top of page

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)

​

  • 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.

​​

​

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.

​​

​

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)

​

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.

​

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

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

​

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

​

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

​

Limitations of franchise:

  • Limited autonomy due to franchisor's rules and regulations

  • High initial investment with uncertain return

  • Ongoing royalty payments reducing profit margins

Next  

Back

bottom of page