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Size of business
Activity 3.1 (page 44): Problem of dening size
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Which business is largest, using the following measures of size:

employees capital employed sales turnover selling space number of outlets? [5]
Measure employees capital employed sales turnover selling space number of outlets Largest business Z Y X Y Z

What do your results tell you about your attempt to measure business size? [5] Business size is not easy to measure objectively. Many factors contribute to an assessment of size when comparing one firm with another, such as their degrees of capital intensity and the markets within which they operate.

Explain which would be the preferred measure of size in the following circumstances:

the government wishes to identify the supermarket with the greatest degree of monopoly power a bank wishes to lend money to the business with the largest capital base a shareholder wishes to invest in the business with the greatest sales potential. [9]

There is no definitive answer to this question; the examiner would be looking for the quality of the candidates justification in choosing between different measures.

the government wishes to identify the supermarket with the greatest degree of monopoly power

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The government might focus on sales turnover in assessing monopoly power. Competition legislation usually defines monopoly in terms of market share; this is best measured by turnover.

a bank wishes to lend money to the business with the largest capital base Capital employed gives an indication of the capital base of a business. Capital employed measures the total value of all the long-term finance invested in the business.

a shareholder wishes to invest in the business with the greatest sales potential. Selling space will be particularly relevant in determining sales potential as this determines the amount of stock that can be displayed for customer purchase and the number of different product lines that can be sold.

What can you conclude about the levels of efficiency of these four businesses? [6] Calculation of various measures of efficiency is necessary to answer this question. These are summarised in the table below:
Sales per unit of capital employed () 1.67 2.4 1.43 1 Sales per square metre of selling space () 4,545 4,000 2,500 2,667

Supermarket W X Y Z

Sales per employee (m) 0.83 1.5 0.83 0.27

Sales per outlet (m) 16.67 60 28.57 10

Efficiency relates to the ability to turn inputs into outputs. Supermarket X appears to be more efficient, based on a number of different measures. The sales turnover it generates per unit of capital is greater than the other three supermarkets. This is also reflected in its ability to generate sales from the available selling space; supermarket X achieves 4,000 per square metre compared to 2,500 for Y and 2,667 for Z. Even though supermarket W, which is the smallest supermarket on all measures, generates the highest level of sales per square metre of selling space, it is much less efficient in terms of sales per employee and sales per unit of capital employed.

Activity 3.2 research activity. Activity 3.3 answer provided on Students CD-ROM.

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A Activity 3.4 (page 50): Jet Airways takes over Air Sahara and Daimler sells Chrysler after failed merger
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How would you classify the type of integration used in both of these case studies? Explain your answer. [4] Both of these case studies relate to horizontal integration. A horizontal merger occurs when two firms in the same industry at the same stage of production come together. Jet Airways and Air Sahara are both airlines. Daimler and Chrysler are both car manufacturers.

If Jet Airways were now to merge with an aircraft manufacturer:

how would this merger be classified? Explain your answer [3] Merging with an aircraft manufacturer would be an example of vertical integration as it would involve two firms in the same industry but at different stages of production merging.

analyse two potential benefits to Jet Airways of this merger. [6] Two potential benefits would be: It would give Jet Airways control over the quality and price of aircraft as well as ensuring an adequate supply of aircraft to meet its needs. Jet Airways would be able to absorb the profit margin of the aircraft manufacturer and this would help make the airline more price competitive in the market. Jet Airways would be able to control supply of aircraft to other airlines. Thus, it would gain competitive advantage by ensuring that new aircraft from the manufacturer are not sold to competitors ahead of Jet Airways.

Assess the likely impact of the Jet Airways takeover of Air Sahara on any two stakeholder groups. [12]
Stakeholder Employees Impact of Jet Airways takeover of Air Sahara

A motivation for the takeover is to streamline the two head offices.

This will mean that some employees will be made redundant.

The combined airline may decide to cut flights where there is a

duplication of services. This could also result in redundancy.

Employees may have better job security as Jet Airways now faces less
competition and is, therefore, in a more secure trading position.

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Stakeholder Customers

Impact of Jet Airways takeover of Air Sahara

Better customer service as the inter-linking of . . . air routes

should allow more passengers to be offered connecting flights.

