Firms

3.5
Objectives

► AO1 Understand how firms may be classified

► AO2 Be able to analyse how and why firms grow
► AO3 Be able to evaluate the advantages and disadvantages of growth
Key terms

► Internal growth
► External growth
► Mergers
► Economies of scale
► Diseconomies of scale
Classification of firms

Primary sector
► The primary sector of industry is concerned with the extraction of raw
materials or natural resources from the land. Any business that grows
goods or extracts materials from the land would be classed as a primary
sector business.
► Examples of businesses that operate in the primary sector would be
farming, mining, fishing or oil production.
Classification of firms

Secondary sector
► The secondary sector of industry is concerned with manufacturing. This
would involve taking the raw materials from the primary sector and
converting them into new products.
► Examples of businesses that operate in the secondary sector would be car
manufacturers, food production or building companies.
Classification of firms

Tertiary sector
► The tertiary sector of industry is concerned with providing a service.
Services are activities that are done by people or businesses for
consumers.
► Examples of businesses that operate in the tertiary sector would be
hairdressers, banks, supermarkets or cinemas.
Sectors of economy

► Private sector
► The type of organisations that would be in the private sector are:
► sole trader
► partnership
► private limited company (Ltd)
► Public limited company (PLC)
► Private sector organisations, such as a local newsagent or large
supermarket chain are owned and controlled by private individuals. Their
primary aims are to survive and make a profit.
Sectors of the economy

► Public sector
► The type of organisations that would be in the public sector are:
► national government
► local government
► Public sector organisations are owned and controlled by the government.
They aim to provide a service to the public and are funded by taxes.
Public sector organisations function in areas such as health, education,
housing and social work.
Benefits of being a small firm

► Concentrate on niche markets

► Small can be a selling point
► Local profile
► Economies of scale are limited in some industries
► Different business objectives
► Tax advantages
Benefits to consumer of using small
firms

► Personal touch
► Individuality
► New ideas
► Small firms will need to impress
Disadvantages of small firms

► Less efficient than big firms

► Lack of resources
► Small firms may lack access to supply chains and retail outlets
► Lack brand awareness
Causes and forms of the growth of
firms

The motives for increasing in size can include:

► Greater sales lead to greater profit, making the firm more attractive to shareholders
► Successful, growing firms are likely to increase salaries/pay bonuses to managers.
► Increasing output enables economies of scale, greater efficiency and lower average
costs.
► Increased prestige for managers seeing the firm become more influential and powerful.
► Greater risk diversification, e.g. when growth comes from product diversification.
► Growing in size enables growth in market share and monopoly power, enabling even
greater profitability.
► Owners having a passion for their product and wanting to see it do well.
► Globalisation has enabled firms to sell product in global market.
Barriers to growth of firms

► Some firms may have a unique niche. e.g. expensive clothing labels may lose their aura
of ‘exclusivity’ if they grow.
► Growing the firm may require issuing shares and listing the firm on the stock market. This
means that the original founder has a greater danger of losing control and being more
answerable to shareholders who want short-term profitability.
► Lack of focus if there is too much diversification.
► It becomes harder to retain high standards of service if the firm grows. The original
founder has to do more delegation; it depends whether he can find good people to
delegate to.
► It depends on the industry. Cafes do not share same economies of scale as airline
industry
► Competition regulation. The government may block mergers which gain more than 25%
market share. Some firms may even be forced to de-merge if they abuse their
dominant market position
How do firms grow?
Organic growth is also known as internal
growth.

It happens when a business expands its own operations rather than relying on
takeovers and mergers.
► Organic growth can come about from:
► Increasing existing production capacity through investment in new capital
& technology
► Development & launch of new products
► Finding new markets for example by exporting into emerging countries
► Growing a customer base through marketing
External Growth of a Business

There are many potential advantages:

► Faster speed of access to new product or market areas
► Increased market share / increased market power
► Access internal economies of scale (perhaps by combining production capacity)
► Secure better distribution channels / control of supplies
► Acquire intangible assets (brands, patents, trademarks)
► Overcome barriers to entry to target new markets
► Defend a business against a takeover threat
► Enter new segments of an existing market
► To take advantage of deregulation in an industry / market
External growth

► Horizontal Integration
► An example would be between two car manufacturers or drinks suppliers.

► Volkswagen buying Porsche

Google
Advantages of Horizontal Integration

► It increases the size of the business and encourages internal economies of

scale – lower long run average costs – improved profits and
competitiveness
► One larger merged firm may need fewer workers, managers and premises
than two – a process known as rationalization designed to achieve cost
savings
► Mergers often justified by the existence of “synergies"
► Creates a wider range of products - (i.e. diversification). Opportunities
for economies of scope
► Reduces competition by removing industry rivals – increases market share
and pricing power
Vertical Integration

Vertical Integration involves acquiring a business in the same industry but

at different stages of the supply chain.
► The supply chain is the process by which production and distribution gets
products to the customer.
► Google - a software business - buying Motorola, a phone maker
► Record labels and music stations
► Forward vertical: Closer to the final consumers of the product e.g. a
manufacturer buying a retailer
► Backward vertical: Closer to raw materials in the supply chain e.g. a steel
firm buying a coal mine
Advantages of Vertical Integration

The main advantages of vertical integration are:

► Control of the supply chain – this helps to reduce costs and improve the
quality of inputs into the production process
► Improved access to key raw materials perhaps at the expense of rivals
who must then pay more
► Better control over retail distribution channels e.g. pub companies who
ensure that their beers and wines are sold in tenanted pubs and clubs
► Removing suppliers, and crucial information from competitors which helps
to make a market less contestable
Conglomerate

► Conglomerate mergers occur when two companies that offer different

services, or are engaged in different types of business, merge. A
conglomerate also can occur when two like companies want to merge to
increase their market share. Usually a conglomerate merger is meant to
make both entities stronger than they would be individually, and it occurs
between two large-scale companies.
 Advantages of a conglomerate
merger

► Increased market
► Diversification
► Economies of scale
Mergers and the consumer

► As the U.S. Federal Trade Commission points out on its website, many
mergers benefit competition and consumers by allowing firms to operate
more efficiently. However, some mergers can lead to monopolistic
positions, which can then lead to higher prices, decreased innovation or a
drop in the quality or availability of goods or services.
Economies of scale

► Economies of scale are the cost advantages that a business can exploit
by expanding their scale of production. The effect of economies of scale is
to reduce the average (unit) costs of production.
► There are many different types of economy of scale and depending on the
particular characteristics of an industry, some are more important than
others.
Economies of scales
 Internal economies of scale

Internal economies of scale arise from the growth of the

business itself.
Economies of scale
Economies of scale
External economies of scale

External economies of scale occur within an industry

► Development of research and development facilities in local
universities that several businesses in an area can benefit from
► Spending by a local authority on improving the transport network for a
local town or city
► Relocation of component suppliers and other support businesses close to
the main centre of manufacturing are also an external cost saving
Diseconomies of scale

Diseconomies of scale occur when a business grows so large that the costs
per unit increase. As output rises, it is not inevitable that unit costs will fall.
Sometimes a business can get too big!
► Poor communication
► Lack of motivation
► Loss of direction and co-ordination
► Inability to adapt quickly to a changing market
Diseconomies of scale
Key terms

► Internal growth
► External growth
► Mergers
► Economies of scale
► Diseconomies of scale
Objectives

► AO1 Understand how firms may be classified

► AO2 Be able to analyse how and why firms grow
► AO3 Be able to evaluate the advantages and disadvantages of growth