1 7 growth and evolution

IB Business and Management

Unit 1.7

Growth and Evolution

Pages 112-136

1. Focus Questions

• 1. What is the difference between economies and diseconomies of scale?

• 2. What are the merits of small vs. large organizations?

2. An Overview• What is a continual aim of a business?

– To grow.

• What does growth refer to?

– The expansion of size of its operation.

• How can an organization’s growth be measured?

– Sales turnover = sale revenue

– Market share

– Capital employed

– Employees

• So, why do businesses seek growth?– Benefits of economies of scale

– Market share / market standing

– Survival in an industry

– To spread risks by diversifying.

– And in the long run…$$$ PROFIT $$$...

3a. Economies & Diseconomies of Scale

• As discussed before, a major reason to grow is to benefit from economies of scale.– What does economies of scale refer to?

• The lower average cost of production.• An improvement in productive efficiency.• Operating on a larger scale.

• Can you give examples of economies of scale?• Sometimes economies of scale refers to increasing returns to

scale.– A firm can gain a competitive cost advantage over

smaller firms.• How is this possible?

• Lower average cost = lower prices being charged to customers + higher profit margin made per unit.

• Confused yet??? …

4. Internal Economies of Scale

• There are two categories of economies of scale:– You guess it…internal and external

• Internal economies of scale: within the company’s control.• External economies of scale: beyond the control of the company.

• With regards to the internal economies of scale, the more you produce the more you will be able to lower your average costs of production.– This is possible due to several factors:

• Technical economies: using sophisticated machinery• Financial economies: lower rates when borrowing• Managerial economies: specialization leads to higher productivity• Specialization economies: division of labour, mass production.• Marketing economies: global marketing economies, selling in bulk• Monopsony economies: strong buying power, gain big discounts• Commercial economies: buying in bulk (purchasing economies / buying

economies) • Risk-bearing economies: where conglomerates, have a diversified

portfolio of products.

5. External Economies of Scale

• External Economies of Scale:

– arise outside the firm due to its location or growth.

– Four factors which may create external economies of scale:

1. Technological progress – increases trading; e-commerce.

2. Improved transportation and communication networks – things arriving on time.

3. Better trained labour – training programs, education in an area.

4. Regional specialization – highly regarded and trustworthy reputation.

…

6a. Diseconomies of Scale• Internal Diseconomies of Scale:

– Is where you can no longer exploit economies of scale.– Also called decreasing returns to scale, result from higher unit costs as a firm

increases the size of its operation.– There are several reasons for this:

• Lack of control and coordination – managers are no longer able to handle the demands of a larger company.– May harm staff morale.

• Poorer working relationships – with a larger workforce, senior management will become detached with the workers.– May harm staff morale and productivity.

• Workers becoming slack – larger workforce, due to specialization, may become bored and less productive.

• Amount of bureaucracy – will make communication more difficult, may reduce productivity.

• Complacency – being a market leader may lead to reduced productivity and raise unit costs. – Large firms will prefer to grow via franchising. Do you know of any?

6b. Diseconomies of Scale• External Diseconomies of Scale:

– Refers to an increase in the average costs of production.

– They occur when there are too many firms in the market.

– Unit cost of production increase for all businesses in the industry.

– For example:

• Too many business in one area.

– Will result in increasing market rents because of landing becoming scarce.

• Traffic congestion.

– Delays in delivery, will increase transportation costs.

• Supply of local labor.

– Since workers have a choice where to work; business will have to offer higher wages.

– This will increase costs, not necessarily increase output.

6c. Diseconomies of Scale• So, how can we deal with these diseconomies of scale?

– Well, firms will have to take several measures to protect their competitiveness.

• They have two options when dealing with diseconomies of scale:

– 1. reduce their level of output.

– 2. remove productive inefficiencies.

• For example:

– If workers are slacking:

» Try outsourcing.

» Performance-related payment systems.

» Motivational strategies (training, empowerment, and teamworking).

7a. Small vs Large Organizations:• All businesses have

an appropriate scale of operation.

• So, how can the size of a market be measured?

– An increase of any of these would result in or suggest that the firm is getting larger.

…Stock marketvaluation

…Balance sheetvaluation

Market value…

Capitalemployed

Profit

Size ofthe workforce

Total Revenue

Market share

Can beMeasured by:

7b. Small vs Large Organizations: • If your firm becomes larger you may also enjoy economies of scope.

– What are economies of scope?• When it is cheaper to produce a range of related products.

• So, how does this differ from economies of scale?– Well…refers to cost savings from producing the SAME product on a

larger scale.

• Economies of Scope:– Give businesses diversity.

– Gives businesses the opportunity to become active in other areas.

• Can you give me examples of economies of scope?– When Amazon started out what did they first sell?

• Books!!!

