Theme 3
3.1.1 Size and types of firms
Why firms want to grow:
● Market dominance, which prevents competition putting them in a better place to exploit the
market in factors such as price setting power and less needs for efficiency.
● Profit maximisation, from market dominance allowing them to sell at the price setting point
where MR=MC and sell more due to a larger market share increasing profits.
● Increased divorce of ownership from controlallows increased salaries for managers as size is
normally to do with salaries and bonuses. It also means stakeholders interfere less with day to
day activities.
● Reduces risk from demand changes as it means that they have more diversified products and
less uncertainty about taste changes and reliance on the business cycle.
● Prevent takeovers, due to such a large company making it too expensive for predatory
competitors.
● Asset stripping is possible due to so many parts to the company in times of loss and also to
make profits.
● Economies of scale, this is as factors like mergers, result in economies of scale being enabled
allowing costs to be reduced increasing profit margins. However, vertical mergers are less
likely to result in technical economies of scale.
● Brand recognition increases consumer consumption and loyalty due to a larger consumed
well known product in many outlets.
Why firms remain small:
● Economies of scalemay be small making it more advantageous due to average costs to stay
small, with factors like technology decreasing economy of scale sizes.
● Costs of production may be larger for large firmsin markets with poor management or
unimported niche sectors. Furthermore, large firms may operate in markets such as more
formal ones resulting in higher pay.
● A highly regulated market makes it difficult to expand due to mergers being banned from the
CMA with other factors such as red tape stopping them from expanding further e.g. in the form
of the environmental laws that taxes pollution or building planning permission.
● Barriers to entry may be low so producers sell homogeneous products resulting in little
incentive due to competition to grow due to perfect competition.
● A naturally small market, resulting in small firms being monopolists such as a local store
which has a small market but is convenient or a niche market like ferrari not giving the ability
to expand and not financially sensible resulting in a declining of profits if they achieved
expansion of potential output. Themarket may also be declining in size. This may result in little
training and thus no labour. This may also result in it being harder to access finance.
➔ The market may be growing with demand increasing, through advertising and other
techniques the firm can expand the market. Internet selling may also widen its scope.
➔ Diversification is also possible.
● Lack of finance availabledue to low levels of equity(small in a market) and a weak
macroeconomic climate and demand. Furthermore there may be less confidence from
investors and they have small volumes of retained profit. Thus they will not be able to expand
and finance new capital.
● High financial growth costs with capital and new staff costs being high.
● Macro economic climate with small levels of demand,low growth, high interest rates and high
inflation rates.
● Personal service is only available by small companies and may be one of the main advantages
and needs of the firm.
● The owner may be satisfied with current profits and have no desire to expand, they may want
to keep it a family business or focus on the objectives of the business and communityit
serves. Furthermore they may have bad managerial skills not wanting to enter into risky
growth resulting in satisfaction.
● Avoid takeovers due to having little threat to incumbents and those with large market share.
,A shareholder owns part of the company and has a vestedinterest whilst a stakeholder has a vested
interest in how the company is doing. The only main influence of a shareholder may be through board
meetings (which only a few take part in) who oversee the running of the business, or selling shares
resulting in the price dropping pressuring stakeholders to change their actions.
Stakeholders have different aims to profit maximising shareholders (increasing dividends), with pay
influenced by factors like sales not profit, they control the day to day running of a company resulting in
them often satisfying such as blocking takeovers if it advantage them but stops extra profit. This
creates a divorce of ownership of control and the principal agent problem (due to the conflict of
interest).
Stakeholders and their control:
● Consumers, want to continue consuming the best product possible and thus are influenced by
a company's innovation and pricing strategies.
● Owners or shareholders want to maximise profits and thus are interested in the profit margins
of companies.
● Directors/managers want the maximum wages which normally come from revenue and sales
maximisation as they can take bonuses when a company is doing well..
● Suppliers want a larger more successful company so they have secure wide scale purchases
and profits. However, if the company is too big it may result in them having monopsonist
power.
● Workers want a more successful company to ensure job security and also increased profits
may result in higher pay.
● The state wants large scale companies that are able to improve balance of payments and
employment levels in the economy whilst increasing the rate of economic growth.
