+1 862 207 3288 Paper instructions:
Using the NHS as an example, assess how private businesses can add some value to services provided by public companies. 10 power point slides,including
1 slide Title page, 1 slide references
Assessment Criteria:
Presentation of key ideas clearly
Ability to communicate the ideas and defend them if and when questioned.
Clearly signing of theory to researched material
HIBT – The economic environment of business – Lecture 1 – Notes
Private and public sector
Most of the businesses or organisations that we have looked at so far have been in the private sector of the economy. These are any organisations owned, controlled and
managed by private individuals, usually for the purpose of making profit. However, they may also be in the public sector of the economy.
The public sector is the government sector of the economy – don’t muddle this with the general public – they are the private sector! This is referred to as public
ownership. It was considered that the government would act in the interests of the population by providing vital services, even if there was no profit in this
provision. Merit goods are goods such as medical care that might not be provided to all of the population by the private sector. Government may allow access to all
people even if they cannot afford to pay.
Public ownership is much less common these days as it is felt that businesses are much more efficient if they are privately owned. In the past few decades (since the
start of the 1980s) many businesses have been privatised. This means that they have been changed from public ownership to private ownership. However, the balance
between public and private ownership varies considerably from country to country. In recent years several government have begun to create partnerships with the private
sector, which may run some aspects of public sector services such as hospitals and schools, even though these services have not been privatised.
SUMMARY of types of organisations in the private and public sectors
Summary of types of organisations
Why not search around government web sites in your country to find data on the proportion of private and public companies?
Privatisation
This is the selling of nationalised or state-owned industries to private investors. It is claimed that privatisation:
• Reduces costs – the profit motive, and competitive pressures will drive costs down. The regulator will help!
• Increases choice
• Increases quality
• Encourages innovation and invention
• Brings market forces into play in a positive manner for the consumer
• Saves the government money -the costs of the nationalised industries would be replaced by income from business taxes
• Widens share ownership in the population
Privatisation also has some possible problems:
• Monopolies would be in private hands
• Loss of equity
• Externalities -the private firm may not be so careful over pollution etc.
Because of these potential problems, privatisation in many countries has been accompanied by the introduction of deregulation and the appointment of Regulators.
Deregulation
Deregulation is the removal of government rules, controls and restrictions on production and trade.
Some industries have in the past been government monopolies to protect them from competition. Deregulation is the removal of these government controls from an
industry. Regulators are offices to control or regulate privatised monopoly industries.
Starting a business
In this section we are looking at profit organisations – that is organisations whose main objective is profit maximisation. We are going to look at this in the context
of starting a small firm. We will be looking at the problems and requirements when aiming to begin a business either in manufacturing or in the tertiary sector.
Most of you will know, but what does TERTIARY mean?
To start a business and run it successfully you need:
1. A product or service
You may have an idea, but how do you progress it further? A well-known entrepreneur in Europe is James Dyson. Dyson (see the Dyson web site for details of their
products) had an idea, but it took him years of R&D, financed on a shoestring, to turn it into his successful vacuum cleaner. You are at a great disadvantage against
the ‘big boys’, so perhaps you should look for a ‘me too’ product to start with and go for a marketing edge. ‘Me too’ products are basically adapted copies of existing
products or services. Service activities are usually cheaper to set up and operate than production industries (sell it, rather than make it!). To find out about your
product, you can do a lot of desk research at your computer, these days, but field research may be too expensive initially. Do you know what these terms means? Have a
think about them and then click RESEARCH.
If you have identified a unique product then you must patent it. This means registering the product and its design to prevent others from copying it. If you don’t,
then the competition can just ‘steal’ the product design from you, and leave you for dead.
A good example of a patent protecting a firm from another business copying its product was when Dyson sued Hoover in a dispute over its bag less vacuum cleaner. Dyson
accepted a £4m ($6.3m) damages offer from its rival Hoover following a court ruling that Hoover’s Triple Vortex cleaner infringed Dyson’s patent for its Dual Cyclone
vacuum cleaner.
Patenting is expensive, though, and it must be done correctly.
So, a service firm is probably easier and cheaper to set up than a production firm.
2. A marketing edge
The new firm may on firmer ground here. This approach may not be too expensive. It may need a unique selling point (USP), though.
In the selling area there may still be room for an Internet service. Look at ‘Lastminute.com’ and the like. Is there any room for further companies in this area?
3. Money / finance
You will never have enough, but your shortage can be serious at first. Depending on the structure of your company, you will have different sources of finance.
