Learn more about economies and diseconomies of scale along with internal and external growth here in Prodat!
Table of Contents
Economies and Diseconomies of Scale
Economies of Scale
The cost-saving benefits of operating on a large scale, i.e. the reduction in unit costs of production as an organization grows
Diseconomies of Scale
When unit costs increase due to the organization being too large and inefficient, e.g. problems with communication and coordination
Graph/Chart
Internal Economies of Scale
Internal Economies of Scale are generated and enjoyed within the organization when it operates on a larger scale. Examples of internal economies of scale include:
Financial economies of scale – larger firms can obtain finance easier and at better lending rates due to their relatively lower risk
Managerial economies of scale – larger organizations can affect greater numbers of specialized managers, thereby boosting productivity and output
Production economies of scale – fixed costs of production are spread out over a larger volume of output, thereby reducing average fixed costs of production
Marketing economies of scale – marketing costs per unit fall when sales volume grows as the larger firm can market its entire product range
Purchasing economies of scale – bulk purchase and delivery of raw materials, components and stock reduces average costs of production
Technical economies of scale – high fixed costs of technological equipment and machinery are spread over the huge scale of output., reducing the average production costs
Specialization economies of scale – similar to managerial economies; results from division of labour of workforce rather than management. Example: motor vehicle manufacturers that use mass production benefit from having specialist labour such as designers, production staff, engineers and marketers. These specialists have skills and expertise that increase productivity of labour.
Risk-bearing economies of scale – these savings can be enjoyed by conglomerates (firms that have a diversified portfolio of products in different markets). Conglomerates can spread their fixed costs, such as advertising or research and development across a wide range of operations.
External Economies of Scale
External Economies of Scale arise from having specialized back up services available in a particular region where firms are located. These are cost-saving benefits of large scale operations arising from outside the business due to its favorable location or general growth in the industry. Examples of external economies of scale include:
Technological progress – increases the productivity within the industry. Example: Internet and e-commerce applications has created huge cost savings for online businesses
Improved transportation networks – ensure prompt deliveries. Prevent employees from going late to work and increasing the business transportation costs. Make sure that customers received their products on time and suppliers are easily accessible. Lower congestion that can increase costs and reduce revenue.
Abundance of skilled labour – through government aided training programs or reputable education and training facilities in a specific location. This provides local businesses with a suitable pool of educated and trained labor.
Regional specialization – a particular location or country that has a highly regarded and trustworthy reputation for producing certain goods and services. Its reputation allows firms to charge higher prices. For example: Murano, in Venice, Italy, is famous for its glass products such as vases, jewellery and chandeliers.
Internal Diseconomies of Scale
Internal Diseconomies of Scale usually occur due to managerial problems that arise as a firm grows too larger. Examples of internal diseconomies of scale include:
Lack of control and coordination – as firms get larger, managers find it more difficult to coordinate, control and communicate with a larger workforce, resulting in higher unit costs
It also occurs when fixed costs increase, such as the purchase of additional premises as a firm grows but this substantially increases its average production costs
Poorer working relationships – senior managers are more likely to become detached from those lower down in the hierarchy, thereby making them feel distanced or out of touch. This damages communication flows and staff morale, reducing their productivity thus leading to higher unit costs
Inefficiency and procrastination (slack) – workers become bored with performing repetitive tasks, leading to lower productive efficiency and hence an increase in the average production costs
Amount of Bureaucracy – administration, paperwork, and company policies. Makes decision-making more consuming and adds business costs while unlikely to contribute to any extra output of goods and services. Make communication more difficult, thereby worsening working relationships, again contributing to higher unit costs.
