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6. The Growth of Firms
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Methods of Comparing Size of Firms
Motives for Growth
Methods of Growth
Optimum Size of Firms
Existence of Small Firms
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6 The Growth of Firms
Flow Measures
� Quantity of Output (theoretical)
� Sales Turnover(‘Total Revenue’)
Stock Measures
� Capital Stock
� Number of Employees
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6.1 Measurement of Size of Firms
Other Measures
� Concentration Ratio
Comparing SingTel and StarHub
Measure
Sales Turnover 16.8 billion (SGD) 2.15 billion (SGD)
Concentration Ratio(mobile phone market only)
0.457 0.30
Capital Stock* 37.9 billion (SGD) 1.73 billion (SGD)
Number of employees 4000 2702
2010 figures*Estimated
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Comparing Apple and Microsoft
Measure
Sales Turnover 65.2 billion (USD) 62.5 billion (USD)
Capital Stock* 75.2 billion (USD) 86.1 billion (USD)
Number of employees 49,400 89,000
2010 figures*Estimated
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Motives for growth
Exploit economies of scale
more fully(reduce cost)
Market domination
(increase price)
Reduce risk
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6.2 Motives for growth
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Exploit (Internal) Economies of
Scale� Assume flour is the only ingredient in bread
and no fixed cost
� 80 � 10 � $3x10=$30 � ATC = $0.375
�
� 8000 �1000�$2x1000=$2000�ATC=$0.25
� [bulk-buying]
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Market Dominance
� Increase market share
� Increase market power
� Increase price
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Reduce Risk
� Diversification reduces market risk
� Market risk includes risk of market demand falling
� Increased market valuation reduce risk of take-over
� Market Valuation = Share Price x No. of shares
� Take-over = Change of ownership where another firm buys up the target firm’s shares and becomes the majority shareholder
� High share price = High market valuation = More difficult to be taken over
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Methods of growth
Internal Growth External Growth
Merger
1. Horizontal integration2. Vertical integration
- Forward
- Backward3. Conglomeration
Take-over/ Acquisition
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6.2
Internal Growth
� Build up productive capacity
� Build a bigger plant (or more plants)
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External GrowthTake-over/ Acquisition
� One firm buying another firm
Merger
� Two firms forming one entity
“Formed in 2000, when Chase Manhattan Corporation merged with J.P. Morgan & Co.”
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3
External Growth: M&A
Vertical IntegrationBackward
� Firms extend into previous stage of production
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VIMALA RELIANCE PRODUCT
External Growth: M&A
Vertical IntegrationForward
� Firms moves into succeeding stage of production
=news ‘producer’
=news distributor
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External Growth: M&A
Horizontal Integration� Firm takes
over/merges with another firm at the same stage of production
� E.g.Daimler-Benz + Chrysler = DaimlerChrysler [1998]
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External Growth: M&A
Conglomeration� Neither vertical nor
horizontal
� Combination of firms not directly related
� E.g.Google bought over YouTube (2006)
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� It all depends on the amount of IEOS available relative to market demand
6.4 The Optimum Size of the Firm
10.18
The minimum efficient scale and market
demand� The minimum efficient scale (mes) is the output at
which a firm’s long-run average cost curve stops falling.
� The size of the mes relative to market demand has a strong influence on market structure
DLAC1
LAC2
LAC3
Output
£
4
10.19
The minimum efficient scale and market
demand� The minimum efficient scale (mes) is the output at
which a firm’s long-run average cost curve stops falling.
� The size of the mes relative to market demand has a strong influence on market structure
DLAC1
LAC2
LAC3
Output
£
q2 q3 Q1q1
P1=C1
Q2
10.20
The minimum efficient scale and market
demand� If market demand is Q1 = 1000
� The firm’s LRAC is LAC1 and its MES is q1=10,
� Then there will be 100 firms in the industry that achieves MES???
� Many firms relative to market demand
DLAC1
LAC2
LAC3
Output
£
Q1=1000q1=10
P1=C1
10.21
The minimum efficient scale and market
demand� If market demand is Q2 = 700
� The firm’s LRAC is LAC3 and its MES is q3=800,
� Then the industry can support 1 firm ??
DLAC1
LAC2
LAC3
Output
£
q3=800Q2=700
10.22
The minimum efficient scale and market
demand
DLAC1
LAC2
LAC3
Output
£
Q2=350 Q2=700
� If market demand is Q2 = 700
� The firm’s LRAC is LAC2 and its MES is q2=350,
� Then the industry will achieve 2 firms MES???
� A few large firms relative to industry’s demand
10.23
The minimum efficient scale and market
demand� The minimum efficient scale (mes) is the output at
which a firm’s long-run average cost curve stops falling.
� The size of the mes relative to market demand has a strong influence on market structure
DLAC1
LAC2
LAC3
Output
£
q2 q3 Q1q1
P1=C1
Q2
10.24
The minimum efficient scale and market
demand� The minimum efficient scale (mes) is the output at
which a firm’s long-run average cost curve stops falling.
� The size of the mes relative to market demand has a strong influence on market structure
DLAC1
LAC2
LAC3
Output
£
q2 q3 Q1q1
P1=C1
Q2
5
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6.5 Existence of Small Firms
Demand Side
Supply Side
Factors
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Supply side factors
1) Internal diseconomies of scale
D
LAC
Output
£
Q
E.g. Hair dressing, dental clinic
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Supply side factors
2) Banding
• Group of firms band together to gain the advantages of bulk buying
• Examples: Market cooperatives such as iEcon
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Supply side factors
3) Vertical disintegration
• Small firms emerge when an entire production process is broken into a series of separate processes• Examples: Hollywood firms
• Studios used to handle everything from production to theatrical presentation• Now, with lighting companies, post-production companies, props and editing industries, etc.
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Supply side factors
4) Low barriers to entry Costs ($)
Quantity0
LRAC1
Examples: Foot wear, accessories stores
LRAC2
Q1 Q2Q3
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Supply side factors
5) Managerial Attitudes
• Risk-averse• Desire to keep firms under family control• Example:
• Lim Chee Guan prior to 2009
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Demand side factors
1) Nature of the product
• BULKY, eg. Bricks & fresh fish
• Perishable eg. Grocery/fruit stalls
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Demand side factors
1) Nature of the product
• Demand for Variety, e.g. Rolex watches, Mont Blanc Pen
• Personalised services, e.g. custom-made to order furniture/clothes• Specialised products, e.g. lab equipment• Prestige markets, e.g. Vertu,
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Demand side factors2) Niche markets
• A subset of the market which a firm carves out for itself• Examples:
• Educational travel industry/eco-tourism• Organic food products• Gaming mouse
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Demand side factors
3) Geographical limitations
• Bulky products where transport costs will be high relative to total production costs.• Examples:
• Supermarkets operating in Russia• Not feasible for them to cater to the whole market due to poor transport infrastructure
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6.5 Existence of Small Firms
Demand SideSupply Side1. Nature of the product
• Bulky, perishable
• Demand for variety
• Personal services
• Specialised products
• Prestige markets
2. Niche markets
3. Geographical limitations
1. Internal economies of scale limited relative to market demand
2. Banding
3. Vertical disintegration
4. Barriers to entry low
5. Managerial attitudes
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Raffles Institution
� How do small firms survive?
� Why do small firms exist?
� Why do firms choose to remain small?
� What are the factors that encourage the existence of small firms?
� Why do firms merge?
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Food for thought:
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