You could go to banks, shareholders and/or partners, depending on the legal structure of your firm. For a small firm, the only real alternatives for a legal structure
are sole trader or private limited company. The latter is probably preferred since it is financially safer for all concerned.
4. Personal skills
Can you, or the fellow members of your team, do everything required? You will not be able to employ many people at the start up stage. (You can use consultants or
contract staff, but they cost a lot of money.)
If you have the product, finance and confidence (and ability) you can go on and start your firm.
What then, though? You will now need:
• Site – another absorber of money. You won’t want to spend too much on capital expenditure here, think about your working capital requirements. Keep the luxury
furniture and big cars for later, when your business is successful!
• Customers – these are vital. Who and where are they? How will you contact and communicate with them? No customers mean any business. Peter Drucker once said
that business is about “the customer, the customer and the customer’.
• Cash flow management – vital. Cash flow is as essential to the life of a business as blood flow is to your personal survival!
• A business plan – last, and by no means least.
You have to decide:
• Where you are going
• How you are to get there
• How you will measure and monitor progress, especially in terms of sales and cash flow
• How it all fits in with the limitations of your capital
You need a plan, in particular a business plan. You will almost certainly need a bank loan, and the first thing that the manager will want to see is your formal
business plan.
The business plan sets out in logical order what a firm proposes to do, how it proposes to do it, how much it will cost, what it will bring in etc. It will contain
forecast accounts and a cash flow forecast. It should be supported by research data where appropriate. A business plan is a very important document.
Profit-based organisations – please not that this is written in the context of the United Kingdom – it might be different in your country.
Legal structure
Firms are either unincorporated or incorporated businesses. This is similar to saying that a firm is not a company (unincorporated) or is a company (incorporated). The
main difference here is that in unincorporated firms the owner is the business and is legally responsible for everything. For incorporated firms, the firm is a legal
entity in itself. When an incorporated firm is formed, it is like the birth of a new baby. The firm has its own legal personality, separate from those who formed it.
The firm can be taken to court, or can take others to court. If, for instance, a person steals from a company, it is the company that prosecutes the offender.
An important difference between incorporated and unincorporated businesses is that of limited liability. An unincorporated business has unlimited liability. The owner
is responsible for all debts of the business and if necessary his/her personal assets, such as a house can be seized to pay off debts. An incorporated business is
owned by shareholders. Every shareholder (owner) has limited liability. In the event of the business failing the shareholders can only lose up to the value of their
investment. Their liability for debts is therefore limited.
Businesses which possess limited liability must say so after their name, e.g. ‘ABC Limited.
There are four main types of business, and these all have their advantages and disadvantages for the business, and also for everybody that the firm deals with. We look
here at common features of these business organisations. However, they may differ from country to country. Why not have a search around your government’s web sites to
find out more detail about business structures where you are? The common international legal structures are:
Unincorporated organisations
The business and the owner/owners are seen legally as being one and the same. If you sue a sole trader for debt, for example, you sue the individual owner of the
business. The owner is entitled to all the profit, but is also personally liable for all the debts.
The owners can be taken to court, and lose all their personal possessions to meet unpaid debts. Sole traders and partners have unlimited liability.
Sole trader
Most new small businesses are set up as sole traders.
• This is the simplest legal structure. It is easy and cheap to set up; you just do it. There are few formalities, although you may need to apply for licences or
to register the name of the business. Unless you do something else, you will be assumed to be a sole trader. The income of the business is your income and you pay tax
on it. It may be hard to grow, though, as borrowing money may be difficult. Sole traders will usually need some security to support borrowing, often their house, and
the loan potential is limited. They stand to lose everything if the business fails and may become bankrupt. This situation is called unlimited liability. Some
businesses, however, stay sole traders for a long time, even when they are large and national. JCB, the digger firm, operated as a sole trader ship for many, many
years.
• You deal directly with the national tax authority, and all profits are treated as income, and taxed accordingly. There are no shares or shareholders. It can be
hard to raise money through the banks because of the unlimited liability and lack of security (your security will usually be your house!). Many sole traders are small
businesses that sell services such as taxi drivers, plumbers, decorators and electricians. A sole trader ceases to exist when the owner retires or dies.
Partnership
• This is a sole trader, in essence, where the ownership, profit and liabilities are shared between partners. There is more work necessary to set up a
partnership. Generally, a legal agreement (a Deed of Partnership) must be drawn up by a lawyer. There is one major problem of a partnership and that is the
responsibility carried by partners. Partners are responsible for losses, ‘wholly or severally’. If they all can pay, they will share the debt, but if only one has any
assets then this partner will pay all. Be careful if invited to be a partner! In other words they still have unlimited liability. A whole section of the law covers
partnerships, and they can be difficult to set up and run.