External Diseconomies of Scale
External Diseconomies of Scale refer to an increase in the average costs of production as a firm grows due to factors beyond its control, i.e. problems that affect the whole industry, often because there are just too many firms. Examples of External Diseconomies of Scale include:
Traffic congestion causing costs to increase
Higher rents costs due to the high demand for firms locating in a particular area
Labour shortages in a certain area, thus leading to increased labour costs
Measuring The Size of A Business
Market share – a firm’s sales revenue as a percentage of the industry’s total revenue
Total revenue – the value of a firm’s annual sales turnover per time period
Size of workforce – the total number of employees hired by the business
Profit – the value fo a firm’s profits per time period
Capital employed – the value of the firm’s capital investment for the business to function
Merits of Small vs. Large Organizations
Merits of small organizations
Merits of large organizations
Small businesses are easier to set up and at a much lower cost
Greater access to financial resources; having more capital than their rivals means larger firms have scope for further growth
Owners of small businesses enjoy independence in decision making, i.e. the freedom to operate independently from demands of directors and shareholders
Can attract better skilled staff as they can offer better career development and remuneration packages
Greater control and ownership of the business
Customers tend to be attracted to larger, well known brand names as they recognize and trust these names more
Greater ease in introducing new goods/services quickly, and typically more flexible in responding to changes in the marketplace
Larger firms are less likely to fail so represent lower risk for owners, investors and financiers; small firms are more vulnerable during an economic recession
They can serve specialized niche markets that are potentially highly profitable
Larger firms benefit from economies of scale so may be able to offer lower prices yet offer greater choice to customers
Small businesses tend to have a closer relationship with their customers
These advantages can give large firms a competitive edge over smaller rivals
Financial accounts can be kept private; only the tax authorities need access to these
Reasons Why Firms Seek To Grow
To reap the benefits of larger scale production, i.e. economies of scale
To gain a larger market share and market power. This allows the firm to charge higher prices and gain more profit
Growth is a means of survival as competitors are also likely to strive for growth. Businesses need to “run faster to stay still”, i.e. grow to compete with their growing rivals
To spread risks by diversifying into new markets rather than focusing only on one specific market. if there are detrimental changes in a particular market, then having operations in other markets might help to safeguard the firm’s survival
Difference Between Internal and External Growth
Internal Growth
External Growth
Brand identity and corporate culture can be maintained
The quickest form of growth
Less risky, especially if financed by using retained profits
Ordinarily requires external sources of finance
Often involves expanding the range of products and/or locations
Often results in the dilution of ownership
Far more bureaucratic, especially with mergers and acquisitions (M&As)
Involves greater financial risk
In the case of M&As, external growth reduces or eliminates competitions
Methods of Internal Growth
Internal Growth
(also known as organic growth) occurs when an organization expands using its own resources, without involving other organizations, e.g. using Ansoff’s Matrix strategies such as market penetration and product development
Changing Price
Customers tend to buy a product at lower prices. If there are very few substitutes for the product, the business will earn more revenue by raising prices. For products in highly competitive markets, a price reduction can generate proportionately more sales revenue.
Effective Promotion
People are more likely to buy a product if they are informed, reminded and persuaded about its benefits. For example, Coca-Cola company spends $2 billion each year on promoting its products, which is one reason why its is the world’s most recognized brand with sales of 1.7 billion servings per day.
Producing Improved or Better Products
Through market research, innovation and new product development, business can produce more appealing to the market which help raise sales. Most new products fail, so it is common for firms to improve on the design and features of their existing products.
Sell Through A Greater Distribution Network
If a product is widely available and easily accessible, customers are more likely to buy it. For example, Coca-Cola is widely available throughout the world in different places, e.g. supermarkets, restaurants, cinemas, airlines and vending machines.
Offer Preferential Credit
Customers are more likely to make a purchase if they are offered the ability to ‘buy now and pay later’. Allowing customers to pay in regular installments perhaps over 12 or 24 months for the purchase of expensive products, such as motor vehicles or large-screen televisions, can attract more customers to the market. However, firms must be careful not to offer too much credit as this can affect cash flow position.
Increased Capital Expenditure
Business can increase investment in new locations or the introduction of new production processes and technologies to improve productivity. However, investment risks might not pay off so careful planning such as investment appraisal is needed.
Improved Training and Development
Employees are often said to be a firm’s most important asset. Training and development (T&D) is vital as customers are unlikely to buy from people with little or no product knowledge. It also helps make staff more confident and competent as well as motivate the workforce as they feel more valued by the employer. This improves level fo customer service and lead to higher customer loyalty and sales for internal growth.
Providing Overall Value For Money
Businesses that provide perceived value for money are most likely to experience internal growth. Customers tend to look at more than just price when making purchasing decisions. Other factors include: quality, after-sales care, brand image, maintenance costs and environmental considerations.
Methods of External Growth
External Growth
(also known as inorganic growth) occurs when a business relies on third party organizations for growth, e.g. mergers, acquisitions, and franchising.
A merger takes place when two firms agree to form a new company, such as the merger between the UK’s British Petroleum and USA’s oil company Amoco in 1998 to form ‘BP Amoco’ – which has since been renamed and shortened to ‘BP’.
Horizontal integration is an external growth strategy that occurs when a business amalgamates with a firm operating in the same stage of production.
Forward vertical integration is a growth strategy that occurs with the amalgamation of a firm operating at a later stage in the production process, e.g. a book publisher merges with a book retailer.
Backward vertical integration occurs when a business amalgamates with a firm operating in an earlier stage of production, e.g. car manufacturer acquires a supplier of tyres or other components.
A takeover (or acquisition) occurs when a company buys a controlling interest in another firm, i.e. it buys enough shares in the target business to hold a majority stake. To attract shareholders of the target company to sell their shares, the offer price is likely well above the stock market value of shares.
For example, in July 2015 British publishing giant Pearson sold the Financial Times to Japanese media firm Nikkei for £884 million ($1.27 billion) in cash.
Advantages of M&As
Disadvantages of M&As
A range of economies of scale gained through external growth
Resistance from employees, trade unions, managers and shareholders (who are unwilling to sell their shares)
Enables the larger firm to spread costs, expertise and risks
M&As are not always successful, especially when firms pursue a diversification strategy
Quick way for the firm to enter new industries and geographic markets
M&As are generally very expensive, especially if there are delays in the process; in some cases the purchase price ends up being unaffordable
Instantaneous growth as M&As are quicker than methods of organic growth
Corporate culture clashes, such as contrasting management styles and organizational structures, cause huge problems for M&As
The cutting of costs and synergies from M&As allow the business to earn higher profits and market share gains
Diseconomies of scale may occur due to a firm’s loss of cost control and the loss of focus of its core activities
The newly formed business gains market power to influence prices and output in the industry
A merger or takeover could be the only way that a business can survive due to its poor cash flow or financial difficulties
Note
It is not necessary for the purchasing company to buy 51% of the shares in the target company to take full management control – purchasing at least 50% and one additional share gives it a majority stake.
A joint venture (JV) is an arrangement between two or more separate parties to pool their resources together to form a new legal entity.
The companies engaged in a JV seek profit, sharing resources (financial and human capital), such as personnel, assets, costs, and revenues.
For example, Hong Kong Disneyland, a joint venture between Hong Kong government (which owns 51% of the JV) and the Walt Disney Company (with a 49% stake).
Advantages of joint ventures
Disadvantages of joint ventures
The firms combine their resources, such as technology and capital, creating synergies and strengthening their position in the market
Possible conflicts and disagreements due to different corporate cultures and management styles of the partner firms
Financial risks of the project are shared between the partner companies
Compromises are often made with JVs and this can lead to suboptimal outcomes for both parent companies
Local firms can enable the partner to overcome cultural difficulties that a foreign company may encounter
Execution of business strategy is more decisive with acquisitions and takeovers
JVs enable companies to become larger and thus benefit form economies of scale
Diseconomies of scale may occur due to operations on a larger scale, e.g. extra meetings and administrative processes, and communication problems
The partner firms enjoy the advantages of growth without losing their identities
JVs are generally more difficult to terminate due to the lawfully binding obligations of the newly created legal entity
Firms in the JV avoid high legal and administrative costs associated with M&As
Strategic alliances (SAs) are formed when two or more businesses join forces to benefit from growth without any fundamental changes to their own long-term strategies.
Unlike joint ventures, the formation of a strategic alliance does not create a new organization.
Examples of SAs include:
Apple has partnered with Sony, Motorola, Philips, and AT&T
Starbucks and Barnes & Noble (coffee shop chain and bookstore) which started in 1993
The Star Alliance consists of 27 airlines, forming the world’s largest global SA in the airline industry
Advantages of strategic alliances
Disadvantages of strategic alliances
Like JVs, firms in a strategic alliance can benefit by sharing expertise and resources with other firms in the SA
Unlike JVs, strategic alliances are easier to enter and exit so can be less stable
Businesses in the SA remain separate legal entities, without the relatively high costs of forming a new company
Strategic alliances are sometimes only short term, temporary agreements
Synergies and economies of scale can be gained by the partner firms in the SA
It can make a business vulnerable to mistakes or malpractice made by partner firms in the SA
Franchising refers to an agreement between a business (the franchisor) giving the legal rights to other organizations (the franchisees) to sell products under the franchisor’s brand name.
Examples of multinational companies that use franchising include:
McDonald’s
Subway
Starbucks
PizzaHut
KFC
Holiday Inn
Advantages of franchising
Disadvantages of franchising
The franchisor can expand the business without the need to raise finance and invest their own funds to make the business grow (as the franchisee pays for the expansion); hence it is a cheaper method of expansion than organic growth
Not all businesses have the expertise to properly manage the franchising model in terms of quality control and marketing activities
The franchisor receives royalties based on a predetermined percentage of the franchisee’s sales revenues
It can be very expensive for the franchisee in terms of start-up and running costs as it has to pay a percentage of its sales revenues to the franchisor
It is s a relatively fast method of external growth which can strengthen the brand name quickly
The franchisee is also usually charged an annual fee by the franchisor, so this can substantially cut the franchisee’s profit margin
The franchisor does not need to closely monitor or control the day-to-day operations of the franchisee (whereas monitoring and control must take place with directly-owned stores)
The franchisee lacks flexibility in decision making as it needs to follow the corporate rules and policies of the franchisor, including what it can and cannot sell, and the marketing used to promote the firm’s goods and services
The franchising model is usually a tried and tested one, so the success rate is high; hence, there can be large profits made or the franchisee and franchisor
Diseconomies of scale can arise, even with franchises, especially if the franchise over expands in too short a time scale
Economies of scale, such as purchasing economies of scale, can be gained and passed onto franchisees when buying products to be sold
Incompetent, substandard or dishonest franchisees can easily damage the corporate image and reputation of the franchisor’s brand
The franchisee receives ongoing support from the franchisor, e.g. marketing, market research, staff training, and distribution networks
Role and Impact of Globalization On The Growth & Evolution of Businesses
Globalization is the growing degree of integration and interdependence of the world’s economies. Decisions and actions taken in one part of the world have a direct impact on those in other parts of the world.
A major contributing factor to globalization is the growth and expansion of MNCs, increasing the pressure for MNCs to market their brands to a worldwide audience.
Globalization helps stimulate competition as there are more foreign firms and products competing in the domestic market.
Businesses must now meet the ever greater customer demands for quality, customer service, price and after-sales care in order to have any competitive advantage.
MNCs and e-commerce businesses in particular benefit from the increased customer base that globalization brings.
Businesses are able to build a global presence can benefit from economies of scale, such as the advantages of global marketing economies and risk-bearing economies. Clearly, these present opportunities for business growth.
Globalization presents MNCs with greater choice of location. The increased choice of location can surely help reduce a firm’s cost of production. For example, Apple chose to outsource production in China due to the relatively low costs of labour and rent.
Mergers, acquisitions, strategic alliances and joint ventures allow businesses to grow at a faster rate that if they were to expand organically. Globalization enables businesses to have more choice in their expansion plans and benefit from external growth opportunities.
Globalization presents more opportunities for seeking external sources of finance to fund business growth and evolution. For example, Tycoon Warren Buffett bought a 10% stake in BYD, a Chinese manufacturer of cars and rechargeable batteries for $230 million.
Reasons For Growth of Multinational Companies (MNCs)
A multinational company (MNC) is an organization that operates, owns, or controls production and/or service facilities in two or more countries.
MNCs benefit from access to larger markets in foreign countries
Benefit from economies of scale
Spread risks by operating in other markets, not just inside their own country
MNCs often operate on a large, global scale with powerful brand names
MNCs expand overseas as a market development strategy when other markets are saturated
They can exploit the potential growth opportunities in certain overseas markets that are still untapped
Cost-saving benefits of operating in overseas countries, e.g. cheaper labour, lower tax rates, access to cheaper raw materials and components, or being closer to global customers
Impact of MNCs On The Host Countries
Positive Impacts of MNCs
Negative Impacts of MNCs
MNCs provide a significant number of employment opportunities, helping to raise the quality of the labour force in the host country
Local businesses may losecustomers, market share and profit to foreign MNCs
MNCs are likely to buy local raw materials and components, thus providing extra revenue for local suppliers and supporting local industries (e.g. packaging and distribution)
Foreign companies may not be socially responsible, especially if rules and regulations are more relaxed in overseas markets, which might results in employees being exploited, scarce resources being depleted or increasing pollution levels
Consumers in the host country do not have to rely only on local suppliers as they have more choice from MNCs, thus helping raise standards of living
The existence of large and powerful MNCs can destroy local competitors as they do not have the resources to compete
Similarly, increased competition from MNCs can force local firms to improve their operational efficiency, quality, customer care and prices
Not all local people and businesses will welcome the presence of foreign companies, especially if it results in a cultural shift in the way of life, and may result in social tension
Transfer of technical knowledge and benchmarking practices from MNCs can also benefit local firms
Profitable MNCs will be taxed by the host government, thus providing added tax revenue to benefit the host economy
Simple Review Questions
Using examples, distinguish between economies and diseconomies of scale!
What is meant by the optimal size of a business? What are the ways to measure the size of a business?
State any 3 merits of being a small and large organization!
Distinguish briefly between internal and external growth!
What are the methods of organic growth? And what are the limitations?
Differentiate between joint ventures and strategic alliances!
What are the benefits of mergers and acquisitions as forms of external growth?
What are the limitations of franchising as a method of growth?
What is globalization and how does it impact a business’ growth?
What are MNCs?
What impact do MNCs have on host countries?
Past Paper Review Questions
Question 1
Answer
(a) Economies of scale might not always benefit customers, such as in the following cases:
Economies of scale can only be achieved with high volume output (quantity), but this might be detrimental to the quality and/or variety of output
Economies of scale can act as a barrier to entry, thereby creating a less competitive market, i.e. the development of monopolies and restrictive trade practices in the long run
With large scale operations, there tends to be less personal attention to customer care
To achieve economies of scale requires an increase in productivity and/or productive capacity; which puts huge burdens and stresses on the business without a focus on customer relations
Any other valid explanation.
Award 1–2 marks for a vague answer that lacks detail and/or depth. The answer may be presented in a bullet point list without sufficient explanation. Award up to 2 marks if only one circumstance is explained.
Award 3–4 marks if there are good explanations of two circumstances when customers do not necessarily benefit from economies of scale. Relevant examples are used with appropriate use of business management terminology.
(b) Economies of scale might be inappropriate, undesirable or inaccessible for certain businesses because:
Some businesses, especially sole traders, might wish to keep tight control and ownership of their business. Hence, large scale operations may prove to be inappropriate and/or undesirable.
Similarly, some firms do not participate in large scale production (e.g. those that operate in niche markets or those that require job production) so economies of scale become inaccessible to them. Instead they may focus on specialization and the uniqueness of the product.
Some firms might choose to limit their output in order to avoid cash flow crises or over-trading, and hence there is limited access to economies of scale.
Some businesses, such as Ferrari and Rolex, will focus primarily on the quality, rather than the quantity, of the product. This therefore limits the economies of scale that the firm can access. It is also undesirable for such firms to produce more simply to have lower costs (such luxury products are perceived to be of extremely high quality).
Award 1–2 marks for a vague answer that lacks detail, depth or relevance. The answer may be presented in a bullet-point list without sufficient depth of explanation.
Award 3–4 marks if there are good explanations of the circumstances surrounding the inappropriateness, undesirability and inaccessibility of economies of scale for some businesses.
(c) Small firms might continue to survive, despite the lure of economies of scale, because:
Small firms may operate in niche markets that do not tend to be of interest to larger businesses, so they are able to survive.
They offer a local, flexible and personal service to their customers.
There are low barriers to entry (e.g. set-up costs), thereby reducing the risks for setting up and running such small businesses.
They may have better cost control due to their smaller-scale operations (large firms can experience diseconomies of scale).
Award 1–2 marks for a generalized answer that lacks detail of why small firms can survive and thrive despite their inability to exploit economies of scale.
Award 3–4 marks for a good examination of two or more factors, with some understanding of why small firms can survive and thrive, even in the absence of economies of scale. However, the answer lacks substance and/or the use of examples.
Award 5–6 marks for a thorough examination of two or more factors, with a detailed understanding of why small firms can survive and thrive, even in the absence of economies of scale. There is sound use of business management terminology and application of relevant examples.
(d) It is debatable whether large firms (always) act in the best interest of the general public. Large firms can exploit the public in several ways, including:
The creation of barriers to entry in order to protect themselves from potential competition, thereby making the industry less competitive. This would result in less price and non-price competition, which can be detrimental to the public. By contrast, rivalry tends to lead to more competitive prices whilst increasing the quality and availability of a variety of products.
Taking advantage of their monopoly power, for example by using price discrimination to charge one market segment a higher price in order to maximize their own profits.
On the other hand, large firms can benefit the public in other ways, such as:
Large firms being able to exploit economies of scale which protects domestic firms from foreign competition (and hence protects domestic employment).
They may be the only firms that have the necessary financial and human resources to undertake research and development. Smaller firms tend not to have the required resources to invest in R&D and innovation.
Competition can be wasteful in some industries, such as excess packaging and confusing pricing policies to sell mobile phone packages. Hence, it makes sense for these large firms to strive to provide a better product, with greater value for money.
The extent to which these large firms operate in the best interest of the public will depend on many factors, including:
The nature and scope of barriers to entry, and hence the potential for competition. The values and visions of the organization.
The extent to which the government plays an active role in controlling the power of large firms (monopoly power).
Award 1–2 marks for a generalized answer that lacks detail or is presented in a list-like manner with undeveloped points.
Award 3–5 marks if the answer contains good explanations but the answer is not written in the context of the wellbeing of the general public or if there is a one-sided (unbalanced) argument.
Award 6–8 marks for a well-balanced answer that considers both the costs and benefits of large businesses, with reference to the interest of the general public. There is good application of business management terminology and relevant use of examples. At the higher end, there is clear evidence of evaluation.
Question 2
Answer
(a) Reasons why banks might be reluctant to fund the expansion plans of Hoang Anh include:
The market for cultural art and craft products is relatively small, so represents a large risk for financiers
The business was founded in 2012, so could lack brand recognition and may not have any form of brand loyalty
Unfamiliarity with doing business in overseas countries such as Laos and Cambodia
Banks would need a lot more information than is provided in the case study about Hoang Anh, e.g. its sales figures, market share, size of the workforce, profit and value of its collateral
Ultimately, banks may not find it financially worthwhile to lend to small firms such as Hoang Anh due to the level of risk involved.
Award 1 mark for each reason, up to the maximum of 2 marks.
(b) Problems that Hoang Anh might encounter when operating in new overseas markets include:
A lack of local knowledge about customer tastes, habits and etiquette in Laos and Cambodia
Cultural issues (such as ethics and language) also need to be considered when operating in overseas markets, from a range of perspectives including customers, employees and governments
Legal issues need to be considered as Laos and Cambodia operate different legal systems from Vietnam.
Candidates may use a STEEPLE or CUEGIS framework to tackle this question (although only two elements are required), so should be awarded accordingly.
Award 1–2 marks for a vague answer that lacks detail and/or depth. The answer may be presented in a bullet point list without sufficient explanation. Award up to 2 marks if only one problem is explained.
Award 3–4 marks if there are good explanations of two problems encountered when operating in new overseas markets. Relevant examples are used with appropriate use of business management terminology. Note: there is no requirement for candidates to know about doing business in Laos and Cambodia.
Question 3
Answer
(a) A.S. Watson Group is likely to be classified as a conglomerate. This is because the firm has a diversified portfolio of businesses that operates in dissimilar industries, e.g. personal care, consumer electronics, supermarkets and beverages.
Note: accept answers that accurately outline A.S. Watson Group as a multinational corporation (e.g. ‘with operations in 33 markets worldwide.’)
Award 1 mark for a vague answer that displays some understanding of the type of business organization operated by A.S. Watson Group.
Award 2 marks for an answer that shows a clear understanding of the type of business organization operated by A.S. Watson Group, with evidence from the case study.
(b) