IB Business Management Unit 1/Section 1.6 Growth and Evolution

1.6 growth and evolution On completing this chapter you should be able to Define and apply the terms economies and diseconomies of scale Distinguish between internal and external growth Compare and contrast the following external growth methods Mergers and acquisitions (M&As) and takeovers Joint ventures Strategic alliances Franchising Examine the role and impact of globalization on the growth and evolution of businesses Discuss the reasons for the growth of multinational companies (MNC)

Economies and Diseconomies of scale Economies of scale: The reduction in average unit cost as a business increases in size (scale of operations) due to an improvement in productive efficiency. Diseconomies of scale: The increase in average unit cost as the business increases in size (scale of operations), due to inefficiencies. Efficiency is measured in terms o costs of production per unit. Total Cost = Fixed cost + Variable Cost Fixed Cost: Costs that do no change according to the amount of goods or services produced by the business for example Rent. Variable Costs: Costs that vary according to the amount of goods or services produced for example Raw materials. Average Cost = Total Cost/ Quantity produced AC= FC + VC/Q

Impact of Economies and Diseconomies of Sale on Average Cost Optimum production

small versus large organizations All businesses have an appropriate scale of operation. The size of a business may be measured by: Market share: firm´s revenue as a percentage of the industry´s total revenue. Total revenue: value of annual sales turnover per time period. Size of work force: total # of employees. Profit: firm´s profit/time period. Capital employed: capital investment. An increase in value in any of the above measures suggests the firm is growing.

small versus large organizations Advantages of Big Businesses Advantages of Small Businesses Survival: Competitors strive for growth. Less likely to fail & being taken over. Economies of Scale: higher profits, returns & healthier balance sheet. Lower prices. Brand recognition/reputation: More trusted Market Leader Status: Can shape market habits/set prices. Increased market share: control of market by determining prices and deciding which services will be the industry standard. Value-added services: Longer working hours, interest free credit. Specialized Managers Greater choice: amazon.com vs. local bookstore Customer Loyalty: Due to perceived status, trust & value for money. Spread Risk: Diversifying into new markets. Access to different sources of finance. Can afford research and development. Greater focus: where they have the greatest profitability and return on investment. Greater cachet (sense of exclusiveness): can charge more- higher profit margins. Greater motivation: All employees matter/easier communication. Competitive advantage: Personalised service to customers. Less competition (in niche markets). Cost control: better coordination & communication Financial Risk: less investment Government aid: Grants and subsidies. Local monopoly power: the only firm in a particular location. Flexibility and adaptive to change Small market sixe: unlikely to attract attention of large firms due to the limited size of market.

small versus large organizations Disadvantages of Big Businesses Disadvantages of Small Businesses Difficult to manage Potential diseconomies of scale. Slow decision making and poor communication. Divorce between ownership and control can lead to conflicting objectives. Difficult access to finance. Owner cant afford specialised managers. Difficult to diversify, greater risk of negative impact of external change. Unlikely to benefit from economies of scale.

Internal and external growth Internal Growth: Expansion of a business by means of opening new branches, shops or factories ( also known as organic growth) External Growth: Business expansion achieved by means of merging with or taking over another business, from either the same or a different industry.

external growth methods 1. Merger & Acquisition (M&A): The amalgamation (integration) of 2 or more businesses to form a single company that is bigger. Mergers: 2 businesses become integrated by joining together and forming a bigger combined business, usually loosing their original identities. Acquisition/Takeover: 2 businesses become integrated by one taking over the other (by buying a controlling interest in another firm, to hold a majority stake). Horizontal Integration: When the 2 businesses integrated are in the same industry, line, and in the same stage and chain of production. Backward vertical Integration: 1 business integrates with a business in the same industry further back in the chain of production (earlier stage of production) – protects the supply chain. Forward vertical: 1 business integrates with a business in the same industry further forward in the chain of production (towards the end stage of production: the consumer). Conglomeration: 2 businesses in different industries of business integrate.

external growth methods 2. Joint venture: An external growth strategy in which 2 or more businesses agree to combine resources for a specific goal/project and over a finite period of time by forming a separate business. They split the costs, risks, control and rewards. A separate business is created with funding by 2 “parent” businesses. After the defined time is over: the new business is dissolved, incorporated into one of the parent businesses or the time frame is extended; one of the company buys out the other.

external growth methods 3. Strategic Alliance: An external growth strategy in which 2 or more businesses cooperate in a business venture for a specific goal (mutual benefit), without the creation of a new legal entity. Differences with Joint Ventures: Individual businesses in the alliance remain independent. They agree to share resources, costs of product development, operations and marketing but often compete against each other. No new business is created. (without legal existence, it has less force than a legally extant enterprise) (do not get the capital strength of a legal merger)

external growth methods 4. Franchise: An external growth strategy in which The Franchisor (the original business that developed the business concept and product) sells to other businesses (Franchisees) the right to offer the concept and sell the product under its name in return for a fee and regular royalty payments. The franchisee has to be consistent with, and in some instances identical to, the original business concept developed by the franchisor. An attractive way of expanding globally/gain advantage over competitors (minimum difficulty & risk: the franchisees have knowledge of local markets, conditions, cultures and language.) Costs: Franchisee pays a license fee for the franchise (the right to operate a business offering the franchisor´s concept and product) & royalties (a percentage of sales or a flat fee).

globalization The growing integration and interdependence of world´s economies, causing consumers around the globe to have increasingly similar habits and tastes. Is the process by which the world´s regional economies are becoming one integrated global unit. Free trade: No restrictions or trade barriers exist that might prevent or limit trade between countries. Protectionism: Using barriers to free trade, such as tariff and quotas to protect a countries own domestic industries. Critics: Globalization has exploited people in developing countries, causing disruption to lives and few noticeable benefits in return. Supporters: Globalization has led to huge reductions in the number of people in poverty by countries which have embraced it for example India, China, Vietnam.

the growth of multinational companies (MNCs) Multinational company (MNC): Business organizations that have their headquarters in one country, but with operating branches, factories and assembly plants in other countries. 4 factors that have allowed them to grow so rapidly and with such reach: Improved communications Dismantling trade barriers Deregulation of world´s financial markets Increasing economic and political power of MNC´s

the impact of MNCs on the host countries Host country: Any nation that allows a multinational company to set up in its country. Advantages for Host Countries Disadvantages Economic growth: providing employment, developing local network of suppliers, paying taxes, providing capital injections, increasing gross domestic product (the value of a countries annual output), boosting export earnings. Profits being repatriated: to the host country. Unemployment: MNCs can pose a threat to domestic business. Pollution/Depletion of limited natural resources Competition: Leads to greater efficiency- benefits customers. More choice of products for consumers New ideas: new ways of doing business & interacting socially Loss of cultural identity: appeal of domestic products, ways of doing business and even cultural norms may suffer – especially younger generations. Loss of market share for domestic producers. Skills & technology transfer: Efficiency of production is raised. Local employees - can later start their own business. Employment opportunities are created Brain drain: many high skilled employees my go to work in another country. Exploitation of local workforce might take place. Short - term infrastructure projects: roads to factory, schools for workers children Short- term plans: MNC´s my not plan to stay for a long time, if lower-cost producers can be found, they may move out at short notice