• Many professional firms are partnerships. Most firms of lawyers, accountants, vets and architects are partnerships. They have the necessary skill and knowledge
to draw up the correct partnership agreement.
• Some partnerships have to be re-established if one partner leaves or dies, as this invalidates the Deed of Partnership.
The owners of sole traders and partnerships run their businesses and make all major decisions. Sole traders and partnerships cannot sell shares in their business to
other people. This can be a restriction on them raising capital. In some countries certain occupations, such as doctors and lawyers, are prevented from incorporating,
as there may be a conflict of interest between clients and owners.
Unlimited liability and difficulties in raising finance may make businesses change their legal form to become incorporated.
Incorporated organisations
Here the firm and its owners are separate legal entities. Shares in the firm can be sold to the public. The firm can be taken to court. The owners of the businesses
have limited liability; they are only responsible for their investment in the firm through their share capital. This can be a major advantage over being the owner of
an unincorporated firm. The owners of the business are its shareholders.
Companies have continuity. They continue to exist if owners change, for instance.
Private limited company (Ltd)
• Most companies start as private limited companies. They can be set up quickly and cheaply, and firms of lawyers are set up which specialise in this. Many
private limited companies are family businesses as there is less risk of a takeover. Shareholders in private companies can put restrictions on which shares are sold
to.
• The owners also have to prepare and publish each year a set of legal accounts. The owners of the firm have to prepare legal documents (often called Articles of
Association and Memorandum of Association) and be registered with the national government. The Articles lay out the internal rules of the business, such as the calling
of meetings, the types of shares and the power of the directors. The Memorandum details any relationship between the business and its external environment. It shows
the objectives of the business, the address of its head office and its maximum share capital.
• There has to be at least one director, but other requirements are few. Shares can be sold, privately, but not on the national stock market. There is no minimum
capital requirement, however. Shareholders have limited liability. That means they can only lose their share capital; creditors cannot claim any other assets. The
company has to prepare legal accounts and should send these to the appropriate government organisation each year. Private companies are hard to take over without the
agreement of the existing shareholders. Equally, they may be hard to sell.
Public limited company (plc)
These are the public companies whose shares are traded on national and international stock exchanges.
With a public limited company qualifying shares are sold on the Stock Exchange to the general public. Anybody can buy them, and if they get 50% of the shares plus one
more, they can control the business by outvoting all the other owners. This is the world of takeovers. You have to have a lot of money to become a plc; the company
must usually have a minimum share capital to become a plc. There may also be many other requirements such as:
• A minimum number of directors.
• A fully qualified Company Secretary (the chief administrative officer responsible for all legal affairs).
• Legal accounts prepared each year and sent to the appropriate national government organisation.
A plc can be taken over without the agreement of the present Directors. If the firm is doing well shares will sell easily, in fact they will be in high demand.
The law sets out a series of requirements, which are shown below:
The legal differences between private and public limited companies
Private Limited Company
(Ltd) Public Limited Company
(plc)
Memorandum of Association Must state that the company is a public company
Name Must end with the word ‘Limited’ or the letters ‘Ltd’ Must end with plc, or the words in full
Minimum Authorised Capital None Varies according to local law, but usually a set limit
Minimum shareholders 2 2
Minimum Directors 1 2
Retirement of Directors No age set, unless the firm is a subsidiary of a plc, when they must retire at 70 Must retire at 70
Issue of shares to the public No advertising to the public. Sale by private agreement only May do so on the Stock Exchange, by means of a Prospectus.
Company Secretary Anybody Must be professionally qualified as a Company Secretary
Accounts Small and medium size companies may submit shortened accounts Must file full accounts and Directors reports with national government.
Meetings Proxy may address the meeting A proxy cannot speak at a public meeting.
Some of these requirements may differ in detail between countries, but this gives a useful guide as to the basis of incorporation of firms.
In incorporated companies, plc’s or limited companies, the decision makers (the Executive Directors) are often not the owners; it is the shareholders who are. This
separation (often called ‘divorce’) between ownership and control can cause major problems, as has been seen recently with firms like Enron and WorldCom.
Typically a new business will start as a sole trader, and then become a limited company as soon as possible. It will then ‘go public’ (float shares) when it thinks it
is appropriate.
