IGCSE Economics 4.3 The Growth of Firms

Recap - Crossword Page 236 of the textbook What can you remember about the last topic? House point for the first person to complete it correctly

Interpreting Breakeven Charts

Questions What is the: 1.Breakeven Output 2.Breakeven Revenue 3.Fixed Costs 4.Selling Price 5.Variable Cost per Unit 6.Profit/Loss at 10,000 units

Questions…. What will happen to the following as output increases: a.Stay the same b.Decrease then rise c.Increase then fall d.Decrease e.Increase Fixed Costs RevenueTotal Variable CostsAverage Fixed Costs Variable Cost per Unit Average Revenue Average Cost per Unit

Paper 1 Question When it produced 100 units, a firm’s total variable cost is $300 and its total fixed cost is $2,700 What is the average cost? A $3 B $24 C $27 D $30

Learning Outcomes Describe the main reasons for the different sizes of firms Describe and evaluate integration Describe and evaluate economies and diseconomies of scale

The size of firms Which of these firms is the biggest? On what basis could we judge?

There are a number of ways to measure and compare the size of firms: SIZE OF WORKFORCE SALES REVENUE CAPITAL EMPLOYED MARKET SHARE Measuring the size of firms

Which is the biggest? What could explain the different results? Which do you think is the most fair measure of business size?

Challenge Forbes ranks businesses in order of size. They use a combination of revenue, profit, assets and market value In pairs – write down a maximum of 20 companies that you think would be in the top 20. House points for the pair that guess the most correctly

Why are firm’s different sizes? Nyeko plumbing is clearly a much smaller firm than Walmart, does that mean it is less successful? Wal-Mart Stores Multinational serving global market Workforce: 2.1 million employees Capital employed: $170 billion Annual revenue: $405 billion Nyeko Plumbing Sole trader serving local households Workforce: 1 owner/employee Capital employed: $5,250 Annual revenue: $23,700

Reasons for growth…. Walmart was founded in 1962 by Sam Walton It is now the biggest employer in the world. Why might Walmart have chosen to grow to such a large size? Wal-Mart Stores Multinational serving global market Workforce: 2.1 million employees Capital employed: $170 billion Annual revenue: $405 billion

Reasons for growth Personal Ambition Lower Costs Increased sales Greater recognition Larger target market More Profit

Reasons some businesses stay small? Nyeko Plumbing is a small business and will probably always remain so. Why do some businesses stay small? Nyeko Plumbing Sole trader serving local households Workforce: 1 owner/employee Capital employed: $5,250 Annual revenue: $23,700

Why do we still have small firms? Personal Service Greater Flexibility No motivation to grow Lower Costs Less Paperwork Niche Markets

Reasons for the size of firms Size of the market Amount of capital investment Type of Organisation Business Objectives * These are stated on your syllabus. You need to learn them

HOW DO FIRMS GROW?

How do Firms Grow? Internal growth or organic growth is when a firm expands its scale of production through the purchase of additional equipment and increasing the size of its premises External growth is when two or more firms join together to form a larger enterprise This is known as integration Integration involves the merger of two or more firms or the takeover of one company by another

External Growth (Integration) Growth by joining firms together. This could be via a Merger Or Takeover What is the difference?

This sums it up! Takeover Merger

Horizontal Integration Horizontal integration occurs between firms engaged in the production of the same type of good or service Examples?

Lateral Integration Lateral integration occurs between firms in different industries in the same stage or different stages of production Examples?

Vertical Integration Vertical integration occurs between firms at different stages of production Examples?

Research Task Using the internet research a merger/takeover that has happened in the last 2 years. Answer the following questions: 1.Was it a merger or takeover 2.When did it take place? 3.Which businesses were involved? 4.Was it a horizontal, lateral or vertical integration…. Why? 5.What sums of money were involved 6.What was the key reasons for the takeover/merger

ECONOMIES OF SCALE

What are Economies of Scale? Economies of Scale refer to concept that bigger firms who produce on a larger scale can make goods more cheaply Economies of scale = When the average unit cost falls as output increases Tip: It is ‘unit costs’ that will decrease NOT total costs

Increasing returns to scaleConstant returns to scaleDecreasing returns to scale A firm doubles all its inputs Output more than doubles Therefore, cost per unit falls A firm doubles all its inputs Output doubles Cost per unit is unchanged A firm doubles all its inputs Output fails to double Cost per unit rises Returns to Scale

Internal economies of scale Increasing the size of a firm provides an opportunity to change the way it is organized, run and financed to reduce the average or unit cost of production External economies of scale These are cost savings enjoyed by firms in large industries compared to firms in smaller industries Types of Economies of Scale There are 2 Types of Economies of Scale:

INTERNAL ECONOMIES OF SCALE Think….. Why can bigger firms produce goods more cheaply then smaller ones?

