Focus 3: Size of Business

Unit 1: Business and its environment

 Chapter objectives
On completing this chapter, you will be able to:

§ Identify several ways of measuring the size of businesses and evaluate each of them

§ Analyse the beneficial impact that small firms can have on a country’s economy

§ Analyse advantages and disadvantages of small and large businesses

§ Explain the difference between internal and external growth.

 Measuring business size
§ It is common to compare diferent businesses in terms of size
Ø There are several diferent ways to measuring business size and may produce
contradictory results
Ø There is no internationally agreed definition of what is a small, medum or large
business
 Different Measures of Size
§ Number of Employees
§ Revenue
§ Capital Employed
§ Market Capitalization
§ Market Share
§ Other measures: no. of beds in a hotal, no. of shops etc
 Number of Employees

§ Simplest of all methods

§ The greater the number of employees, the larger the business is

§ Problem: inappropriate measurement sometimes

Labour Intensive >< Capital Intensive
 Revenue

§ Revenue: total value of sales made by a business in a given time period

§ More accurately when comparing business size in the same industry

§ Not very effective when used to compare size of businesses in different industries
 Capital Employed

§ Capital Employed: the total value of long term finance invested in the business

§ The larger the business, the greater the need of long term finance (capital
employed)

§ Problem: Different industry will determine the amount of capital employed

 Market Capitalisation

§ It is the total value of the company’s issued shares.

Market capitalisation = Current share price × Total number of shares issued

§ As the share price keep changing so this is not a stable measure of business size

and may give misleading results

 Market Share

§ Market share: sales of the business as a proportion of total market sales

Total sales of the business

Market share = * 100
Total sales of industry
§ A firm with large market share will be a comparatively large firm

§ However, if a market size is small, a large market share may not necessarily
indicate a large firm
Problem of defining size
 Best Measure

§ Which is the best measure of business size?

Ø There is no “best” measure
Ø Depends on whether we are interested in absolute size or comparative size within one
industry.
 Significance of Small Scale Business

• Many jobs are created

• Often run by dinamic entrepreneurs with new ideas for consumer goods
• Competition for large business
• Small firms often supply specialist goods and services
• Lower costs which may be passed to consumers
• All great businesses were once small businesses
 Government Assistance for Small Businesses

§ Reduced Tax
§ Loan Guarantee Scheme
§ Information, advice and support
§ Others:
o Establishment of small workshops, at reasonable rents.
o Training specialist management expertise
o Offer more products from banks
Advantages & Disadvantages of Small Scale Businesses

Advatages of small businesses Disavantages of small businesses

• Can be managed by the owner(s) • Limited access to sources of finance

• Adapt quickly to changes of customer needs • A large burden of responsibility for owners
• Offer personal service to customers • May not be diversified, so greater risks of
• More “human” business negative impact of external change
• If family-owned, the business culture if often • Few opportunities for economies of scale
informal, employees well-motivated and
family members perform multiple roles
 Advantages & Disadvantages of Small Scale Businesses

Advatages of large businesses Disavantages of large businesse

• Can employ specialist managers • Difficult to manage

• Cost reductions by large-scale production
• Set low prices that other firms have to follow
• Acess to several different sources of finance •
• Diversified in several markets and products
so that risks are spread
• Afford research and development (R&D)
• Potential cost increases with large-scale
production
Suffer from slow decision-making and poor
communication
• Suffer from a divorce between ownership
and control
 Family Owned Businesses

• Family owned business is the one which is owned by at least two members of the
same family

Strengths Weaknesses

Commitment Succession Problem

(~15% continue till the 3rd generation)

Reliability and Pride Informality

Knowledge Continuity Traditional

Conflict
 Why Businesses Grow?

§ Increased Profit
§ Increased Market Share
§ Increased Economies of Scale
§ Increased Prestige for owners and directors
§ Reduced risk of a takeover
 Businesses Growth
§ Business can grow internally and/or externally
Ø Internal Growth: opening more branches or expanding its current scale of production
Ø External Growth: integration of two or more firms either through a merger or a takeover
=> Rapid expansion but may management problem
 Integration: Merger & Takeover

• Merger is when two or more businesses permanently join together to become one
business. The shareholders of both the businesses agree to form one firm to be
controlled under common board of directors and the shareholders of both the
businesses will have shares in the newly merged business.
• Takeover is when one business buys out another business and is also referred to as
acquisition. In a takeover, a company buys more than 50% shares of another company
and becomes the controlling owner of it.
Problems of growth through mergers/ takeovers (financial)
Problems of growth through mergers
• Takeovers can be very costly, stretching
the financial resources of the
• Additional fixed capital and working
capital will be required quickly
• A merger/takeover could lead to negative
cashflow and an increase in long-term
borrowing and interest payments.
Possible strategies to overcome
problems
• Use internal sources of finance, when
possible, for example retained earning
• Raise finance from share issues.
• Offer shares, not cash to pay for a
takeover
 Problems of growth through mergers/ takeovers (managerial)
Problems of growth
• Existing management may be unable to •
cope with problems of controlling an
operation.
• Lack of coordination between divisions
of an expanding business-a real problem
for integrating businesses.
• The culture clash between the two
management teams may be very great.
Possible strategies to overcome
New management systems and
structures are required
• A decentralisation policy could provide
motivated managers with a clear local
focus.
• A new management culture needs to be
put in place rapidly.
 Hostile takeover
§ A hostile takeover occurs when an acquirer buys another entity despite the objections of the
managers of the target organization. A hostile takeover can be accomplished either through a tender
offer or a proxy fight.
§ The goal of the takeover by the acquirer is to achieve at least 51% ownership in the target company's
stock. The strategies used in a hostile takeover can create additional demand for shares while
creating an acrimonious battle for control of the target company.
§ A hostile takeover occurs when an acquiring company attempts to take over a target company
against the wishes of the target company's management. An acquiring company can achieve a
hostile takeover by going directly to the target company's shareholders or fighting to replace its
management.
§ Hostile takeover methods include buying a majority of the shares on the open market, a direct
premium offer to the existing shareholders from the acquiring company (a tender offer) and using
existing shareholders voting rights (a proxy war).
 Synergy
§ Synergy (1+1 > 2): When two firms integrate, it is assumed that the new bigger
firm will be more efficient, effective and profitable than the two separate
companies because:
Ø Shared research facilities and pool of ideas will benefit both the firms but this will only
be the case if both firms deal with same technology
Ø New business will enjoy economies of scale
Ø Marketing and distribution costs will be shared
 Different forms of external growth
• Horizontal integration: integration with a business in the same industry and at the
same stage of production
• Vertical integration: integration with a business in the same industry
• Forward vertical integration: vertical integration with a customer business
• Backward vertical integration: vertical integration with a supplier business.
• Conglomerate integration: integration with a business in a different industry.
 SUMMARY POINTS
§ External business growth results from mergers and takeovers (acquisitions)
§ External growth can be horizontal, vertical (backwards and forwards) and
conglomerate
§ These forms of external growth result in different potential benefits and limitations
§ Rapid growth can create problems for management
§ The synergy from mergers and acquisitions is not always as great as expected
THANK YOU!