It is possible to set up as a private limited company quite easily and cheaply these days as shell companies are available to buy, i.e. companies where all the legal
requirements have been completed, but the purpose is left very general. A good advisor can select the right one for you, and you have limited liability at once.
Advantages and disadvantages – summary
As we have seen above there are a number of advantages and disadvantages of each company structure. You need to make sure that you remember these. Here’s a brief
summary.
Sole trader or Private limited company
Easy and cheap to set up Can be costly. Legal requirements.
Unlimited liability Limited liability
Difficult to raise money Easier to raise money
Other types of private sector organisations
Co-operatives
A co-operative is an organisation run by a group of people, each of whom has a financial interest in its success and how it is managed. That group may be the producers
(agricultural cooperative), the workers or the customers (retail cooperative). The profits of the co-operative will be shared on an individual basis. Co-operatives are
found across all sectors, but their importance differs from country to country. In Europe co-operatives are popular in the agriculture and retailing. Much of the wine
industry in Europe is organised on a cooperative basis. Almost all of Japanese farmers belong to Nokyo, one of the largest co-operatives in the world
Nowadays, most co-operatives are registered as limited liability companies.
Non-governmental organisations
Non-governmental organisations (NGO’s for short) are organisations that may take part in business activity (as we have described it) but their interests are more
likely to be the development of the community or countries than the pursuit of profit.
NGO’s are non-profit organisations, which are independent from government. In the US they may be more commonly known as PVO’s – private voluntary organisations.
Economies and diseconomies of scale
The level of efficiency of a firm depends on people as well as the equipment used. There is an optimum level of output for a factory where average costs are minimised.
We now will examine how this optimum cost depends on the scale or size of the factory and on its management or rather management style.
Most firms start as small businesses, sometimes owned and operated by a single person. If they are successful they grow. Some firms stay quite small, however, and
others grow and become very large. Some even expand beyond their home country and become multi-national. Why is this so?
Growth brings both advantages and disadvantages to a business. These interact, and depending on the nature of the business and the way it is managed, decide the
optimum or most efficient size for the business.
This is the area of economies and diseconomies of scale.
First, some definitions:
Economies of scale
Those factors which determine that as a business becomes bigger it becomes more efficient – In other words, those factors that cause the average cost of the product or
service (unit cost) produced to fall as the scale of operation increases.
Diseconomies of scale
Those factors which determine that as a business becomes larger it becomes less efficient – in other words, those factors that cause the average cost of the product or
service produced (unit cost) to rise as the scale of operation increases.
Economies and diseconomies of scale are separate and both start to affect the business from the first expansion. The effects of the economies of scale tend to
decrease, however, as the firm grows, but the effects of the diseconomies of scale increase. Look at the three diagrams below that illustrate the two effects and the
overall effect for a company.
The effect of economies of scale on average cost
Observe the effect of diminishing returns. It takes a bigger and bigger increase in size to produce a reasonable reduction in average cost the bigger the unit becomes.
The effect of diseconomies of scale on average cost
Observe the reverse here. For a long time there is no significant increase in costs, and then they shoot away.
The effect of economies and diseconomies of scale on average cost
It looks as if the economies of scale stop at the minimum AC and then the diseconomies of scale set in. You now know that this is not true and is only an optical
illusion. It is all to do with their relative importance at various scales of operation.
Logically, a firm will try to maximise the benefits it gets from economies of scale but minimise the effects of the diseconomies. This is entirely possible, but firms
take different approaches
Now, what are economies and diseconomies of scale?
The first thing to note is:
Economies of scale are factual or scientific (a bit like gravity); they are there to be exploited by firms.
Diseconomies of scale, however, tend to be a matter of trust. They are due to people. They are there to be avoided.
What are the major economies of scale?
• Technical – big pieces of plant, equipment and buildings are cheaper per unit the bigger the item purchased. For example, four times the capacity will only be
about twice the price. Managerial – this includes personnel in general. The larger the business the easier and cheaper it is to employ specialist staff. People can be
better utilised, and will be more productive. A small business may have to use expensive contract staff or consultants. The large multinational employs and fully uses
its own staff.
• Financial – it becomes cheaper to borrow money the bigger and more successful you are (the better your reputation). Interest rates are lower on larger
borrowings.
• Purchasing – It is possible to get greater discounts as more items are purchased (bulk buying) This applies to purchases of raw materials etc. as well as other
business purchases such as advertising space.