– What are they selling now?• Books, CDs, DVDs, you name it

7c. Small vs Large Organizations:• What are some

other benefits of being large?

Barrier to entry

Morechoice

ImprovedCustomer

loyaltyDiscounts

Convenience

Image And

reliability

BrandRecognition

Other benefitsof being large

7d. Small vs Large Organizations:• What are some

benefits of being small?

• Remember being small doesn’t mean you can not survive and flourish.

SmallMarket

Size

Flexibility

Personalizedservices

Local Monopoly

Power

Governmentaid

Financialrisk

Cost control

Other benefitsof being small

7e. Small vs Large Organizations: • So, what is the best or optimum size?

– Well, it will depend on its internal structure.– Its costs and size of the market.– It will also depend on your aims and objectives.

• REMEMBER:– If a firm operated beyond its optimum size the diseconomies of scale will

be experienced.– And if this occurs…what will happen?

• Your unit costs will increase and… • will REDUCE your $$$ PROFITS $$$.• Which is NOT GOOD

• Also, a firm may not run at its financially optimum level either.– Due to a lack of resources or demand.– No finances = no expansion = lack of production capacity

• Even if you are producing more…if there is no demand…guess what??? …

IB Business and Management

Unit 1.7 Internal (Organic) Growth / External

GrowthPages 119-128

1. Focus Questions

• 1. What are the internal growth strategies?

• 2. What are the external growth strategies?

2. Internal Growth

• Is one method of business growth, also known as organic growth.– It occurs when you use the firm’s resources to

increase the size of its operation.– Thus increasing its sales revenue.

• This growth is financed through the profits of the business and not from outside sources.

3a. External Growth

• Business growth through M&A’s (mergers and acquisitions).– Also called amalgamation or inorganic growth.– …

3b. Can Grow in Several Ways :• Business can

grow organically or inorganically.

…Stock marketvaluation

Training and development

Capitalexpenditure

CreditPayment terms

Placements(locations)

Better products

AdvertisingAnd promoting

Changing price

Can grow inSeveral ways:

3c. Benefits and Limitations of Organic Growth

• Benefits:– Better control and

coordination.

– Inexpensive.

– Maintain corporate culture.

• Limitations:– Diseconomies of scale.

– Overtrading.

– Need to restructure.

– Dilution of control and ownership.

– …

3d. External Growth

• Inorganic growth, which comes from M & A’s• Benefits of external growth:

– A faster way to grow.

– Quick way to reduce competition.

– Greater market share.

– Can generate new ideas, skills and customers.

– Can spread risk to different markets.

• The only disadvantage is the cost.• Take over bids and be in the billions of dollars.• …

4. Joint Ventures :Other methods:• Joint Ventures:

– When one or more businesses decide to split the costs, risks, control and rewards.

• What are the disadvantages?– 1. rely on the

resources of your partner.

– 2. Dilution of brands.

– 3. Spending lots of money to develop brands.

– 4. Organizational culture clash.

– See case study 1.7.4 on page 124.

High successrate

Exploitation Of local

knowledge

Competitiveadvantage

Cheap

Entry of Foreign markets

Spreading of Costs and risks

Synergy

Joint VentureAdvantages

5a. Strategic Alliances

1. Feasibilitystudy

2. PartnershipAssessment

3. ContractNegotiation

4. Implementation

• Similar to joint venture.

• Where two or more businesses form a business venture.

• The share the cost of production, operations and marketing.

• They remain independent organizations.

• So, how are they formed? …

Four KeyStages

5b. Strategic Alliances• The main goal of a strategic alliance is to gain synergy.

– So, what is synergy? How can it be beneficial to a company?• From Webster: “ a mutually advantageous conjunction or compatibility of distinct business

participants or elements (as resources or efforts)”• Such as:

– Pooling resources.– Expertise.– Financial support.– Gain economies of scale.– Value added services.– Wider channels of distribution.– …

Taken from: http://www.maximizepossibility.co

m/RMGpictures/Synergy.jpg

6a. Mergers and Takeovers• M & A’s = Mergers and Acquisitions.

– The Merger:• The combination if two or more businesses form one single company.

– So, why merge?

» The new merger will usually bring about economies of scale and larger market share.• The Takeover (Acquisition):

– Occurs when a company buys a controlling interest in another company.• That means; buying enough shares to hold a majority stake.• Used as a method of business growth.

