“Be not afraid of going slowly;be afraid only of standing still”

Chinese proverb

Thought for the day:

Growth and Evolution:

dis/economies of scaleMerits of small and large business

Internal/External growth strategiesFranchising

The Ansoff matrixHL: Porter’s Matrix

1.7 Growth and evolution Economies and diseconomies of scale Apply the concepts of economies and diseconomies of scale to business decisions.Small versus large organizations Evaluate the relative merits of small versus large organizations. Recommend an appropriate scale of operation for a given situation. Internal/organic growth Explain the difference between internal and external growth.External growth Evaluate joint ventures, strategic alliances, mergers and takeovers as methods of achieving a firm’s growth objectives. Evaluate internal and external growth strategies as methods of business expansion.Porter’s generic strategies Examine Porter’s generic strategies for building competitive advantage. Franchises Analyse the advantages and disadvantages of a franchise for both franchisor and franchisee. Evaluate the use of franchising as a growth strategy. Ansoff matrix Explain the value of the Ansoff matrix as a decision-making tool. Apply the Ansoff matrix growth strategies to a given situation.

Getting the grade: Key words

Getting the grade: Key words

• In order to measure the growth of a business, look at:

• its sales turnover, • its market share, • its capital employed, and • the number of employees employed. Most businesses that look to expand are in the

private sector.

Activity

Spider diagram why do you think business’ reasons to grow are?

Complete

Getting the grade: Key words

Businesses, whether large or small, generally look to expand their entities for four main reasons: •to enjoy economies of scale, •gain larger market shares, •for survival, and •to spread risks out amongst their branches.

Economies and diseconomies of scale

Long run average total cost curve:

This graph shows how as a firm operates, economies of scale are experienced, where avg. costs are minimized.

However, continual expansion will lead to diseconomies of scale

Economies of scale

In VERY simple terms

If Fixed costs (eg Rent, electricity, wages) are $2000And it costs $30 to make the product.

If you only sell two products:$2060/2 = cost is $1030 per item

You sell 8 then:$2240/8 = $280 per item

But there are also lots of other reasons for costs being reduced as you grow….

Economies scale

Internal Economies of Scale

Also known as increasing returns to scale, internal economies of scale is achieved by a business with its own ability,

for instance, reducing their average production costs by producing on a much larger scale.

There are several branches that affect internal economies of scale:

Technical Economies

•use sophisticated machinery to mass produce•fixed costs spread out over huge scale of output = lower average costs•benefits businesses with products that have large market demand vs. impractical for small businesses (due to excess supply produced)

Economies of scale

Financial Economies

•large firms can borrow massive sums of money at lower rates of interest than smaller rivals (they seem less risky to financial lenders)•established businesses will look for lender with the most attractive rate of interest•vs. smaller firms struggle to raise external finance and have to pay higher rates of interest on overdrafts and loans

Economies of scale

• Managerial Economies

• sole trader has to fulfill all business functions• vs. specialization of larger firms (higher

productivity)• loss in one area will not jeopardize entire business

Economies of scaleSynergy

•through growth, businesses can avoid excess efforts in processes (reducing their units costs of production)

Specialization Economiessimilar to managerial except results come from division of labour, not management•specialists boosts firm’s productivity•motor vehicle manufacturer --> designers, production staff, engineers, marketers

Economies of scaleMarketing Economies•lower avg. costs by selling in bulks•large businesses can exploit global marketing economies (same marketing campaign translated for each respective country)

Monopsony Economieslarge firms with strong buying power (e.g. Walmart, McDonald’s)•can demand low prices from suppliers

Commercial Economiespurchasing/buying economies•similar to monopsony economies•lower avg. costs by buying supplies in bulks

Risk-bearing Economiesenjoyed by conglomerates•loss in one area will not jeopardize entire business

External economies of scale

Technological progressImproved transportation and communication networks

Better trained labourRegional specialisation

External Economies of Scale

• External economies of scale are, self explanatorily, affected by external factors.

• These factors are out of the companies' control, and allow firms to reap the benefits of economies of scale.

External Economies of Scale

• Technological Progressincreases productivity of trading

• Improved Transportation & Communication Networksdeliveries arrive on time

• easily accessible venues to shop at• Better Trained Labour• gov. training programmes or reputable training facilities• cut recruitment costs without compromising productivity levels• Regional Specialization

industry benefits from specialist & efficient labour, subcontractors, suppliers

Internal Diseconomies of Scale

• Lack Control & Coordinationas a firm continues to grow, managers begin to lose control and coordination

• additional time needed to communicate effectively with larger # of staff

• slow decision-making• different locations in the world• workers lack staff morale

Internal Diseconomies of Scale• Poorer Working Relationships

larger workforce = senior management more detached• affect communication flows negatively• Slack

procrastination & inefficiency• specialists get bored of doing repetitive tasks• Bureaucracy

Administration, paperwork, company policies increased• time consuming decision-making• communication more difficult• Complacency

being large and dominant player/market leader

External Diseconomies of Scale

• - increasing market rentsdue to excessive businesses in one area

• - traffic congestiontoo many businesses in one area

• increased transportation costs• - higher wages

workers have more job opportunities

Dealing with diseconomies of scale

• Reduce the level of output, • Introduce methods that will increase levels of

productiveness in the workforce (Motivational strategies, Performance related pay).