● Pressure groups want companies to operate in a sustainable way that maximises social
welfare.
Private business types:
● A sole trader owns the whole business and is liable for all losses and debts but takes all
profits after tax. There is no difference between them and the company.
● A partnership is when two or more parties manage a company but are jointly liable.
● A private limited business, is a privately held business with owners only liable to their shares
and no assets can be claimed by debts. The company and owners are separate entities. They
raise finance through selling to friends or family.
● A public limited company is a publicly held businesses with shares held by the general public
who are not liable to anything but the shares they own. The owners and company are separate
entities.
Public sector organisations are controlled and owned by the state such as the NHS, OFWAT or BBC,
their aim is to improve society's welfare using taxes efficiently through providing services with a social
objective and may be able to make losses (hard to profit on these goods) unless they are privatised.
Private sector organisations like Apple are owned by individuals or companies with the aim to profit
maximise (subject to the owners wants and balancing of lifestyle).
Private sector organisations can be for profit aiming to profit maximise such as samsung or not for
profit with different aims. This is seen in companies like shelters, diversity UK (encouraging
acceptance and diversity) and the NSPCC (protecting children), who spend all their profits achieving
their aims.
Business objectives change with:
● Macro economic climate, with profit maximisation becoming the objective.
● Changes within a market and competition.
● Government legislation increases social responsibility
3.1.2 Business growth
, Organic/internal growth (within the firm) is the growth of firms through increasing outputsuch as
through increasing investment in itself e.g. reinvesting profits and taking loans. This is as they are
● Small
● Less expensive
● Less risky as the owners know the business environment well.
● The growth can be financed internally
● More likely to keep business control
● Less time-consuming.
➔ For some types of growth that is hardthrough organic growth such as expanding into
a new market with no knowledge making it easier to buy a company already operating
in that market.
➔ It is slower for directors to grow through organic growth who also want to maximise
salaries and justify higher remuneration.
➔ You can lose control if shares are sold of franchisesestablished.
➔ If loans are taken to expand if not profitable it could lead to debt.
External growth (outside a firm) is through mergers/amalgamation which is the joining together of two
or more firms under common ownership with the agreement of shareholders to merge. It can also be
through a takeover (more hostile) where one company buys another, the board of directors have to
agree to the price.
Merger types:
Horizontal integration occurs when two firms in the same industry at the same stage of production
merge e.g. two bakeries. Reasons for this is:
● Allows economies of scalelowering the average costs and increasing supernormal profits.
● Reduce market competition through taking out a competitor increasing market power.
● It can allow one firm to buy unique assets owned by another company like a drug or the
market operated in.
● It results in a larger recognition and knowledge of the brand as more people recognise the
two companies.
● It allows a business to grow rapidly in a market it already has expertise in.
● There are large synergies with them working well together.
➔ Firms may overpay for this new firm.
➔ The two firms may be poorly managed resulting in key workers and expertise leaving.
➔ Diseconomies of scalereducing supernormal profits may occur.
➔ It may result in a brand being associated in a negative light with the new brand being
seen in a worse light.
Vertical integration occurs when two firms in the same industry at different stages of production
merge (primary, secondary and tertiary). This can be forward when a supplier mergers with a buyer
such as a car manufacturer merging with a car dealership. This can be backwards when a drink
manufacturer buys a bottling manufacturer. Reasons for this is:
● Cost saving through integrating a supplier or buyer into the firm making operations more
efficient as it also cuts out the middleman due to control of the supply chain.
● Allows larger economies of scaleto occur through increasing size.
● Access to raw materials may allow you to access these resources at a lower price.
● Reducing risk through controlling the supply chain such as making sure you receive constant
supplies of your production factors.
● Increase market control as it results in a firm owning another that has brought its products,
thus increasing control of the price and market it is sold in. This could control branding of the
product itself.
➔ This is risky as it may have little expertise in this industry and a lack of knowledge
resulting in a worse performance in this new integrated business. The more distinct
the businesses are the less likely it will succeed under new ownership.
➔ Firms can often pay too much for a firm as they take over it resulting in the share
price falling after the rise.