Internal Economies of Scale PURCHASING ECONOMIES MARKETING ECONOMIES FINANCIAL ECONOMIES TECHNICAL ECONOMIES RISK-BEARING ECONOMIES What do you think these might refer to?

Purchasing Economies Larger firms buy materials in larger amounts They will get discounts from suppliers for large orders This is called bulk-buying The cost per unit will be lower

Marketing Economies Advertising and marketing can be a huge expense for a business The more items a company sells the more units this cost can be spread over Eg. A company places an advert which costs £1, units are sold this is £2 per item. If 2000 are sold this is 50p per item Businesses also benefit from being able to sell in bulk. Admin costs and distribution costs will be cheaper per unit

Financial Economies Large companies are seen to be less of a credit risk than small companies Banks will tend to lend to bigger companies at lower rates of interest Also cheaper sources of finance such as trade credit are more widely available

Managerial Economies In small businesses one manager will often have to fulfill many functions In larger firms, managers can specialise which means that they can be expert in their area of work and therefore more efficient

Technical Economies Large businesses are more likely to be able to afford more sophisticated machinery They will also use any machinery more effectively In small businesses machinery may lay unused for most of the day whereas in a larger firm it may be used nearer to full capacity

Risk-Bearing Economies A larger firm can be safer from the risk of failure if it has a more diversified product range. R&D costs are spread over a larger number of units

What type of economy?

The business hires a full time accountant to deal with the business finances Question 1

Conveyor belts & specialised machinery are purchased for producing in huge numbers Question 2

Large businesses have more power to negotiate prices down with suppliers as their custom is important Question 3

One advert can sell 100,000 items or 100 items – the cost is the same Question 4

Using CAD speeds up the design process Question 5

HSBC offer a lower rate of interest to bigger businesses who they consider to be less of a risk Question 6

Printing leaflets to advertise the business costs $100 for 1000 leaflets but only $200 for 10,000 Question 7

HSBC offer a lower rate of interest to bigger businesses who they consider to be less of a risk Question 8

When buying large quantities of goods, the price per unit is cheaper Question 9

Workers and managers can specialise in one area which means they will be more productive Question 10

Fixed delivery costs are spread over a larger number of items Question 11

Trade Credit and other cheap forms of finance might be available to larger firms Question 12

Machines can do work more quickly and with less mistakes and wastage Question 13

EXTERNAL ECONOMIES OF SCALE

These are cost savings enjoyed by firms in a large industry or when an industry is located in a particular area These may be: Access to a skilled workforce because firms can recruit workers trained by other firms in their industry Ancillary firms that develop and locate nearby large firms in other industries to provide them with the specialized equipment and business services they need Joint marketing benefits: for example, new firms locating near to others in the same industry may share their reputation for producing high-quality products Cooperation Shared infrastructure: for example, the growth of an industry may persuade firms in other industries to invest in new infrastructure such as power stations, dock facilities and airports to meet increasing demand for these services External Economies of Scale

BUT……. Sometimes larger businesses may suffer from diseconomies of scale ……..

Unit Costs- Graph Cost Per Unit Output Economies of scale Reducing unit costs Lowest Unit Costs Diseconomies of scale Outweighing economies

Question Why might ‘unit costs’ start to increase again?

Diseconomies of Scale Where average unit costs rise as the business grows larger Diseconomies of scale tend to occur because it is more difficult to manage a large business than a small one

Examples of Internal Diseconomies of Scale Bureaucracy Poorer labour relations ‘Small fish in a big pond’ Communication difficulties Lack of control and coordination Too much specialisation demotivates workers Complacency How could these factors lead to an increase in average unit costs?