• Risk bearing. The bigger and more established a business, the less vulnerable it is to external shocks. A multi-product firm does not have ‘all its eggs in one
basket’.
• Research and development. This is a fixed cost in many ways and can be hugely expensive. The larger the firm, the smaller the cost is as a proportion of total
income. Hence we get a few large pharmaceutical companies with large R&D units. In the aerospace industry, it has got so expensive that only one or two companies in
the world can afford it, and then only with the support of military contracts.
All of these will cause average cost per unit to fall as the scale of operation increases.
What are the major diseconomies of scale?
• Lack of control – as a business grows it can become very complex with many layers of management. Control can be difficult and decision making take a long time.
This will increase cost if nothing is done about it. Its effects can be minimised, however, if authority is devolved down the line and the managers trusted to make
decisions themselves. Directors and senior managers have to trust their juniors to do their jobs. (Link to style of management)
• Poor communication – as a business grows it can become very complex with many layers of management. Communication can become slow and decision making take a
long time. This will increase cost if nothing is done about it. Its effects can be minimised if communication is kept to a minimum and modern communication methods are
used. The managers must be trusted again. (Link to style of management)
• Poor motivation – large organisations can be very demotivating. People can become lost. Management must work on keeping morale and motivation high. Another
clear link with personnel.
• Excessive bureaucracy – there is a strong link here to management style. Some firms, as they grow, set up extremely complicated systems of reporting and record
keeping. Excessive bureaucracy is a sign of lack of trust.
All of these will cause cost per unit to increase as the scale of operation increases.
Economies and diseconomies of scale can be external or internal to the firm itself.
External economies of scale are those that benefit the industry as a whole, especially as the industry grows. An example would be the concentration of industry, and
the availability of specialised training, supply and maintenance services. Look at Sheffield in the UK, the region that specialises in steel production. Here will be
found the entire specialist training and support facilities.
External diseconomies occur when this concentration becomes excessive. Everything is then in short supply.
Internal and external growth
Firms are rather like shellfish; they are constrained by their shells. To go on growing they have to shed the old one and grow a larger, new one. So, many things have
to adapt and change as size grows beyond a certain critical size. For shellfish it is the shell, for a firm it is the way that it is organised. This is why many
companies seem to grow in a cyclic manner
Internal growth
Internal growth, as we have seen, is a firm expanding by using its own resources. This, however, can cause problems within the firm.
When a firm grows its management structure, its decision making process and its reporting systems will have to change. Imagine the situation where a small company, a
sole trader, grows and becomes first a private limited company, then a full plc.
If we add some numbers here it might help to shed light on the problem. This is how a firm might grow in size and structure.
The chain of command has become longer. Decision-making will slow down (who can make decisions anyway?). Much, if not everything will have to change as the firm grows.
The owner, when the business was a sole trader, took all the decisions; there was nobody else. Now, assuming that the old owner is a non-executive director or perhaps
the Chairman, he takes very few decisions at all. Is it still his company, anyway? A sole trader fully owns his/her business. His/her interests are the interests of
the business. Sole traders can do what they like, as long as it is legal.
For private and public limited companies, the owners are the shareholders. The original sole owner now has to consider the interests of the other shareholders.
As a plc, the owners are the shareholders. In theory the directors look after their interests. In reality they can often run the company for themselves, almost
ignoring the shareholders. Much harder if there is a single, major shareholder.) Real conflicts can develop between the owners and the operators of a large company.
The way the firm is run will also change – initially the owner is in full control. The owner is the decision maker and there is little need to consult. The owner will
also multi-task, largely because the firm cannot afford specialists.
Expansion brings with it the employment of managers. This means that authority to make decisions has to be delegated down by the owner. Eventually, as a plc, the
original owner becomes a Director. He has responsibility towards all the shareholders, and has to manage their interests as well as his own. This can be hard.
Excessive control from the top will stifle thinking in the management, and cause dissatisfaction.
Management structures will have to change as a firm grows. Chains of command will lengthen. Reporting and decision-making will slow. Businesses will have to
decentralise, and allow decision making to be taken more remotely. Trust will have to be earned and given. This is the area of diseconomies of scale, and will be a
distinct disadvantage to future growth. Firms will have to cut bureaucracy, and eliminate layers (de-layering) of non-productive staff officers. Old owners,
particularly if they go back to sole trader days, will have to start trusting their staff.
If a firm grows faster than its ability to manage its staff or control its costs, it is said to be ‘overtrading’.