3.1.1 Size and types of firms
Why firms want to grow:
● Market dominance, which prevents competition putting them in a better place to exploit the
market in factors such as price setting power and less needs for efficiency.
● Profit maximisation, from market dominance allowing them to sell at the price setting point
where MR=MC and sell more due to a larger market share increasing profits.
● Increased divorce of ownership from controlallows increased salaries for managers as size is
normally to do with salaries and bonuses. It also means stakeholders interfere less with day to
day activities.
● Reduces risk from demand changes as it means that they have more diversified products and
less uncertainty about taste changes and reliance on the business cycle.
● Prevent takeovers, due to such a large company making it too expensive for predatory
competitors.
● Asset stripping is possible due to so many parts to the company in times of loss and also to
make profits.
● Economies of scale, this is as factors like mergers, result in economies of scale being enabled
allowing costs to be reduced increasing profit margins. However, vertical mergers are less
likely to result in technical economies of scale.
● Brand recognition increases consumer consumption and loyalty due to a larger consumed
well known product in many outlets.
Why firms remain small:
● Economies of scalemay be small making it more advantageous due to average costs to stay
small, with factors like technology decreasing economy of scale sizes.
● Costs of production may be larger for large firmsin markets with poor management or
unimported niche sectors. Furthermore, large firms may operate in markets such as more
formal ones resulting in higher pay.
● A highly regulated market makes it difficult to expand due to mergers being banned from the
CMA with other factors such as red tape stopping them from expanding further e.g. in the form
of the environmental laws that taxes pollution or building planning permission.
● Barriers to entry may be low so producers sell homogeneous products resulting in little
incentive due to competition to grow due to perfect competition.
● A naturally small market, resulting in small firms being monopolists such as a local store
which has a small market but is convenient or a niche market like ferrari not giving the ability
to expand and not financially sensible resulting in a declining of profits if they achieved
expansion of potential output. Themarket may also be declining in size. This may result in little
training and thus no labour. This may also result in it being harder to access finance.
➔ The market may be growing with demand increasing, through advertising and other
techniques the firm can expand the market. Internet selling may also widen its scope.
➔ Diversification is also possible.
● Lack of finance availabledue to low levels of equity(small in a market) and a weak
macroeconomic climate and demand. Furthermore there may be less confidence from
investors and they have small volumes of retained profit. Thus they will not be able to expand
and finance new capital.
● High financial growth costs with capital and new staff costs being high.
● Macro economic climate with small levels of demand,low growth, high interest rates and high
inflation rates.
● Personal service is only available by small companies and may be one of the main advantages
and needs of the firm.
● The owner may be satisfied with current profits and have no desire to expand, they may want
to keep it a family business or focus on the objectives of the business and communityit
serves. Furthermore they may have bad managerial skills not wanting to enter into risky
growth resulting in satisfaction.
● Avoid takeovers due to having little threat to incumbents and those with large market share.
,A shareholder owns part of the company and has a vestedinterest whilst a stakeholder has a vested
interest in how the company is doing. The only main influence of a shareholder may be through board
meetings (which only a few take part in) who oversee the running of the business, or selling shares
resulting in the price dropping pressuring stakeholders to change their actions.
Stakeholders have different aims to profit maximising shareholders (increasing dividends), with pay
influenced by factors like sales not profit, they control the day to day running of a company resulting in
them often satisfying such as blocking takeovers if it advantage them but stops extra profit. This
creates a divorce of ownership of control and the principal agent problem (due to the conflict of
interest).
Stakeholders and their control:
● Consumers, want to continue consuming the best product possible and thus are influenced by
a company's innovation and pricing strategies.
● Owners or shareholders want to maximise profits and thus are interested in the profit margins
of companies.
● Directors/managers want the maximum wages which normally come from revenue and sales
maximisation as they can take bonuses when a company is doing well..
● Suppliers want a larger more successful company so they have secure wide scale purchases
and profits. However, if the company is too big it may result in them having monopsonist
power.
● Workers want a more successful company to ensure job security and also increased profits
may result in higher pay.
● The state wants large scale companies that are able to improve balance of payments and
employment levels in the economy whilst increasing the rate of economic growth.
