The maximum output that can be achieved using the available inputs – this scale can only be increased in the long term by employing more of all inputs
Economies of scale
Reductions in a firm’s unit costs of production that result from an increase in the scale of operations
Purchasing economies – bulk-buying economies of scale
Technical economies – Only justified by large firms with high output levels through flow production, that can afford it and so that average fixed costs can be reduced
Financial economies – banks are more willing to lend money to large businesses at low interest rates and raising finance by ‘going public’ or through further public issues of shares is very expensive and thus it only reduces average costs once it’s done on a large scale
Marketing economies – Marketing costs rise with the size of a business, however large businesses with high levels of sales can spread costs
Managerial economies – As a firm grows it is able to employ specialist functional managers who operate more efficiently, thus reducing average costs Diseconomies of scale
Factors that cause average costs of production to rise when the scale of operation is increased
Communication problems – communication worsens with increased size of operation, leading to poor decision-making, due to inadequate/delayed information and management inefficiency
Alienation of the workforce – workers feel insignificant, which demotivates them and thus reducing efficiency
Poor co-ordination and slow decision-making – When a firm has many departments and branches in different countries, it becomes difficult for managers to co-ordinate. Smaller businesses have tighter control and can make quicker and better decisions, benefiting from flow average costs in the end Merits of small and large organizations
Small organizations Large organizations
Managed and controlled by owners
Adapt quickly to changing consumer needs
Offer personal service to customers
Staff knows each other
Average costs low due to diseconomies of scale and low
Afford to employ specialist managers
Benefit from cost reductions linked to large-scale production
Able to set prices that other firms have to follow
Access to different sources of finance
Diversified in several markets and
Small organizations Large organizations
Limited access to sources of finance
Owner has to carry large burden of responsibility if unable to afford employing specialists
Not diversified so greater risks of negative impact of external change
Unlikely to benefit from economies of scale
Difficult to manage
Potential cost increases associated with large-scale production
Suffer from slow decision-making and poor communication due to structure
Suffer from divorce between ownership and control, leading to conflicting objectives
Recommending an appropriate scale of operation Business owners must assess:
Owners’ objectives
Capital available
Size of the market the firm operates in
Number of competitors
Scope of scale economies Business growth
Possible reasons:
Increased profits
Increased market share
Increased economies of scale
Increased power and status of the owners and directors
Reduced risk of being a takeover target Internal growth/Organic growth
Expansion of a business by means of opening new branches, shops or factories External growth
Business expansion achieved by means of merging or taking over another business, from either the same or a different industry
Horizontal integration
Integration with firm in the same industry and at the same stage of production
Consumers have less choice
Workers may lose job security as result of rationalization
Eliminates one competitor
Possible economies of scale
Scope of rationalizing production (eg.: Focusing production on one plant not two)
Increased power over suppliers
Rationalization may bring bad publicity
May lead to monopoly investigation if combined business exceeds size limits
Forward vertical integration
Integration with a business in the same industry but at a later stage of production
Workers have greater job security as business has secure outlets
More varied career opportunities
Consumers resent lack of competition in retail outlet due to withdrawal of competitor products.
Able to control promotion and pricing of own products
Secures an outlet for firm’s products
Consumers may suspect uncompetitive activity & react negatively
Lack of experience in this sector of retailing
Backward vertical integration
Integration with a business in the same industry but at an earlier stage of production
Greater career opportunities
Improved quality and more innovative products for consumers
Control over supplies to competitors may limit competition and choice for consumers
Control over quality, price and delivery times of supplies
Encourages joint R&D into improved quality of supplies of components
Control supplies of materials to competitors
Lack experience of managing a supplying company
Supplying business may become complacent having a guaranteed customer
Conglomerate integration
Merger with or takeover of a business in a different industry
Greater career opportunities
More job security as risks are spread across industries
Diversifies the business away from original industry/markets
Spreads risk and takes business into faster-growing market
Lack of management experience in acquired sector
Lack of clear focus and direction now that business is spread across more than one industry
Merger
An agreement by shareholders and managers of two businesses to bring both firms together under a common board of directors with shareholders in both businesses owning shares in the newly merged business
Takeover
When a company buys over 50% of the shares of another company and becomes the controlling owner – often referred to as ‘acquisition’
Joint venture
Two or more businesses agree to work closely together on a particular project and create a separate business division to do so
Styles of management and culture might clash
Errors and mistakes might lead to arguments
Business failure of one of the partners puts the whole project at risk Strategic alliances
Agreements between firms in which each agrees to commit resources to achieve an agreed set of objectives
Can be set up with:
A university – finance provided by business allows new training courses to increase supply of suitable staff for company
A supplier – to design and produce components and materials used in a new range of products, helping to reduce total development time of getting the new products to market and gaining competitive advantage
A competitor – reduce risks of entering a market new to both firms. Care must be taken that actions aren’t seen as ‘anti-competitive’ and against the law in the specific country
Franchise
A business that uses the name, logo and trading systems of an existing successful business
Fewer chances of new businesses failing as it’s an already established brand
Share of profits or sales revenue is paid to franchisor
Advice and training offered by franchisor Initial franchise license fee can be high National advertising paid for by
franchisor
Local promotions still paid for by franchisee
Supplies obtained from established and quality-checked suppliers
No choice of supplies or suppliers to be used
Franchisor agrees not to open another branch in local area
Strict rules over pricing and layout of the outlet reduce owner’s control
Ansoff’s matrix
A model used to show the degree of risk associated with the four growth strategies of market penetration, market development, product development and diversification
Market penetration
The objective of achieving higher market shares in existing markets with existing products
Product development
The development and sale of new products or new developments of existing products in existing markets
Market development
The strategy of selling existing products in new markets Diversification
The process of selling different, unrelated goods or services in new markets Analysis of Ansoff’s matrix:
Allows managers to analyze the degree of risk associated with each strategy
However it only considers two main factors in the strategic analysis of a business’s options – it’s important to also consider SWOT and PEST
Further research into the selected strategy is vital Evaluation of growth strategies
Internal growth
Avoids problems such as the need to finance expensive takeovers, offer new share issues or expensive additional loans
Management issues in bringing together different businesses with their own attitudes and cultures are avoided
It is very slow, with perhaps only a few branches opening each year External growth
Rapid expansion, which might be vital in a competitive and expanding market
Takeovers can be very expensive and may result in management problems
Porter’s generic strategies
1. Cost leadership strategy
Being the lowest-cost producer allows company to make higher profits than competitors
Allows firm to lower prices below competitors to increase market share Stems from internal strengths:
High levels of investment in advanced production methods, requiring access to much capital
Efficient production methods
Efficient distribution channels 2. Differentiation strategy
Value added to product may allow premium pricing Stems from internal strengths:
Excellent R&D facilities and track record in developing unique goods
Corporate reputation for innovation and quality
Strong sales team able to promote perceived strengths of brand 3a&b. Focus strategy
High degree of customer loyalty within the market segment
Can lead to imitation by rivals, so continued success depends on continuing to tailor a broad range of products to a relatively narrow market segment that the business knows well
Unit 1.8 – Change and the management of change