Growth And Survival of Firms (Copy)
7.7.1 Reasons for Different Sizes of Firms
- Market Size:
- Larger markets support larger firms due to higher demand.
- Access to Capital:
- Larger firms have easier access to finance for expansion.
- Economies of Scale:
- Firms grow to reduce average costs via internal economies of scale.
- Management Efficiency:
- Small firms might remain due to effective close control; large firms due to managerial expertise.
- Regulatory Environment:
- Laws and policies may limit or encourage firm size.
- Technology and Industry Type:
- Some industries require large capital investment (e.g., manufacturing); others allow small scale.
- Barriers to Entry:
- High barriers prevent small firms from entering, leading to fewer large firms.
7.7.2 Internal Growth of Firms: Organic Growth and Diversification
- Organic Growth (Internal Growth):
- Expansion through increased output, sales, or market share using own resources.
- Methods include: increasing production capacity, marketing, developing new products.
- Diversification:
- Expanding product range or entering new markets to reduce risk.
- Can be related (similar products/markets) or unrelated diversification.
7.7.3 External Growth of Firms – Integration (Mergers and Takeovers)
- Methods of Integration:
- Horizontal Integration:
- Merger/takeover between firms in the same industry and stage of production.
- Example: Two car manufacturers merging.
- Vertical Integration:
- Merger/takeover between firms at different stages of production.
- Backward Vertical Integration: Firm acquires a supplier.
- Forward Vertical Integration: Firm acquires a distributor or retailer.
- Conglomerate Integration:
- Merger between firms in unrelated industries.
- Horizontal Integration:
- Reasons for Integration:
- Increase market share and reduce competition.
- Gain control over supply chain.
- Achieve economies of scale.
- Diversify risk.
- Access new technology or markets.
- Consequences of Integration:
- Increased market power.
- Potential for higher profits.
- Risk of inefficiency or monopoly power.
- Job losses due to restructuring.
- Greater financial and managerial resources.
7.7.4 Cartels
- Conditions for an Effective Cartel:
- Few firms dominate market.
- Products are similar or homogeneous.
- Firms agree on output quotas and prices.
- Ability to monitor and punish cheating members.
- Barriers to entry to prevent new competition.
- Consequences of a Cartel:
- Higher prices for consumers.
- Reduced output and consumer choice.
- Increased profits for cartel members.
- Potential legal penalties if cartel is illegal.
7.7.5 Principal–Agent Problem
- Definition:
- Conflict of interest when the owners (principals) of a firm (shareholders) delegate decision-making to managers (agents).
- Causes:
- Managers may pursue personal goals (e.g., job security, perks) rather than profit maximisation.
- Asymmetric information: managers have more info about operations than owners.
- Solutions:
- Performance-related pay and bonuses.
- Share ownership schemes for managers.
- Monitoring and corporate governance.
Diagrams
Diagram 1: Types of Integration
Stages of Production →
Suppliers → Manufacturer → Distributor → Retailer
- Horizontal Integration: Between manufacturers (same stage)
- Backward Vertical Integration: Manufacturer acquires supplier
- Forward Vertical Integration: Manufacturer acquires distributor/retailer
- Conglomerate Integration: Unrelated industries merging
Diagram 2: Cartel Behaviour
Price
↑
|--------- Cartel Price (Higher)
| _______________
| /
| / Market Price (Lower)
|_______/____________________→ Quantity
- Cartel restricts output to raise prices above competitive levels.
Diagram 3: Principal-Agent Problem
Owners (Principals) Managers (Agents)
------------------ -----------------
| Want profit | <----------> | May want perks |
| Want growth | | Want job security|
| Control costs| | Less risky projects|
- Information asymmetry causes conflict.
- Monitoring aligns interests.