Figure 1 Growth of a firm
Growth is often split into two types – internal and external. These can be defined as follows:
Internal growth
Internal growth is where a firm gets larger from expanding by using its own resources. This is often known as organic growth. Growth comes from increased sales and
higher profits, which are then reinvested in the business.
External growth
External growth is when a firm grows by taking over or merging with another firm (integration). This is often known as inorganic growth
Problems of transition in size
Problems of direction, management and control will occur when firms expand and grow. Problems will occur on changes from sole trader to limited company, from limited
company to plc, from national to international company. It will also face problems when growth stops and it starts to shrink again.
Growth
Legal actions have to be taken when the legal structure of a firm changes. These may be expensive. It may also be hard to change the legal structure unless conditions
are right. It may not be possible to sell shares in a company unless:
• The financial history of the firm is good
• Its prospects for the future are good
• The overall market conditions are good.
It was difficult to float firms in the first three months of 2003. What chance of an airline going public just after ‘September 11th ‘?
Going international can cause real problems, examples of which are:
• Adjustment to new laws.
• Having to deal with foreign languages (the old Commonwealth gave UK firms going international a real advantage).
• Having to deal with different cultures.
• Long chains of command and communications.
Reductions in size
So far we have concentrated on growth. Many firms expand and shrink on a cyclical basis. Shrinkage can cause real problems as well, examples of which are:
• Reductions in staff and workers level. Trade unions will have to be dealt with. Redundancies will have to be organised. Will these be voluntary or compulsory?
How will you keep the people you want, and lose only the unwanted?
• Loss of morale amongst the staff.
• Loss of motivation amongst the staff.
• Cost of redundancies, which will delay any cost savings for some time (costs may even rise for a few months
Joint ventures and strategic alliances
One method of external growth that a firm could adopt is to enter into a joint venture or strategic alliance. There is a difference between these two methods, but they
do represent a similar method of external growth. Let’s start with definitions.
Joint venture
An agreement between two or more organisations to undertake a particular business activity – there will be a contractual agreement between the organisations and the
joint venture becomes a separate legal entity. All organisations share in the profits or losses of the enterprise and will share the investment.
Strategic alliance
A strategic alliance is a collaborative agreement between two or more firms to pursue a set of agreed goals, but the firms remain completely independent organisations.
Hopefully these definitions make the differences clear. A joint venture means setting up a separate organisation that all the ‘partners’ have a stake in. They will
then share the profits (or losses if there are any) according to the ownership of the joint venture. A strategic alliance, however, may simply be a looser form of
agreement between two organisations for a specific purpose, e.g. the firms may get together to combine buying power and negotiate better terms, but still remain
separate organisations.
Joint ventures or strategic alliance have a number of possible advantages and disadvantages.
Advantages
• They may represent a good way for firms to partner each other and combine skills, but without a full merger being necessary. This may help lower costs and
result in less regulation.
• They allow companies to grow but maintain their own identity and brands
• Competition may be reduced – by working in cooperation with another firm, it may be possible to reduce the level of competition
• Joint ventures or strategic alliances may be a good way to enter a new market. By partnering with a local firm, there may be fewer logistical problems and it
may be possible to take advantage of the local knowledge and distribution channels of the partner firm. This may lower distribution costs and may also reduce any
problems due to language or cultural issues.
• Mergers or takeovers are expensive and difficult to reverse. A joint venture or strategic alliance allows firms to work together without being burdened by
these costs or the permanency of the arrangement.
• A joint venture or strategic alliance may be more flexible and enable to firm to move into a new product or market much faster than is otherwise the case
• Avoidance of taxation, or at least rates on tax in the country of production
Disadvantages
• Profits are shared – this may be regretted by the firm if subsequently they feel they could have carried out the activity quite easily themselves.
• Communication and control issues – there may be some issues with control in a joint venture – who has the final say if there are disputes for example? There
may also be communication issues if the firms are very different in their approach.
• Conflict – there may be disagreements between the partner organisations and if this may be a problem if there is not a proper conflict resolution procedure.
Conflict may also be caused by cultural difference.
Mergers and takeovers
The growth of firms may lead to changes in their ownership. Buying another firm may be a way of getting hold of technology or a product. It might save time. It might
even save money. Other growing firms may become very vulnerable to such activities.
We all have heard of mergers, takeovers and other changes. We will now look at these in the context of an example firm – Student Computers plc. This company
manufactures computers that it sells to retailers. It buys in most of its components. How might it grow?