● Pressure groups want companies to operate in a sustainable way that maximises social
welfare.
Private business types:
● A sole trader owns the whole business and is liable for all losses and debts but takes all
profits after tax. There is no difference between them and the company.
● A partnership is when two or more parties manage a company but are jointly liable.
● A private limited business, is a privately held business with owners only liable to their shares
and no assets can be claimed by debts. The company and owners are separate entities. They
raise finance through selling to friends or family.
● A public limited company is a publicly held businesses with shares held by the general public
who are not liable to anything but the shares they own. The owners and company are separate
entities.
Public sector organisations are controlled and owned by the state such as the NHS, OFWAT or BBC,
their aim is to improve society's welfare using taxes efficiently through providing services with a social
objective and may be able to make losses (hard to profit on these goods) unless they are privatised.
Private sector organisations like Apple are owned by individuals or companies with the aim to profit
maximise (subject to the owners wants and balancing of lifestyle).
Private sector organisations can be for profit aiming to profit maximise such as samsung or not for
profit with different aims. This is seen in companies like shelters, diversity UK (encouraging
acceptance and diversity) and the NSPCC (protecting children), who spend all their profits achieving
their aims.
Business objectives change with:
● Macro economic climate, with profit maximisation becoming the objective.
● Changes within a market and competition.
● Government legislation increases social responsibility
3.1.2 Business growth
, Organic/internal growth (within the firm) is the growth of firms through increasing outputsuch as
through increasing investment in itself e.g. reinvesting profits and taking loans. This is as they are
● Small
● Less expensive
● Less risky as the owners know the business environment well.
● The growth can be financed internally
● More likely to keep business control
● Less time-consuming.
➔ For some types of growth that is hardthrough organic growth such as expanding into
a new market with no knowledge making it easier to buy a company already operating
in that market.
➔ It is slower for directors to grow through organic growth who also want to maximise
salaries and justify higher remuneration.
➔ You can lose control if shares are sold of franchisesestablished.
➔ If loans are taken to expand if not profitable it could lead to debt.
External growth (outside a firm) is through mergers/amalgamation which is the joining together of two
or more firms under common ownership with the agreement of shareholders to merge. It can also be
through a takeover (more hostile) where one company buys another, the board of directors have to
agree to the price.
Merger types:
Horizontal integration occurs when two firms in the same industry at the same stage of production
merge e.g. two bakeries. Reasons for this is:
● Allows economies of scalelowering the average costs and increasing supernormal profits.
● Reduce market competition through taking out a competitor increasing market power.
● It can allow one firm to buy unique assets owned by another company like a drug or the
market operated in.
● It results in a larger recognition and knowledge of the brand as more people recognise the
two companies.
● It allows a business to grow rapidly in a market it already has expertise in.
● There are large synergies with them working well together.
➔ Firms may overpay for this new firm.
➔ The two firms may be poorly managed resulting in key workers and expertise leaving.
➔ Diseconomies of scalereducing supernormal profits may occur.
➔ It may result in a brand being associated in a negative light with the new brand being
seen in a worse light.
Vertical integration occurs when two firms in the same industry at different stages of production
merge (primary, secondary and tertiary). This can be forward when a supplier mergers with a buyer
such as a car manufacturer merging with a car dealership. This can be backwards when a drink
manufacturer buys a bottling manufacturer. Reasons for this is:
● Cost saving through integrating a supplier or buyer into the firm making operations more
efficient as it also cuts out the middleman due to control of the supply chain.
● Allows larger economies of scaleto occur through increasing size.
● Access to raw materials may allow you to access these resources at a lower price.
● Reducing risk through controlling the supply chain such as making sure you receive constant
supplies of your production factors.
● Increase market control as it results in a firm owning another that has brought its products,
thus increasing control of the price and market it is sold in. This could control branding of the
product itself.
➔ This is risky as it may have little expertise in this industry and a lack of knowledge
resulting in a worse performance in this new integrated business. The more distinct
the businesses are the less likely it will succeed under new ownership.
➔ Firms can often pay too much for a firm as they take over it resulting in the share
price falling after the rise.
