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There are two ways a firm can grow — internally, by expanding their own activities, and externally. It's important to learn why firms grow as well as how they grow.
Firms Grow for Five Main Reasons
Economies of scale - Larger firms can produce at lower average cost than smaller firms. They can pass on these economies of scale to consumers as lower prices. This will help them increase their sales, their market share and their profits.
Diversification Larger firms can afford to produce more products than smaller firms. They can sell into different markets and so reduce the risks that a decline in sales of one product will harm the business. That means there's less threat to their profits.
Financial support Larger firms are less likely to go bankrupt than smaller firms. That's mainly because they can borrow money more easily from banks so they will find it easier to survive cash flow problems. Larger firms can also receive more financial support from the government than smaller firms because they employ lots of people.
Personal vanity Some owners also enjoy the power and status that comes from owning a large business.
Domination of the market The larger the market share a firm has, the more it can control the price of its products. It will face fewer threats from competitors and may even be able to eliminate rivals by charging prices that they can't compete with.
There are Three Main Methods of Internal Expansion
Internal expansion is also called organic growth.
1) The firm can produce more of its current products to sell in its existing markets. For example Glugg Soft Drinks Ltd. could try to increase its market share in the UK fizzy cabbage juice market from 1% to 20%.
2) The firm can sell its current product into new markets. Glugg Soft Drinks could try to export its fizzy cabbage juice to the USA.
3) The firm could launch a new product. This could be a similar product to existing ones, like fizzy turnip juice — this is called line extension, because you're extending your line of products. Or it could be a completely new product, like sports cars — this is called diversification.
Internal Expansion has its Benefits and Problems
1) Infernal growth is good in that it is relatively inexpensive to achieve. Also, with the exception of diversifying with a completely new product, the firm expands by doing more of what it is already good at — making its existing products. That means it's less likely to go horribly wrong.
2) The problem is that it can take a long time to achieve growth. Some owners are not prepared to wait that long — that's why they go for external growth.
Growth of Firms — Internal Expansion
Q1 Explain what each of the following mean, and why they might provide a small firm with an incentive to expand.
a) Economies of scale
b) Diversification
c) Financial security
d) Domination of the market
Which of the following is not an example of internal expansion? Tick the correct answer.
a) Producing more of the same product to sell in existing markets.
b) Buying a competitor and selling its products in existing markets.
c) Producing a new product and selling it in new markets.
d) Targeting new markets in which to sell existing products.
Q3 Explain the difference between line extension and diversification.
Q4 Write down one advantage and one drawback to small firms of internal expansion.
Advantage
Drawback
Growth of Firms — Internal Expansion