1. It could arrange a merger or a takeover.
Merger
Two firms agree to become one. They agree to merge. They become partners. This will not stay for long and one partner will start to dominate. Staff will have to be
made redundant, as two parallel staffs are not required. The new business starts to look for economies. At Board level, there is no room for two Chairmen, two Chief
Executive Offices. Which of the directors leave the organisation will indicate which of the firms is become dominant.
Takeover
A takeover is when one firm buys another, with or without its approval. One firm is dominant and becomes the owner. It is the taken-over firm that will face the brunt
of the redundancies.
Takeovers and mergers could be horizontal or vertical.
Horizontal merger
A horizontal merger is when two companies in the same industry and at the same stage in the chain of production merge. An example is a merger between two breweries. It
is also known as horizontal integration.
Vertical merger
A vertical merger (integration) is where firms at different stages of the production chain merge together. It may be either vertical forward integration where a firm
merges with another further up the chain (e.g. a brewery taking over a chain of pubs) or vertical backward integration where a firm merges with one further down the
production chain (e.g. a brewery taking over a hop farm).
If a firm controls the whole distribution channel it is totally vertically integrated e.g. Shell owns oil-rigs, oil tankers and pipes, refineries and petrol stations.
Firstly, a reminder of the organisation of business – firms operate in the:
• Primary sector – farming, mining, basic power supplies etc.
• Secondary sector – manufacturing.
• Tertiary sector – services (shops, banks etc.)
• Quaternary sector – high technology businesses
Horizontal mergers or takeovers occur when two firms come together at the same level. Student Computers plc would join with another computer manufacturer.
Vertical mergers or takeovers occur when firms in different sectors come together. Student Computers plc may take-over a retailer (forward vertical merger) or it might
buy a producer of silicon wafers, or paper pulp (backward vertical merger).
Figure 1 below summarises these possible types of integration.
Figure 1 Different types of integration
2. It might aim to become a conglomerate.
This means that the firm, for example Student Computers plc, would expand into all sorts of activity – property management, mining, selling of CD’s. The only
requirement is that they can make money out of it.
Most conglomerates are multinationals, operating in more than one country.
3. In certain circumstances, there may be a management buy-out.
This is when the management of a firm, usually with the help of a venture capitalist, offer to buy the company. This rarely occurs when a firm is doing really well,
more often when it is in trouble, or is facing a take-over from other companies.
4. They may buy a brand from another firm
The process of buying a brand from another firm is known as brand acquisition. It is not a full merger – that means the purchase of the whole company, but is simply
the takeover of one of the firm’s brands. Firms may often sell brands if they feel they do not tie in with their core business.
Risks and rewards
The opportunities from takeovers and mergers are obvious – increased market share, access to new markets, access to private R&D, less competition – but they can be
obvious to the competition as well. If you are a plc you are vulnerable. You can be taken-over, even if you do not want it. All that is needed is that 50% of your
shares plus one more is bought by the new potential owner.
The rewards can be summarised as:
• Faster growth
• New products
• Access to R&D
• New key personnel
• Access to new markets
• Greater market share
Firms looking for suitable merger partners or acquisitions often seek economies of scale and synergies. Synergies refer to a fit of complementary activities; rather
like pieces of a jigsaw. A synergy is like saying ‘1 + 1 = 3’; the whole is greater than the value of the two independent parts.
Problem may arise with takeovers and mergers. Mergers are dangerous; one side will want to dominate. It might mean you lose control at the critical moment. You may
also pay too much and this may cause financial problems in the future (perhaps from having had to borrow too much and therefore having become too highly geared).
Valuation of another firm can be difficult from the outside.
Porter’s generic strategies
For an organisation to obtain a sustainable competitive advantage, Michael Porter suggested that they should follow either one of three generic strategies.
These ideas were developed by Michael Porter in 1980 in his book Competitive Strategy: Techniques for Analysing Industries and Competitors. He argued that the
strengths of a firm basically fall into one of two categories:
1. Cost advantage or
2. Differentiation
He then looked at applying these strengths in either a broad scope (looking at the whole market) or a narrow scope (looking at a particular segment of the market). As
a result of this approach, he came up with three ‘generic strategies’. They are called generic strategies because they are not firm or industry dependent. Figure 1
below illustrates these different strategies.
Porter’s generic strategies
Let’s look at each of these strategies in turn:
Cost leadership strategy
If a firm wants to adopt this strategy then it needs to be a low cost producer in its particular industry. It then has the choice of selling at the average industry
price and earning above average profits or cutting prices below competitors and earning slightly lower profits, but with the aim of increasing market share.
