. http://timesofindia. forcing price reductions that swallowed up the cost savings anticipated from the merger.cms Chapter 3 © Cambridge University Press 2010 4 . If some of the anticipated savings are passed on to the customer.uk/1/hi/business/607338. then there will be lower prices. difficult to control. 17 January 2000. http://news. BBC Online. • Culture clashes − management teams may find it difficult to work together. • External factors. Alcatel-Lucent suffered from difficult economic conditions. 8 February 2007. then the level of • Suppliers • Suppliers will face an organisation that has enhanced its market • 4 Using the Daimler−Chrysler case study and any other researched examples. power.  Potential factors leading to disappointing outcomes following mergers include: • Diseconomies of scale − mergers may create organisations that are too large and are. Times of India.indiatimes. leading to greater potential dividends for the shareholders and an increase in the share price of Jet Airways. As Jet Airways now has a market share of about 32%.stm ‘Merger woes plague Alcatel-Lucent’. The disruption of rationalisation may well contribute to disappointing outcomes from the merger. http://news. • Shareholders • If there is synergy between the two businesses. air routes should allow more passengers to be offered connecting flights’. employees are likely to oppose job losses. profits should increase. • Customers may also benefit from reduced air fares due to economies of scale for Jet Airways leading to a reduction in costs.co. this will give it a degree of monopoly power.bbc. therefore.g.co.uk/1/hi/business/7234245. .g. The merger offers potential savings to Jet Airways. discuss why many mergers and takeovers fail to give shareholders the benefits originally predicted. This could be used to increase prices to the customer on routes where previously the two airlines were competitors. Suppliers of Jet Airways may benefit if they win contracts to supply the Air Sahara part of the business. Mergers often seek to benefit from rationalisation of operations.stm ‘It takes a whole lot to sing a perfect chorus’. 1 February 2007. e. • Resistance to change − it is often suggested that it is human nature to oppose change. Any significant change in business is likely to have a significant impact on employees. thus reducing profit margins.bbc. These cost savings can lead to higher profit margins for the business.com/It_takes_a_whole_lot_to_sing_a_perfect_chorus/ articleshow/1548108. Further reading ‘Culture clash: the risks of mergers’. This will put pressure on suppliers to offer better prices. . e. such as a downturn in the economy − macro-economic conditions can change. BBC Online.
For: • Businesses do not operate in a moral vacuum.  • • Create employment − small businesses are significant employers in the economy. There is no divorce between ownership and control.  This is a matter of personal opinion. Government interference is necessary to prevent rogue businesses neglecting their duties to society. Chai Wei’s poor food safety. customers will ultimately take their custom elsewhere. Where standards in business are unsatisfactory. Dynamic impact of small businesses on the economy − small businesses are often owned and managed by ambitious individuals such as Chai Wei.Revision case study 1 (page 53): Small restaurant business expands rapidly 1 State two aspects of Chai Wei’s business that seem to be covered by government controls. Employees who are paid low wages could seek employment elsewhere. taking advantage of the relatively weak bargaining position of employees. they have a clear incentive to work hard to grow their business.g. therefore. but you still need to support your point of view with a reasoned business argument. Chai Wei minimises costs by paying low wages. they are not forced by Chai Wei to accept a job. • Without government controls. They are part of society and should. Chapter 3 © Cambridge University Press 2010 5 . • Government controls may restrict business activity and add to costs. As they enjoy the rewards of business success. By creating employment. take responsibility for their actions and consider a range of stakeholders when making decisions. Against: Businesses exist primarily to make profit and should be able to act freely in pursuit of profit. He is also prepared to put customers at risk through unsatisfactory food safety in his restaurants. This will increase prices to consumers and threaten job opportunities. e. they are reducing the burden of unemployment on the state and the taxpayer. • 3 Analyse reasons why the government seems to be keen to encourage small firms such as this one. there may be a ‘race to the bottom’ where businesses are forced to adopt ever-lower standards in order to remain price competitive. For example. 2 Do you think the government should control the activities of businesses such as Chai Wei’s? Explain your reasons.  Aspects covered by government controls include: • location decisions – cheap loans to businesses setting up in areas of high unemployment • payment of workers – national minimum wage • consumer protection − Food Safety Department inspection.