• Outsourcing

• Extension: watch - 7 mins• http://www.youtube.com/watch?

v=AZshS761WsE

REVISION:

• http://www.teachingbusiness.co.uk/index-12.html

• Economies of scale penalty game

Assessment task 2

• 4. Describe, with relevant examples, three internal economies of scale and consider how these will apply to Open Views as it grows in size.

• (Total 8 marks)

Business Growth and Size

Small, Medium or Large?

Classifications vary in industry and country.

This is how the size is measured:

Problems with measuring size

• The number of people employed is a straight forward method.

• But how do you compare business in different industries….

• E.g a huge modern farm (using machinery) may employee just a few people, a local supermarket may employ a hundred or more?

EU & South African examples

SA: Small Business (varies industry to industry)

Problems measuring size…

• A highly automated plant may employ only 45 people, but have a turn over of 50 million euros…. Small or large?

• Turnover

• Number of employees

• Amount of capital employed

• Market share

• Question 2.• Analyse whether small and medium size firms

such as Open Views’ have commercial and competitive advantages over multinationals like McGregor’s & Blue Seas. (total 8 marks)

• There are perks to small and large businesses alike. • For instance, even though sole proprietors may be

responsible for all the risks of their businesses, they receive all the profits earned.

• Large businesses benefit from factors such as brand recognition, reputability, and convenience, while small benefit from factors such as government aid, local monopoly power, and flexibility.

• Each type of business will look to expand in different ways, depending on their respective aims and objectives.

• Pg 72 (advantages and disadvantages of Small and large businesses).

Business Growth and Size

Why remain a Small Business

• remain control • avoid risk • prevent increase

workload

Reasons for Staying Small

Reasons for Staying Small

1. For a Sole Trader or a Partnership, a larger business could mean more responsibility and work.

2. A bigger business is likely to mean taking on more workers.

3. Some owners don’t want to lose control of the business they have created.

4. The business may only sell to a small or local market.

Business Growth: Why be Large?So why do owners and directors seek growth?

Reasons For Growth:• Larger returns for the owners/ Increase future profits – greater profit (larger, sell

more)• More rewards for the Directors and Managers. – bonuses, return on investment• Increase power and status of owners and directors• Survival – stay in business• Increase market Share• Increase economy of scale• Investment opportunities – elsewhere, projects, assets• Reduce the risk of being a takeover target• Business may be able to gain advantages over competitors by growing.• Reduce/Spreading risk (diversification)• Investment opportunities

Other benefits of being large:

• Brand recognition• Image• Convenience• discounts• Customer loyalty• More Choice

Problems with growth

• Diseconomies of scale• Resistance from shareholders• Lack of expertise• Lack of funds

Business Growth

•Growing can be internal or external

Internal growth• Internal growth is also sometimes referred to as organic growth, as

companies use their own resources to grow.

• There are several ways that a business may choose to take in order to grow internally. For example, they might decide on changing their products’ prices depending on price elasticity of demand.

Internal growth• If a product is in wider demand, the company may wish to increase the

prices, and vice versa, in order to attract more customers to increase their sales revenue. Other ways that firms could grow organically is by:

• Advertising• Producing improved products• Increasing availability• Increasing capital expenditure (investment)• Improving training and development

Benefits Limitations

– better control and coordination– relatively inexpensive– maintains corporate culture

– diseconomies of scale– overtrading– a need to restructure– dilution of control and ownership

Summary: Internal Growth

• An increase in the size of the business which is achieved through the existing business increasing profits, sales and employment.

• Can be achieved by marketing, product development, and there just being a general increase in demand for existing products.

External growth

…is sometimes referred to as inorganic growth. •Though organic growth is a great way for businesses to expand, external growth also has benefits that businesses may enjoy.

External growth

Advantages Disadvantages

– much faster way to grow and evolve– quick way to reduce competition in market– greater market share– working with other businesses means sharing of good practice and ideas– spreads risks across several distinct markets

– costly

Summary: External Growth

External growth can be categorized into four different methods – joint ventures, strategic alliances, mergers/takeovers, and franchises.

•Mergers When two businesses agree to join, usually two similar sized business.•Take-overs When one business buys another can be hostile or agreed.•Acquisitions When a business buys a part of another business.•Joint Venture Two business join together for a specific project.

Now in detail…..

