http://www.bized.ac.

uk

Business Economics

Copyright 2006 – Biz/ed

 http://www.bized.ac.uk

Business Economics

Copyright 2006 – Biz/ed

 http://www.bized.ac.uk

The Growth of Firms

Copyright 2006 – Biz/ed

 http://www.bized.ac.uk

The Growth of Firms

Internal Growth:
• Generated through increasing
sales
• To increase sales firms need to:
– Market effectively
– Invest in new equipment and capital
– Invest in labour

Copyright 2006 – Biz/ed

 http://www.bized.ac.uk

The Growth of Firms

External Growth:
• Through amalgamation, merger
or takeover (acquisitions)
• Mergers – agreed amalgamation
between two firms
• Takeover – One firm seeking
control over another
– Could be ‘friendly’ or ‘hostile’

Copyright 2006 – Biz/ed

 http://www.bized.ac.uk

External Growth

• Vertical Integration
• Horizontal Integration
• Conglomerate Merger

Copyright 2006 – Biz/ed

 http://www.bized.ac.uk

The Growth of Firms

External growth – types of
acquisition:
• Vertical integration –
amalgamation, merger or takeover
at different stages of the
productive process

Copyright 2006 – Biz/ed

 http://www.bized.ac.uk

Vertical Integration
Primary Vertical
Integration
Backwards –
acquisition takes
place towards the
source
Secondary Manufacturer

Tertiary Retail Stores

Copyright 2006 – Biz/ed

 http://www.bized.ac.uk

Vertical Integration
Primary Dairy Farming Co- Vertical
operative Integration
Forwards –
acquisition takes
place towards the
market
Secondary Cheese Processing
Plant

Tertiary

Copyright 2006 – Biz/ed

 http://www.bized.ac.uk

Horizontal Integration
• Amalgamation, merger or takeover
at the same stage of the
productive process

Copyright 2006 – Biz/ed

 http://www.bized.ac.uk

Horizontal Integration
Primary

Confectionery Soft Drinks

Secondary Manufacturer Manufacturer

Tertiary

Copyright 2006 – Biz/ed

 http://www.bized.ac.uk

Conglomerate Acquisition
• Amalgamation, merger or takeover
of firms in different lines of
business.

Copyright 2006 – Biz/ed

 http://www.bized.ac.uk

Motives
• Cost Savings • Shareholder Value
– External growth may be – Improve the value of the
cheaper than internal overall business for
growth – acquiring an shareholders
underperforming or
young firm may
• Asset Stripping
represent a cost – Selling off valuable parts
effective method of of the business
growth • Economies of Scale
• Managerial Rewards – The advantages of large
– External growth may scale production that
satisfy managerial lead to lower unit costs
objectives – power,
influence, status

Copyright 2006 – Biz/ed

 http://www.bized.ac.uk

Motives
• Efficiency • Control of Markets
– Gain some form of
– Improve technical, productive monopoly power
or allocative efficiency
– Control supply
• Synergy – Secure outlets

– The whole is more efficient • Risk Bearing

than the sum of the parts (2 – Diversification to spread
+ 2 = 5!) risks

Copyright 2006 – Biz/ed

 http://www.bized.ac.uk

Key Issues

Copyright 2006 – Biz/ed

 http://www.bized.ac.uk

Key Issues
• Divorce between ownership and control –
who runs the business?
– Shareholders?
– Board of Directors?
• Principal-Agent Relationship:
– Shareholders act as principals, Board as agents –
principals expect agents to act in their interest
– Sub-contracting work operates on a similar basis
– Contracts and compensation procedures to ensure
agents act on behalf of principals

Copyright 2006 – Biz/ed

 http://www.bized.ac.uk

Key Issues

• The Law of Diminishing Returns:

– Increasing successive units of a variable
factor to a fixed factor will increase
output but eventually the addition to
output will start to slow down and would
eventually become negative
• To prevent diminishing returns setting in,
all factors need to be increased – returns
to scale
Copyright 2006 – Biz/ed
 http://www.bized.ac.uk

Key Issues
Diminishing Returns –
assume the amount of
land/plant was fixed.
Adding labour and capital
units would initially
increase output but the
rate at which output
would rise will start to
decline and eventually
would become negative
unless the amount of
land/plant was increased
to accommodate the
increase in variable
factors.