• See Box 1.7a, pg. 125 Reasons for Takeovers.• Black knight = hostile takeover.• White knight = friendly bidder.• …

Taken from: http://30gms.com/images/uploads/sharks.jpg

6b. Mergers and Takeovers

4. ConglomerateM & A

(diversification)

3. LateralIntegration

(similar operations)

2. HorizontalIntegration

(same industry)

1b. BackwardVertical

Integration(towards supplier)

1a. Forward Vertical

Integration(towards consumer)

1. VerticalIntegration

(different stages of production)

Four TypesOf

Integration

6c. Mergers and Takeovers

Diversification

SurvivalSynergy1+1=3

Economiesof

Scale

GreaterMarket share

The Advantages

of M & A’s

6d. Mergers and Takeovers

RegulatoryProblems

Diseconomiesof

Scale

Redundancies

Conflict

CultureClash

Loss ofControl

The Disadvantages

of M & A’s

6e. Mergers and Takeovers• They are very common in today’s business environment.

• With increasingly competitive markets, M & A’s are used to maintain growth and competitiveness.

• Stock markets, deregulations, and globalization have made M & A’s more attractive.

• The success of M & A’s depend on several factors such as:

– The level of planning.• Communication to shareholders of the benefits.

– Aptitudes of senior management.• Negotiation skills are important to handle problems that arise.

– Regulatory problems.• Government interference, stopping a company from having too much

monopoly power

– Running into diseconomies of scale.• A demerger might take place (selling off a major part of a company’s

business).

• …

6f. Mergers and Takeovers• Management Buy-out (MBO):

– A defensive strategy to combat a hostile takeover.

– It involves the management team of the target business buying shares in the company to become the owners, thus preventing the company from being taken over.

– The team can also seek financial assistance from venture capitalists.

• This strategy can save jobs. Your job • Brand Acquisition:

– Instead of completely tasking over a company, you may buy one of the brands from the firm.

• Why would firms sell off one or more of their brands?

– Maybe they have a liquidity problem ; they are short on cash that it jeopardizes the survival of the firm.

– May also want to demerge or feel that the brand no longer suits the corporate image.

– …

IB Business and Management

Unit 1.7

Franchises

Pages 128-136

1. Focus Questions

• 1. What is a franchise

• 2. What is the Ansoff Matrix and how is it used?

• …

2a. Franchises• What is a franchise?

– A form of business ownership.

– You buy a license to trade using another firm’s name, logo, brands, and trademarks.

• So, how does one buy into a franchise?

– The franchisee (the purchaser), pays a license fee to the parent company; the franchisor.

– The franchisee pays a royalty payment.

– Used as a means of growth.

– …

2b. Franchises• The benefits

of franchising as a method of growth for the franchisor.

• Pg. 129 read

• …

Greater local Market

awareness

More incentives

Receive a Royalty payment

Less worry aboutThe running costs

Economies of scale

Allows for aNational or International

presence

Rapid growthWithout huge

risks

Benefits ofFranchising

2c. Franchises• The

Advantages for the franchisee

• Pg. 129 read

• …Large scaleAdvertising –

Reducing costs

Added services

Lower start-upcosts

Low riskHigh success

Advantages forThe franchisee

2d. Franchises• The pitfalls

of franchising to the franchisor.

• Pg. 129 read

• …

Not a quickMethod of growth

Huge risk to Reputation.

Difficult toControl

franchisees

The pitfallsof franchising

2e. Franchises• The

disadvantages to franchisees

• Pg. 129 read

• …

Less flexibilityPay large %

To the franchisor.

Can be veryexpensive

DisadvantagesTo franchisees

3a. The Ansoff Matrix• Developed in 1957, it is an

analytical tool.

• Helps managers to devise their products and market growth strategies.

• There are four growth strategies…

• …

• 1. Market Penetration:– Advantage:

• Focus on markets and products that the firm is familiar with.

• Safest of the four growth strategies.

– Limitation:• Competitors will react to your firms trying to “steal” their customers and market share.

• Might cause price wars, could hurt profits in the short term.

• 2. Product Development:– Medium-risk strategy.

– Suitable when products reach saturation or declining stage of product life cycle.

– Lower risks when launching a product under a well-known brand name.

• 3. Market Development:– Medium-risk strategy.

– Advantage:• Not high risk; using familiar products.

– Limitation:• Success in one market does not guarantee success in other markets.

– Cell phones in Asia for example.

3b. Advantages / Limitations

• 4. Diversification:– High risk growth strategy.– Involves marketing new products in new markets.– Advantage:

• Trying to spread your risk.• A good strategy when a firm has reached saturation in their markets and are seeking new

opportunities for growth.• So, how do companies diversify?

– One way is to become a holding company.• A holding company is a business that owns a controlling interest in other diverse

companies.• They are also known as parent companies.

– Advantage:» Wide range of products and markets in different regions of the world.

– Another way is to create a SBU; a strategic business unit.• Are very similar to subsidiaries.

– They have a separate vision and mission statement.– They can handle different product lines.

» Japanese auto-manufacturers have SBUs.• Limitation: it is the riskiest of the four options in the Ansoff Matrix. …

3c. Advantages / Limitations