Generates tax revenue for the government − the business will pay corporation tax and/or the owner will pay income tax. shops or factories. Thus. the business has a beneficial impact on economic growth. Such areas may struggle to attract other businesses due to low incomes. it should not be supported as this will give it a further competitive edge against other businesses that abide by the laws. A Revision case study 2 (page 54): Growth strategy in dispute at Trafﬁc Clothing plc 1 What is the difference between ‘internal’ and ‘external’ growth?  Internal growth. No • • Exploits workers by paying less than minimum wage − as the business is operating outside the law. e. They often provide a more personalised service for customers than large businesses.  Yes • • • Creates employment − the business operates in areas of high unemployment where there may be few job opportunities. food. The more successful the business is. A business such as Chai Wei’s may be more responsive to customer needs than a large multinational. is the expansion of a business through opening new branches. External growth is business expansion through merging with or taking over another business. its lack of corporate social values might be considered to be more important.g. such as McDonald’s. Evaluation may consider: Although the business makes a valuable contribution to the economy. the greater will be the tax revenue for the government. Exploits consumers by storing food incorrectly − the government has a duty to ensure that taxpayers’ money is spent effectively. The restaurant benefits other businesses by providing demand for supplies. Chapter 3 © Cambridge University Press 2010 6 . Subsidising this restaurant is not acceptable as it does not consider its duty of care to the consumer. Aids economic growth − output of the restaurant is a direct addition to GDP of the economy. or organic growth.• Small businesses create competition and offer alternatives to large businesses. 4 What other measures might the Trade Department have used to assess the size of Chai Wei’s business other than number of employees?  • • • • 5 sales turnover profit capital employed added value Do you think Chai Wei deserves government support for his business? Explain your answer.
Consumers may suspect uncompetitive activity. 3 Analyse the likely advantages and disadvantages of vertical integration for this business. Traffic Clothing is a manufacturing business and does not necessarily understand the retail industry. products are displayed and promoted. Management and marketing skills necessary in retailing will be different from those needed in manufacturing. Lower prices have reduced the profit margin that Traffic Clothing can achieve. as well as the standard of customer service offered.A 2 Explain how the business increased sales revenue. the retailers can effectively force Traffic to accept lower prices.  Vertical integration for Traffic Clothing may either be forwards with retailers or backwards with suppliers. yet gained no increase in profits for the last three years. This may generate negative publicity.  A number of factors have clearly squeezed the profit margins of Traffic Clothing: • Prices have fallen within the market due to new competitors entering the market. • Traffic Clothing will be able to ensure that distribution outlets for its products are available. • Traffic Clothing will gain more direct feedback from the consumer. Advantages Forward vertical integration • Traffic Clothing may gain control over the marketing of its products to the retailer It can thus determine the way. Thus. a higher volume of sales is required to keep profit the same. The type of integration will affect the outcome for Traffic Clothing. Disadvantages Forward vertical integration • Traffic Clothing lacks experience in selling clothing to consumers. Thus. This will reduce the gross profit margin of the company. • • (Continued) Chapter 3 © Cambridge University Press 2010 7 . This may enable Traffic Clothing to increase sales of its own products. • Raw material prices have also risen. • The products of competitors may be excluded from the retailers it takes over. This will enable it to be more responsive to changes in the market and be more customer oriented. Traffic Clothing lacks experience in this sector. • Retail mergers have increased the bargaining power of Traffic Clothing’s customers. • Traffic Clothing will be less reliant on the merged retailers that are driving down the prices paid to Traffic Clothing.
However. that is manufacturing companies. Absorbing the profit margins of suppliers will make Traffic Clothing more price competitive. A policy of rapid external growth may bring risks of Traffic over-extending itself. Forward integration enables Traffic to exclude the products of competing manufacturers. • Traffic Clothing may gain some control over supply of materials to some competitors. However. Chapter 3 © Cambridge University Press 2010 8 . but it will still have to remain price competitive unless it is able to develop a strong brand image to enable a premium pricing strategy to be implemented. • Traffic Clothing will be able to control the quality of materials directly. therefore. Disadvantages Backward vertical integration • Traffic may lack experience of managing a supplier of materials. be more risky. loan finance may be possible. Backward integration may involve taking over the producers of materials. it may be argued that this is preferable as Traffic Clothing is already a manufacturing company. • Traffic Clothing will be able to gain control over the cost of materials. A move into retailing may be more alien to the existing directors and. Increasing material costs have been a problem for Traffic Clothing. Your report should contain an assessment of the advantages and disadvantages of each proposal and a final recommendation for the board of directors. The three key problems faced by the business are: • Increasing input prices − backward vertical integration will give Traffic Clothing some control over the cost of materials. • Mergers between retailers leading to increased buying power − forward integration will give Traffic Clothing some protection against this problem. • The supplying business may become complacent due to having a guaranteed customer.  In assessing the advantages and disadvantages outlined above it is important to make a judgement about the relative importance of each factor. Thus. such as the price of cotton and wool and the price of oil and other inputs into synthetic material production.A Advantages Backward vertical integration • Traffic Clothing will gain a secure supply of key materials. • Increased competition from new manufacturers − backward integration has the benefit of securing supplies for Traffic Clothing and of absorbing the profit margin of suppliers. 4 Write a report evaluating the proposed forms of external integration for this business. There may be problems with financing rapid growth and suitable takeover targets will need to be identified. This may be a critical factor in determining the direction of growth. the cost of producing materials will be influenced by factors beyond the control of the producers. given that the firm has achieved growth over the last decade without ‘too much external debt’.