External growth

Joint VenturesJoint ventures are created when two or more separate companies merge to become one single legal entity. There are many benefits to doing so, such as the pooling of experiences by the two companies (synergy), and the ability to enter foreign markets. The costs for starting a joint venture is relatively cheap, there would also be reduced competition for the newly formed company. Joint ventures generally have high success rates. However, the businesses in joint ventures depend heavily on both the resources and goodwill of their counterparts, which may be considered a disadvantage to forming joint ventures.

External growth Strategic AlliancesStrategic alliances are much like joint ventures. The main difference between the two is that companies that are part of strategic alliances remain as individual organizations.A business goes through four key stages before the forming of a strategic alliance with other companies is finalized.Feasibility study – investigate & establish rationale, objectives, and feasibility of alliance•Partnership assessment – analyze potential of different partners•Contract negotiation – determine contributions and rewards in form of contract•Implementation – initiate operations•Like joint ventures, the main purpose of strategic alliances is to gain synergy and resources from different strengths of alliance members. The formation of strategic alliances also helps alliance members gain credibility and brand awareness.

External growth

Mergers and Takeovers‘Mergers and takeovers’ (also referred to as ‘mergers and acquisitions’) means the amalgamation or integration of two or more companies to form one single company. The new firm generally benefits from factors such as economies of scale, as well as obtaining a larger market share than they previously had.

i. MergerMergers are almost the same as joint ventures, when two or more firms agree to merge into one single company without retaining their own individual identities.

An example of a merger is the UK's British Petroleum and US' oil company Amoco in 1998. 

Together, they formed BP Amoco.

Play

http://news.bbc.co.uk/1/hi/business/8492572.stm

•ii. Takeover/AcquisitionUnlike mergers, takeovers are generally much less friendly. A takeover occurs when a company buys the controlling interest in another company, which can be due to many reasons. Some businesses become targets for takeovers because they seem to have space for growth, but lack funds, or they recently experienced a drop in profits.

Businesses that takeover other companies are separated into two types – the ‘Black Knight’ and the ‘White Knight’.

• Just as the titles suggest, the ‘Black Knight’ represents hostile takeovers, when the takeover’s targeted business does not wish to be taken over. Often times, businesses that are to be acquisitioned look for ‘White Knights’, companies that might be considered friendlier and better partners for the company, as opposed to the ‘Black Knight’.

External growth

Advantages and Disadvantages of Mergers & Aquistions

Advantages Disadvantages

– greater market share– economies of scale– synergy– survival– diversification

– loss of control– culture clash– conflict– redundancies– diseconomies of scale– regulatory problems

.

Integration

• There are four types of integration when it comes to mergers and takeovers.1. Vertical Integrationbusinesses at different stages of production

• forward or backward• Forward Vertical Integation• An example of a forward vertical integration: a

coffee bean manufacturer may choose to merge with a caféBackward Vertical Integration

2. Horizontal Integrationbusinesses at the same stage of production•perhaps the most common type•larger market share for amalgamated business•greater market power3. Lateral Integration•similar operations, but don’t directly compete with each other (e.g. Cadbury-Schweppes, 1969)

Integration

4. Conglomerate Mergers and Takeoversbusinesses in completely distinct markets•Diversification•Conglomerates•economies of scale, spreading of risks, access to new and diverse markets, global recognition

Integration

• Management buy-out (MBO)MBO is a defensive strategy businesses use when they are faced with a hostile takeover. When a 'black knight' is trying to take over a company, the company's board of directors may choose to purchase the controlling interest of the company in order to retain the firm's ownership.

• Management buy-outs – occur when management of a company bys the company from the current owners. (would need a financial package: own investment, loans, equity investment from Venture capital company)

• Venture capitalists company – Specialise in buying shares in medium size companies.

•

Brand acquisitionAnother way to take over a company completely is to buy one of its brands. For instance, in 2003 BMW bought the Rolls-Royce brand in order to appeal to a bigger market. Some companies may decide to sell certain brands of they are facing a liquidity problem (company's jeopardized due to shortage of cash).

External Growth: Summary

• Mergers When two businesses agree to join, usually two similar sized business.

• Take-overs When one business buys another. can be hostile or agreed.

• AcquisitionsWhen a business buys a part Of another business.

• Joint Venture Two business join together for a specific project.

