Growth (Edexcel A Level Business)

• Many firms start small & will grow into large companies or even multi-national corporations (Amazon started in a garage)
   

Reasons why Businesses grow

Owners/Shareholders/Managers desire to run a large business & continually seek to grow it	Owners/shareholders desire higher levels of market share and profitability	The desire for stronger market power (monopoly) over its customers and suppliers
Desire to reduce costs by benefitting from economies of scale	Growth provides opportunities for product diversification	Larger firms often have easier access to finance

• As a business grows, it can increase its scale of output generating efficiencies that lower its average costs (cost per unit) of production
  • These efficiencies are called economies of scale
  • Economies of scale help large firms to lower their costs of production beyond what small firms can achieve
     
• As a firm continues increasing its scale of output, it will reach a point where its average costs (AC) will start to increase
  • The reasons for the increase in the average costs are called diseconomies of scale
      
• Internal economies of scale occur as a result of the growth in the scale of production within the firm

Economies of scale occur when average costs decrease with increasing output & diseconomies of scale occur when average costs increase with increasing output

  

Diagram Analysis

• With relatively low levels of output, the businesses average costs are high
• As the business increases its output, it begins to benefit from economies of scale which lower the average cost per unit
• At some level of output, a business will not be able to reduce costs any further - this point is called productive efficiency
• Beyond this level of output, the average cost will begin to rise as a result of diseconomies of scale
  

• Internal economies of scale occur as a result of the growth in the scale of production within the business
  • The firm can benefit from lower average costs (AC) generated by factors from inside the business
     
• External economies of scale occur when there is an increase in the size of the industry in which the firm operates
  • The firm can benefit from lower average costs (AC) generated by factors outside of the business

 

Types of Internal Economies of Scale

Type	Explanation
Financial economies	Large firms often receive lower interest rates on loans than smaller firms as they are perceived as less risky A cheaper loan lowers the cost per unit (average cost)
Managerial economies	Occurs when large firms can employ specialist managers who are more efficient at certain tasks and this efficiency lowers the average cost (AC) Managers in small firms often have to fulfil multiple roles and are less specialised
Marketing economies	Large firms spread the cost of advertising over a large number of sales and this reduces the AC They can also reuse marketing materials in different geographic regions which further lowers the AC
Purchasing economies	Occur when large firms buy raw materials in greater volumes and receive a bulk purchase discount which lowers the AC
Technical economies	Occur as a firm can use its machinery at a higher level of capacity due to the increased output thereby spreading the cost of the machinery over more units & lowering the AC
Risk bearing economies	Occur when a firm can spread the risk of failure by increasing its numbers of products i.e greater product diversification - less failure lowers AC

 

Sources of External Economies of Scale

Source	Explanation
Geographic Cluster	As an industry grows, ancillary firms move closer to major manufacturers to cut costs & generate more business This lowers the AC e.g. car manufacturers in Sunderland rely on the service of over 2,500 ancillary firms
Transport Links	Improved transport links develop around growing industries to help get people to work & to improve the transport logistics This lowers the AC e.g. Bangalore is known as India's Silicon Valley & transportation projects have been successful in transforming the movement of people & goods
Skilled Labour	An increase in skilled labour can lower the cost of skilled labour, thereby lowering the AC The larger the geographic cluster, the larger the pool of skilled labour
Favourable Legislation	This often generates significant reductions in AC as governments support certain industries to achieve their wider objectives

• Rapid business growth may create challenges that can negatively impact a company's operations and financial performance
• Three of these challenges are diseconomies of scale, internal communication issues, and overtrading
   

1. Diseconomies of scale
   Occurs when a company grows too large, making it difficult to manage and control its operations. E.g It may face challenges in coordinating its various departments, managing its workforce, or maintaining quality control. The cost per unit ends up increasing as a result of these inefficiencies
   
   

2. Internal communication
   Rapid growth may strain communication channels or result in miscommunication, conflicting priorities and lack of coordination. This may result in delays, errors, missed opportunities and impact on employee morale
   
   

3. Overtrading
   Occurs when a company takes on more business than it can handle, leading to a strain on its resources or an inability to meet its financial obligations (lack of liquidity). This may cause cash flow problems or decreased customer satisfaction. E.g A company that expands too quickly may struggle to hire and train enough staff to handle increased demand, leading to a backlog of orders and dissatisfied customers