Customers may also benefit from reduced air fares due to

economies of scale for Jet Airways leading to a reduction in costs. If some of the anticipated savings are passed on to the customer, then there will be lower prices. As Jet Airways now has a market share of about 32%, this will give it a degree of monopoly power. This could be used to increase prices to the customer on routes where previously the two airlines were competitors. profits should increase, leading to greater potential dividends for the shareholders and an increase in the share price of Jet Airways. The merger offers potential savings to Jet Airways, e.g. streamlining the two head offices and better deals from aircraft manufacturers. These cost savings can lead to higher profit margins for the business. power. This will put pressure on suppliers to offer better prices, thus reducing profit margins. Suppliers of Jet Airways may benefit if they win contracts to supply the Air Sahara part of the business.

Shareholders

If there is synergy between the two businesses, then the level of

Suppliers

Suppliers will face an organisation that has enhanced its market

Using the DaimlerChrysler case study and any other researched examples, discuss why many mergers and takeovers fail to give shareholders the benefits originally predicted. [10] Potential factors leading to disappointing outcomes following mergers include: Diseconomies of scale mergers may create organisations that are too large and are, therefore, difficult to control. Culture clashes management teams may find it difficult to work together. External factors, such as a downturn in the economy macro-economic conditions can change, e.g. Alcatel-Lucent suffered from difficult economic conditions, forcing price reductions that swallowed up the cost savings anticipated from the merger. Resistance to change it is often suggested that it is human nature to oppose change. Any significant change in business is likely to have a significant impact on employees. Mergers often seek to benefit from rationalisation of operations; employees are likely to oppose job losses. The disruption of rationalisation may well contribute to disappointing outcomes from the merger.

Further reading
Culture clash: the risks of mergers, BBC Online, 17 January 2000, http://news.bbc.co.uk/1/hi/business/607338.stm Merger woes plague Alcatel-Lucent, BBC Online, 8 February 2007, http://news.bbc.co.uk/1/hi/business/7234245.stm It takes a whole lot to sing a perfect chorus, Times of India, 1 February 2007, http://timesofindia.indiatimes.com/It_takes_a_whole_lot_to_sing_a_perfect_chorus/ articleshow/1548108.cms

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Revision case study 1 (page 53): Small restaurant business expands rapidly
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State two aspects of Chai Weis business that seem to be covered by government controls. [2] Aspects covered by government controls include: location decisions cheap loans to businesses setting up in areas of high unemployment payment of workers national minimum wage consumer protection Food Safety Department inspection.

Do you think the government should control the activities of businesses such as Chai Weis? Explain your reasons. [6] This is a matter of personal opinion, but you still need to support your point of view with a reasoned business argument. For: Businesses do not operate in a moral vacuum. They are part of society and should, therefore, take responsibility for their actions and consider a range of stakeholders when making decisions. Government interference is necessary to prevent rogue businesses neglecting their duties to society. For example, Chai Wei minimises costs by paying low wages, taking advantage of the relatively weak bargaining position of employees. He is also prepared to put customers at risk through unsatisfactory food safety in his restaurants. Without government controls, there may be a race to the bottom where businesses are forced to adopt ever-lower standards in order to remain price competitive. Against: Businesses exist primarily to make profit and should be able to act freely in pursuit of profit. Employees who are paid low wages could seek employment elsewhere; they are not forced by Chai Wei to accept a job. Where standards in business are unsatisfactory, e.g. Chai Weis poor food safety, customers will ultimately take their custom elsewhere. Government controls may restrict business activity and add to costs. This will increase prices to consumers and threaten job opportunities.

Analyse reasons why the government seems to be keen to encourage small firms such as this one. [6]

Create employment small businesses are significant employers in the economy. By creating employment, they are reducing the burden of unemployment on the state and the taxpayer. Dynamic impact of small businesses on the economy small businesses are often owned and managed by ambitious individuals such as Chai Wei. As they enjoy the rewards of business success, they have a clear incentive to work hard to grow their business. There is no divorce between ownership and control.

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Small businesses create competition and offer alternatives to large businesses. They often provide a more personalised service for customers than large businesses. A business such as Chai Weis may be more responsive to customer needs than a large multinational, such as McDonalds.

What other measures might the Trade Department have used to assess the size of Chai Weis business other than number of employees? [4]

sales turnover profit capital employed added value

Do you think Chai Wei deserves government support for his business? Explain your answer. [7] Yes

Creates employment the business operates in areas of high unemployment where there may be few job opportunities. Such areas may struggle to attract other businesses due to low incomes. Aids economic growth output of the restaurant is a direct addition to GDP of the economy. The restaurant benefits other businesses by providing demand for supplies, e.g. food. Thus, the business has a beneficial impact on economic growth. Generates tax revenue for the government the business will pay corporation tax and/or the owner will pay income tax. The more successful the business is, the greater will be the tax revenue for the government.