Copyright 2006 – Biz/ed

 http://www.bized.ac.uk

Diminishing Returns –
Graphical representation
Output

Total Product (TP)

Quantity of the
variable factor

Copyright 2006 – Biz/ed

 http://www.bized.ac.uk

Efficiency

Copyright 2006 – Biz/ed

 http://www.bized.ac.uk

Productive

• Lowest Cost
– Productive efficiency can be achieved
where the same output could be
produced at lower total cost
– Achieved through re-organisation
(e.g. to cell production), investment
in new technology, training for staff
and so on

Copyright 2006 – Biz/ed

 http://www.bized.ac.uk

Technical
• Minimum inputs
– Technical efficiency can be achieved
if the same output can be produced
using fewer inputs
– Can be achieved using labour saving
devices, more efficient machinery,
more effective re-organisation of
restructuring and so on

Copyright 2006 – Biz/ed

 http://www.bized.ac.uk

Allocative

• Needs of Consumers (P = MC)

• Allocative efficiency occurs where the goods
and services being produced match the
demand by consumers
• P = MC – the value placed on the product
by the buyer (the price) = the cost of the
resources used to generate the good/service

Copyright 2006 – Biz/ed

 http://www.bized.ac.uk

Social

• MSC = MSB
• Social efficiency occurs where the private and
social cost of production is equal to the private
and social benefits derived from their
consumption
• A measure of social welfare

Copyright 2006 – Biz/ed

 http://www.bized.ac.uk

Motives of Firms

Copyright 2006 – Biz/ed

 http://www.bized.ac.uk

Profit Maximisation
• Profit maximisation – assumed to be the
standard motive of firms in the private sector
• Profit maximisation occurs where Marginal
Cost = Marginal Revenue
• MC = MR
• The firm will continue to increase output up to
the point where the cost of producing one
extra unit of output = the revenue received
from selling that last unit of output
• This assumes that firms seek to operate at
maximum efficiency

Copyright 2006 – Biz/ed

 http://www.bized.ac.uk

Profit Maximisation – Diagrammatic Representation

Cost/Revenue Assume output is at

MC
IfIfThe
100
theMC
theMR units.
firm ––the
process
firm The
were
The
decides cost
continues
to
MC
additiontoof
produce
for
produce toeach
producing the
total
one successive
104100
the
revenue
more
th
unit,
th
unit as–
150
this of
unit producing
145 the unitalast
101 produced.
unit
isst 20.
result
– the ofwould
addition cost
tomore ONE
Provided
total tocost
producing extra
produce
the
is MCthan
now
one unit
is18, it
140 The MR received from
Total Reduces earns
the of
less production
than
in
addition
more
selling
revenue
the
unit
that to MR
of
total(-105)
100 total
th
it
unit
added total this
willoutput
revenue would
be is worth
reduce
140
– the– the
price firm
to profit
120
profit by is 150.
profit
expanding
and The
soto firm
output
would can as
not
Added to this willaddadd
received
the 128 from
profit
difference of– it
isbetheworth
difference
producing.
total Added amount
profit to total worth
the selling
cost expanding
andthattheextra
profit between
output. unit. the two is
The profit received
revenue maximising from
ADDED to total profit.
40 output
that 100 is where
th
unit toMR =
30
20
MC.
profit (130).
18 MR

100 101 102 103 104 Output

Copyright 2006 – Biz/ed

 http://www.bized.ac.uk

Revenue Maximisation

• Total Revenue
• Average Revenue
• Marginal Revenue
• In this model the policies to achieve revenue
maximisation may be different to those
adopted to maximise profits

Copyright 2006 – Biz/ed

 http://www.bized.ac.uk

Other Objectives of Firms

• Sales maximisation:
– Attempts to maximise the volume of sales
rather than the revenue gained from them
• Share Price Maximisation:
– Pursuing policies aimed at increasing the
share price
• Profit Satisficing:
– Generating sufficient profits to satisfy
shareholders but maximising the rewards to
the managers/board and avoiding attention
from rivals or regulatory authorities

Copyright 2006 – Biz/ed

 http://www.bized.ac.uk

Behavioural Objectives
• Modern firms have to attempt to match
competing stakeholder needs:
– Shareholders
– Employees
– Consumers
– Suppliers
– Government
– Local communities
– Environment

Copyright 2006 – Biz/ed

 http://www.bized.ac.uk

Behavioural Objectives
• Firms may have to balance out
their responsibilities:
– ‘Fat cat pay’
– Management rewards – bonuses, etc.
– Social and environmental audits
– Employee welfare
– Meeting consumer needs
– Paying suppliers on time
– Satisfying shareholders and ‘The City’ about
its policies, plans and actions

Copyright 2006 – Biz/ed