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1.5 Growth and Evolution

Costs and Revenue 

  • Average cost (AC) is the cost per unit of output. It's calculated by dividing total cost (TC) by the quantity of output (Q): AC = TC / Q.

  • Average cost is composed of two parts: average fixed cost (AFC) and average variable cost (AVC).

  • AFC is calculated by dividing total fixed cost (TFC) by the level of output: AFC = TFC / Q.

  • Similarly, AVC is calculated by dividing total variable cost (TVC) by the level of output: AVC = TVC / Q.

Economies of Scale 

  • Technical economies: They can use advanced machinery to mass produce goods, spreading high equipment costs over a larger output. This reduces the cost per unit.

  • Financial economies: They can borrow money at lower interest rates due to lower perceived risk.

  • Managerial economies: Employing specialized managers for different functions (like marketing, accounting, and production) leads to increased efficiency and productivity.

  • Specialization economies: Dividing labor among specialized workers (designers, production staff, engineers) boosts productivity.

  • Marketing economies: Selling products in bulk to larger customers and spreading advertising costs over wider markets reduces costs.

  • Purchasing economies: Buying resources in bulk results in lower prices.

  • Risk-bearing economies: Diversified companies can spread risks and costs across different products or industries.

Diseconomies of Scale

As a business grows larger, it faces increasing challenges that can lead to higher costs. These issues include:

  • Management difficulties: Coordinating a larger workforce becomes harder, leading to slower decision-making and communication problems.

  • Employee morale: Workers may feel alienated, reducing motivation and productivity.

  • Inefficiencies: Specialization and division of labor can lead to boredom, decreased productivity, and increased bureaucracy.

  • Complacency: Large, successful firms may become complacent, leading to decreased productivity.

External Economies of Scale

  • Technology: Technological progress, such as the internet, can reduce costs by enabling efficient operations like e-commerce.

  • Infrastructure: Improved transportation networks enhance delivery speed and reduce employee tardiness, ultimately benefiting the business.

  • Labor: Access to skilled labor through local training programs or regional specialization can lower recruitment and training costs while boosting productivity.

External Diseconomies of Scale

  • Increased land costs: As more businesses compete for space, land prices rise, increasing fixed costs for all.

  • Higher labor costs: With more firms competing for workers, wages increase, raising operating costs.

  • Traffic congestion: Increased business activity leads to traffic congestion, which raises transportation costs.

How to achieve internal growth

  • Pricing: Businesses can adjust prices based on demand. Lower prices can attract more customers (elastic demand), while raising prices can increase revenue (inelastic demand).

  • Promotion: Increased marketing and advertising efforts can raise brand awareness and sales.

  • Product Development: Creating new or improved products that appeal to customers can attract new buyers and boost sales.

  • Distribution: Expanding sales channels (e.g., more stores) makes products more accessible and increases sales potential.

  • Credit Options: Offering financing options like installments attracts customers and increases sales.

  • Investment: Investing in new facilities, technology, or processes can improve efficiency and lead to higher sales.

Advantages and disadvantages of internal growth

Advantages:

  • Control: Businesses maintain full control over their growth process.

  • Lower cost: Typically less expensive than external growth methods.

  • Preserved culture: Maintains existing company culture.

  • Lower risk: Less risky compared to external growth options.

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Disadvantages:

  • Slower growth: Often results in a slower growth rate compared to external methods.

  • Diseconomies of scale: Can lead to increased costs as the business grows.

  • Restructuring: Requires changes in organizational structure as the business expands.

  • Dilution of ownership: For businesses transitioning to public ownership, control is shared with shareholders

External Growth

  • External growth is a way for a company to expand its operations by working with other businesses, rather than relying solely on its resources. 

  • This involves strategies like mergers, acquisitions, takeovers, joint ventures, strategic alliances, and franchising

  •  Essentially, it's about combining forces with other companies to achieve growth.

Advantages and Disadvantages of external growth

Advantages:

  • Faster growth: Achieved through acquiring existing resources and markets.

  • Synergies: Combines strengths of different companies.

  • Reduced competition: Can lead to increased market share.

  • Economies of scale: Benefits from larger-scale operations.

  • Risk diversification: Spreads business risks across different areas.

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Disadvantages:

  • Higher costs: Often involves significant financial investments.

  • Increased risk: Involves uncertainties and potential failures.

  • Regulatory hurdles: May face government restrictions.

  • Diseconomies of scale: Can occur if the merged company becomes too large.

  • Cultural clashes: Integrating different company cultures can be challenging.

Reasons for businesses to grow large

  • Market share: Percentage of total industry sales.

  • Sales revenue: Total income from sales.

  • Number of employees: Workforce size.

  • Profit: Earnings.