No

Exploits workers by paying less than minimum wage as the business is operating outside the law, it should not be supported as this will give it a further competitive edge against other businesses that abide by the laws. Exploits consumers by storing food incorrectly the government has a duty to ensure that taxpayers money is spent effectively. Subsidising this restaurant is not acceptable as it does not consider its duty of care to the consumer.

Evaluation may consider: Although the business makes a valuable contribution to the economy, its lack of corporate social values might be considered to be more important.

A Revision case study 2 (page 54): Growth strategy in dispute at Trafc Clothing plc
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What is the difference between internal and external growth? [4] Internal growth, or organic growth, is the expansion of a business through opening new branches, shops or factories. External growth is business expansion through merging with or taking over another business.

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Explain how the business increased sales revenue, yet gained no increase in profits for the last three years. [6] A number of factors have clearly squeezed the profit margins of Traffic Clothing: Prices have fallen within the market due to new competitors entering the market. Lower prices have reduced the profit margin that Traffic Clothing can achieve. Thus, a higher volume of sales is required to keep profit the same. Raw material prices have also risen. This will reduce the gross profit margin of the company. Retail mergers have increased the bargaining power of Traffic Clothings customers. Thus, the retailers can effectively force Traffic to accept lower prices.

Analyse the likely advantages and disadvantages of vertical integration for this business. [10] Vertical integration for Traffic Clothing may either be forwards with retailers or backwards with suppliers. The type of integration will affect the outcome for Traffic Clothing.
Advantages Forward vertical integration Traffic Clothing may gain control over the marketing of its products to the retailer It can thus determine the way. products are displayed and promoted, as well as the standard of customer service offered. Traffic Clothing will be able to ensure that distribution outlets for its products are available. Traffic Clothing will be less reliant on the merged retailers that are driving down the prices paid to Traffic Clothing. The products of competitors may be excluded from the retailers it takes over. This may enable Traffic Clothing to increase sales of its own products. Traffic Clothing will gain more direct feedback from the consumer. This will enable it to be more responsive to changes in the market and be more customer oriented. Disadvantages Forward vertical integration

Traffic Clothing lacks experience in

selling clothing to consumers. Traffic Clothing is a manufacturing business and does not necessarily understand the retail industry. Consumers may suspect uncompetitive activity. This may generate negative publicity. Traffic Clothing lacks experience in this sector. Management and marketing skills necessary in retailing will be different from those needed in manufacturing.

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Advantages Backward vertical integration Traffic Clothing will gain a secure supply of key materials. Traffic Clothing will be able to gain control over the cost of materials. Increasing material costs have been a problem for Traffic Clothing. Absorbing the profit margins of suppliers will make Traffic Clothing more price competitive. Traffic Clothing will be able to control the quality of materials directly. Traffic Clothing may gain some control over supply of materials to some competitors.

Disadvantages Backward vertical integration Traffic may lack experience of managing a supplier of materials. The supplying business may become complacent due to having a guaranteed customer.

Write a report evaluating the proposed forms of external integration for this business. Your report should contain an assessment of the advantages and disadvantages of each proposal and a final recommendation for the board of directors. [15] In assessing the advantages and disadvantages outlined above it is important to make a judgement about the relative importance of each factor. The three key problems faced by the business are: Increasing input prices backward vertical integration will give Traffic Clothing some control over the cost of materials. However, the cost of producing materials will be influenced by factors beyond the control of the producers, such as the price of cotton and wool and the price of oil and other inputs into synthetic material production. Backward integration may involve taking over the producers of materials, that is manufacturing companies. Thus, it may be argued that this is preferable as Traffic Clothing is already a manufacturing company. A move into retailing may be more alien to the existing directors and, therefore, be more risky. Mergers between retailers leading to increased buying power forward integration will give Traffic Clothing some protection against this problem, but it will still have to remain price competitive unless it is able to develop a strong brand image to enable a premium pricing strategy to be implemented. Increased competition from new manufacturers backward integration has the benefit of securing supplies for Traffic Clothing and of absorbing the profit margin of suppliers. Forward integration enables Traffic to exclude the products of competing manufacturers. A policy of rapid external growth may bring risks of Traffic over-extending itself. There may be problems with financing rapid growth and suitable takeover targets will need to be identified. This may be a critical factor in determining the direction of growth. However, given that the firm has achieved growth over the last decade without too much external debt, loan finance may be possible.