A firm may become a cost leader through economies of scale, outsourcing, and reducing costs more than competitors or just general productivity improvements.
Differentiation strategy
A differentiation strategy requires the firm to develop a product or service that is unique or differentiated in some way from the rest of the products or services on
the market. The product is likely to have a unique selling point and given the uniqueness of the product, the firm may be able to charge a premium price for it. This
premium price will hopefully cover the extra costs that are likely to be associated with developing a unique product. These may include higher than usual R&D costs for
example.
Focus strategy
There are two possibilities for the focus strategy, but the main characteristic of this approach is that the firm is ‘focusing’ just on a small segment of the market.
The idea is that the firm will produce a more specialist product that caters more precisely for the needs of this narrow market segment. Firms in this position may
well enjoy high customer loyalty as they are fulfilling the needs of their target market more closely than other firms. The focus may either be in terms of lower cost
or differentiation. Firms pursuing this type of strategy are likely to sell lower volumes of their products and therefore have less bargaining power with suppliers.
Overall these strategies can be a useful framework for a firm to judge their strategic approach to growth.
Franchises
A franchise may be set up as a sole trader, partnership or company. Examples are McDonalds and Body Shop.
A franchise is an agreement between two parties; the Franchisor and the Franchisee. The franchisee is allowed to use the brand name, logo, trademark and
products/services of the Franchisor in return for:
1. An up-front, one-off payment called a ROYALTY to be allowed to use the brand name
2. An annual share of the profits
There are clear ADVANTAGES to setting up a new business as a Franchisee:
• You don’t have to come up with a new idea – someone else has had it and tested it, too! Consequently failure rates are far lower than other start ups, often
around one in ten.
• Larger, well-established franchise operations will often have national advertising campaigns and a solid trading name
• Good franchisors will offer comprehensive training programmes in sales and indeed all business skills.
• Good franchisors can also help secure funding for your investment as well as e.g. discounted bulk-buy supplies for outlets when you are in operation
• If aware that you are running a franchise, customers will also understand that you will be offering the best possible value for money and service – although
you run your ‘own show’, you are part of a much larger organisation.
There also many ADVANTAGES for the Franchisor:
• -The business can achieve rapid growth without high capital investment and running costs.
• Franchisees are likely to be more motivated and committed than paid managers as increasing profits is a major incentive.
However, there are RISKS or DISADVANTAGES associated with franchising for both the franchisor and franchisee:
Franchisee:
• Costs may be higher than you expect. As well as the initial costs of buying the franchise, you pay continuing royalties and you may have to agree to buy
products from the franchisor.
• The franchise agreement usually includes restrictions on how you run the business. You might not be able to make changes to suit your local market.
• The franchisor might go out of business, or change the way they do things.
• Other franchisees could give the brand a bad reputation.
• You may find it difficult to sell your franchise – you can only sell it to someone approved by the franchisor.
• Reduced risk means you might not generate large profits.
Franchisor:
For the franchisor, there is a risk that a poor or unscrupulous franchisee may affect the brand image of the entire business. It is not unknown for franchisees to
‘steal’ an idea and then set up in opposition. Franchisors attempt to prevent this by restrictions in the franchise contract, but it may be very difficult and costly
to enforce.
Franchising is a major growth area in many countries.
Ansoff matrix
This is another useful tool for a business when it is analysing its growth potential and setting its marketing objectives. It illustrates BOTH existing and new
products within BOTH existing and new markets. Within it is shows the only FOUR possible marketing strategies. These are:
• Market penetration – this is the when a business wants to achieve growth in existing markets with existing products. This normally involves (a) increasing
brand loyalty of customers so as they use substitute brands less frequently (b) encouraging consumers to use the product more regularly and (c) encouraging customers
to use more of the product.
• Product development – this is when a company markets new or modified products in an existing market or markets.
• Market development – this involves marketing of existing products in a new market.
• Diversification – This is when new products are developed for new markets. This is the most risky of any growth strategy as the firm lacks core competence and
market knowledge.
The diagram below summarises these options.
Some questions
1. Which industries add the most value to your economy and why?
2. What are your main exports and imports?
3. Explain why a recent merger or take-over in country took place.
4. How is the ‘power’ of business regulated in your economy?
5. Analyse the advantages to your economy of a joint venture or the creation of a strategic alliance
PLACE THIS ORDER OR A SIMILAR ORDER WITH US TODAY AND GET AN AMAZING DISCOUNT 🙂