Horizontal IntegrationBuying a competing firm in thesame market.Eg. IBM buying Dell

Forward Vertical Integrationeg. Buying retail outlets

Eg. IBM buying PC world

Backwards Vertical integration.eg. buying the suppliers

Eg. IBM buying Intel

Lateral integrationBuying a firm in related marketeg. IBM buying a softwarecompany

Conglomerate integrationBuying a business in an unrelated marketeg. computer firm buying a chemicalsbusiness

Forward Vertical integration, eg. buying your retail outlets

Backwards Vertical integration.eg. buying your supplies

Horizontal IntegrationBuying a competing firm in thesame market.Eg. IBM buying Dell

Lateral integrationBuying a firm in related marketeg. IBM buying a softwarecompany

Conglomerate integrationBuying a business in an unrelated markete.g. computer firm buying a chemicalsbusiness

Eg. IBM buying Intel

Eg. IBM buying PC world

Reasons for integration

• Cost saving• Greater control of markets• Under valued assets• Diversification• Rewards to management

What is this?• Some businesses become smaller because they think it will

make them more profitable. • Some large public limited companies DEMERGE.

• DEMERGE: split up into two or more smaller independent companies.

Why demerge?

• Some parts of company performing poorly• A company may have debt• Some companies specialise in start ups• Allows management to concentrate on

running a smaller more focused business• PLC can split and combine share prices

Summary:• How do businesses grow?• There are two ways in which a business can increase its size. Most firms

will grow slowly through internal growth; other businesses who wish to grow more rapidly may choose to use external growth this is also known as INTEGRATION

Internal growth can be achieved through:• Producing and selling more products in its existing markets• Selling its products in New markets (eg. overseas)• Making and selling new products.• External growth can take the following forms:• Horizontal integration• Vertical integration• Lateral integration• Conglomerate integration

Franchises

• Another common way through which businesses expand is by franchising.

• Good way to grow nationally and internationally.

• Rely on the know-how, brand recognition and trust of the parent company.

Franchises

• Another common way through which businesses expand is by franchising.

• If one is looking to start a business with lower start-up costs, he or she may consider starting a franchise by buying the rights to using a particular business’ already established brand name and products from the franchisor.

• However, there are many advantages and disadvantages to starting a franchise for both parties.

Benefits Disadvantages

Franchisor

- rapid growth with less risks than organic growth- national/international presence- growth and expansion --> economies of scale- no need to worry about running costs (e.g. staff wages, purchase of stocks)- receive royalty payments- local franchisees more aware of local market conditions & cultural differences

- difficult to control franchisees’ activities to control their quality standards- huge risk in nominal franchising; reputation may be soiled- slower than mergers/acquisitions

Franchisee

- lower risks- lower start-up costs- franchisor will provide added-services (e.g. advice on $ management)- ‘free’ large scale advertising by parent company

- expensive to buy franchise- royalty payments- less flexibility (e.g. prices, promotional campaigns)

• A great example of a franchise would be Burger King, the second largest fast food chain in the world. 11,000 outlets, 90% franchises.

Constraints to Growth

• Finance needed for expansion• Limited size of market (might need to grow

overseas or diversify products)• Borrowing money from banks (makes you

vulnerable to unfavorable trading periods/paying your debt.

Competitive Advantage

Porter’s Generic Strategies

• http://www.youtube.com/watch?v=ndARJzmKras

Help business to determine a stratgy to growth or evolve.

Porter’s Generic Strategies• Generic Strategies – They outline the ways that any

business can gain a competitive advantage. As businesses face harsh competition people are always trying new strategies to sustain a competitive advantage.

- Cost leadershipThis strategies means to become the lowest cost supplier of a product within the market. Companies that use such strategy are McDonalds or Ikea. Although they have low cost products they are very profitable and market leaders.

– The only way to compete with such strategy is by using penetration or predatory pricing strategies that may be prohibited by certain governments.

Porter’s Generic Strategies• Differentiation

This strategy means the firm makes its mass-market products distinct form those of its competitors. Whether is it usage of packaging or branding to make the product seem unique, the focus of this strategy is quality. Apple is a very good example of this strategy as they use their unique style to maintain their competitive edge.– Although this strategy may be rewarding, it is

very expensive to promote.

Porter’s Generic Strategies•

- FocusWhen a firm targets a niche or single segment of the market. Due to the lack of competition focus can be highly profitable.– However focus doesn’t just apply for high pricing

firms, it may also be used by low-cost businesses that cater for a certain market segment, such as discount bric-a-brac stores.

– The drawback of focus as a strategy is that the market size is very limited.

• - These strategies are meant for firms to use alone. If any firm tried to use a mixture of these strategies, it will not survive the long term.Firms cannot expect to be highly profitable and to have an image of outstanding quality by charging low prices.

Analytical Tool

The Ansoff matrix

• Ansoff matrix – provides four strategies for enlarging a business.

• http://www.youtube.com/watch?v=AORoMxgp428

Growth and Evolution:

• Internal Growth – Maintain control, requires finance, slower

• External Growth – quicker, can lose control• Why grow – economies of scale• How Grow? – USP, first mover advantage, market

leader (customers willing to pay more – cost leadership or product differentiation also), branding, diversification

• Ansoff matrix – provides four strategies for enlarging a business.

• Question 1 & 6 of pre-release