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A Essay
2 a Examine three different ways in which business size may be compared. [10]

Measure Number of employees

Commentary

This is a very simple measure that is easy to understand and

make comparisons, e.g. a small retailer employing a few people compared to a national chain employing thousands. Many countries will have clear definition of size according to the number of full-time equivalent employees, e.g.: small: less than 50 employees medium: between 50 and 250 employees large: more than 250 employees.

Problem with using employees is that some firms are capital

intensive, whilst others are labour intensive. For example, a firm with a highly automated production line will have relatively few employees. Sales turnover

This is the total value of sales made by a business over a given

time period.

It is a common measure of size used for comparing

Capital employed businesses in the same industry a useful comparator in businesses such as supermarkets. A potential weakness is that some firms may have high turnover, but add relatively little value to the productive process. Comparisons between firms in different markets, based on turnover, may also be misleading. business.

This is the total value of all long-term finance invested in the A large business will usually have a high value of capital for
long-term investment. For example, a nuclear power station will have significant capital needs. When making comparisons between industries a problem will be the different amounts of capital required to operate. For example, a dentist employing a few people will have much higher capital needs than a window-cleaning service employing the same number of people.

Market capitalisation

This is the total value of a companys issued shares. This is only relevant for businesses quoted on a stock
exchange where shares can be traded. Market capitalisation = current share price total number of shares issued. Share prices can be very volatile and thus the market capitalisation of a business may change rapidly despite no significant change within the business. The turmoil on stock exchanges around the world illustrates this problem. A business such as the Royal Bank of Scotland saw its market capitalisation fall from over $100bn to less than $20bn over a matter of months in 2008. for comparing businesses producing the same goods and services. However, as the sizes of markets vary enormously, it does not follow that a firm with high market share is a large company.

Market share

This indicates relative size within an industry, so is useful

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b Evaluate the consequences for a business of deciding to integrate vertically in order to achieve expansion. [15] Definition of vertical integration: this occurs when two businesses in the same industry join together that operate at different stages of the production/supply chain. Answer could be viewed from the perspective of businesses at different stages of the productive process. A simple approach would be to consider a specific type of business involved in the primary sector, the secondary sector or the tertiary sector. This way application could be developed with relative ease and evaluative marks accessed. Possible suggestions: a farmer integrating forward with a greengrocer backward integration of a clothes retailer forward integration of a TV manufacturer. Alternatively, the theoretical arguments for and against integration can be explained and reference made to specific examples. The following points relate to the vertical integration of a TV manufacturer.
Advantages Forward vertical integration The manufacturer will gain control over the marketing of TVs to the retailer and can thus determine the way products are displayed and promoted, as well as the standard of customer service offered. The manufacturer will be able to ensure that distribution outlets for products are available. The products of competitors may be excluded from the retailers it takes over. This may enable it to increase sales of its own products. The manufacturer will gain more direct feedback from the consumer; this will enable it to be more responsive to changes in the market and be more customer oriented. Disadvantages Forward vertical integration

The management of a TV
manufacturer may not understand the retail industry. Consumers may suspect uncompetitive activity. This may generate negative publicity. There may be lack of experience in this sector. Management and marketing skills necessary in retailing will be different from those needed in manufacturing. There may be increased problems of managing the business due to its increased scale.

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Advantages Backward vertical integration Closer links with a supplier will aid new product development. The manufacturer will gain a secure supply of key components. The manufacturer will be able to gain control over the cost of components. Absorbing the profit margins of suppliers will make the TV manufacturer more price competitive. The manufacturer will be able to control the quality of components directly. The manufacturer may gain some control over supply of components to some competitors.

Disadvantages Backward vertical integration

The manufacturer may lack

experience of managing a supplier of components. The supplying business may become complacent due to having a guaranteed customer. There may be increased problems of managing the business due to its increased scale.

Evaluation may consider: Consequences depend on the direction of integration and the stages involved. For example, a component manufacturer that takes over a TV manufacturer will not gain any control over how its products are sold by retailers. Thus, in this case, one of the most important advantages of forward integration disappears.
Conditions within a particular industry may determine what the most important consequences of vertical integration are, e.g.: Are supplies of materials secure for a manufacturing firm? A manufacturing firm that requires access to scarce resources may benefit significantly from backward vertical integration. How powerful are retailers? In some countries, farmers are relatively powerless in the face of big supermarkets. Therefore, it may be beneficial for a farmer to integrate with a small retailer.

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