Sales turnover • This is the total value of sales made by a business over a given time period.  Measure Number of employees Commentary • This is a very simple measure that is easy to understand and • make comparisons. a nuclear power station will have significant capital needs. a firm with a highly automated production line will have relatively few employees. • It is a common measure of size used for comparing • • Capital employed businesses in the same industry − a useful comparator in businesses such as supermarkets. as the sizes of markets vary enormously.g. Many countries will have clear definition of size according to the number of full-time equivalent employees. Share prices can be very volatile and thus the market capitalisation of a business may change rapidly despite no significant change within the business. A business such as the Royal Bank of Scotland saw its market capitalisation fall from over $100bn to less than $20bn over a matter of months in 2008. • This is only relevant for businesses quoted on a stock • exchange where shares can be traded. Comparisons between firms in different markets. it does not follow that a firm with high market share is a large company. • This is the total value of all long-term finance invested in the • A large business will usually have a high value of capital for • long-term investment. but add relatively little value to the productive process. For example. However. for comparing businesses producing the same goods and services. The turmoil on stock exchanges around the world illustrates this problem. For example. e. Market share • This indicates relative size within an industry. based on turnover. Market capitalisation • This is the total value of a company’s issued shares. a small retailer employing a few people compared to a national chain employing thousands. so is useful • Chapter 3 © Cambridge University Press 2010 9 . A potential weakness is that some firms may have high turnover. business. a dentist employing a few people will have much higher capital needs than a window-cleaning service employing the same number of people.: small: less than 50 employees medium: between 50 and 250 employees large: more than 250 employees. Market capitalisation = current share price × total number of shares issued.A Essay 2 a Examine three different ways in which business size may be compared. whilst others are labour intensive.g. e. may also be misleading. For example. When making comparisons between industries a problem will be the different amounts of capital required to operate. • Problem with using employees is that some firms are capital intensive.
Disadvantages Forward vertical integration • The management of a TV • • manufacturer may not understand the retail industry. There may be increased problems of managing the business due to its increased scale. A simple approach would be to consider a specific type of business involved in the primary sector. the theoretical arguments for and against integration can be explained and reference made to specific examples. Advantages Forward vertical integration • The manufacturer will gain control over the marketing of TVs to the retailer and can thus determine the way products are displayed and promoted.  Definition of vertical integration: this occurs when two businesses in the same industry join together that operate at different stages of the production/supply chain. Consumers may suspect uncompetitive activity. This way application could be developed with relative ease and evaluative marks accessed. • (Continued) Chapter 3 © Cambridge University Press 2010 10 . as well as the standard of customer service offered. This may generate negative publicity. • The manufacturer will be able to ensure that distribution outlets for products are available. Possible suggestions: • a farmer integrating forward with a greengrocer • backward integration of a clothes retailer • forward integration of a TV manufacturer. There may be lack of experience in this sector. this will enable it to be more responsive to changes in the market and be more customer oriented. The following points relate to the vertical integration of a TV manufacturer. • The products of competitors may be excluded from the retailers it takes over. Alternatively. Answer could be viewed from the perspective of businesses at different stages of the productive process.A b Evaluate the consequences for a business of deciding to integrate vertically in order to achieve expansion. This may enable it to increase sales of its own products. • The manufacturer will gain more direct feedback from the consumer. Management and marketing skills necessary in retailing will be different from those needed in manufacturing. the secondary sector or the tertiary sector.
Disadvantages Backward vertical integration • The manufacturer may lack • • experience of managing a supplier of components. Thus. it may be beneficial for a farmer to integrate with a small retailer. Therefore. • The manufacturer may gain some control over supply of components to some competitors. Conditions within a particular industry may determine what the most important consequences of vertical integration are. a component manufacturer that takes over a TV manufacturer will not gain any control over how its products are sold by retailers.: • Are supplies of materials secure for a manufacturing firm? A manufacturing firm that requires access to scarce resources may benefit significantly from backward vertical integration. • The manufacturer will be able to control the quality of components directly.A Advantages Backward vertical integration • Closer links with a supplier will aid new product development. There may be increased problems of managing the business due to its increased scale. • The manufacturer will gain a secure supply of key components. one of the most important advantages of forward integration disappears. farmers are relatively powerless in the face of big supermarkets. • Absorbing the profit margins of suppliers will make the TV manufacturer more price competitive.g. • The manufacturer will be able to gain control over the cost of components. For example. Evaluation may consider: Consequences depend on the direction of integration and the stages involved. in this case. Chapter 3 © Cambridge University Press 2010 11 . • How powerful are retailers? In some countries. e. The supplying business may become complacent due to having a guaranteed customer.
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