  • Capital employed: Investment in the business.

Reasons for businesses to remain small

  • Lower costs: Smaller scale operations often lead to lower costs due to avoiding diseconomies of scale and lower borrowing costs.

  • Control: Owners maintain greater control over their business.

  • Lower financial risk: Smaller businesses typically have lower financial stakes.

  • Government support: Small businesses often qualify for government grants and subsidies.

  • Local monopoly power: Can operate without direct competition in certain areas.

  • Personalized service: Ability to build strong customer relationships.

  • Flexibility: Can adapt to market changes more quickly.

  • Niche markets: Can focus on specific, smaller markets without attracting large competitors

What are mergers and acqusitions?

  • Merger: Two or more companies combine to form a new legal entity. (e.g., BP Amoco)

  • Acquisition: One company purchases a controlling interest in another company. (e.g., Google acquiring YouTube)

Examples:

  • Daimler Benz & Chrysler (1998)

  • GlaxoWellcome & SmithKline Beecham (2000)

  • American Airlines & US Airways (2013)

  • Amazon & Whole Foods (2017)

Types of mergers and acquistions

  • Horizontal integration: Combining companies in the same industry to increase market share. (e.g., Nike acquiring Umbro)

  • Vertical integration: Merging with companies involved in different stages of production. Can be forward (towards the consumer) or backward (towards raw materials).

  • Lateral integration: Combining companies with similar but not competing operations. (e.g., Tata Motors acquiring Jaguar and Land Rover)

  • Conglomerate integration: Merging companies in unrelated industries. (e.g., Berkshire Hathaway)

Benefits and drawbacks of mergers

Benefits:

  • Increased market share and power

  • Economies of scale (lower production costs)

  • Synergy (combined strengths for greater output)

  • Survival (defensive strategy to compete better)

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Drawbacks:

  • Job losses due to redundancies

  • Conflicts and disputes between companies

  • Conflicts and disputes between companies

  • Loss of control for original owners

What are takeovers?

  • A takeover is the acquisition of a controlling interest in a company without the target company's approval. This is often done by offering shareholders a price higher than the current market value.

  • Examples of takeovers:

  • Heineken's dominance in the Dutch brewing industry

  • Kraft's acquisition of Cadbury

  • Walt Disney's purchase of 21st Century Fox

What are joint ventures?

  • A joint venture is a partnership between two or more companies to create a new business entity. They share costs, risks, control, and profits.

Advantages and disadvantages of joint ventures

Advantages:

  • Synergy: Combining strengths for mutual benefit.

  • Shared costs and risks: Reducing financial burden on individual companies.

  • Exploitation of local knowledge: Accessing expertise in foreign markets.

  • Market entry: Facilitating entry into new markets, especially with legal restrictions.

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Disadvantages:

  • Dilution of brands: Potential weakening of individual brand identities.

  • Culture clashes: Differences in company cultures can hinder collaboration.

  • Dependency on partners: Reliance on the performance and cooperation of other companies.

  • Potential conflicts: Disagreements between partners can arise.

Strategic Alliances

  • A strategic alliance is a cooperative agreement between two or more independent businesses to achieve a common goal. Unlike joint ventures, strategic alliances do not involve creating a new legal entity. Partners share costs, risks, and benefits while maintaining their individual identities.

  • Stages of forming a strategic alliance:

    1. Feasibility study: Assessing the potential benefits and viability of the alliance.

    2. Partnership assessment: Identifying suitable partners and their strengths.

    3. Contract negotiation: Establishing terms and conditions for the alliance.

    4. Implementation: Initiating the alliance and fulfilling contractual obligations.

Franchising

  • Franchising is a business arrangement where a company (franchisor) licenses its brand, products, and business model to an individual or another company (franchisee).

  • The franchisee pays a fee to the franchisor and typically a percentage of sales (royalty) in exchange for the right to operate the business. Examples of well-known franchises include McDonald's, Subway, and The Body Shop.

Advantages and disadvantages of franchising

Back

Benefits to franchisor:

  • Rapid expansion with minimal financial risk

  • National and international reach without high costs

  • Reduced operational burdens (recruitment, training, etc.)

  • Steady income through franchise fees and royalties

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Benefits to franchise:

  • Lower startup costs due to established business model

  • Reduced business risk due to proven concept

  • Support and training from franchisor

  • Benefit from franchisor's advertising and brand recognition

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Limitations to franchisor:

  • Risk of reputational damage from unsuccessful franchisees

  • Difficulty in maintaining quality control across franchises

  • Slower growth compared to some other external growth methods

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Limitations of franchise:

  • Limited autonomy due to franchisor's rules and regulations

  • High initial investment with uncertain return

  • Ongoing royalty payments reducing profit margins

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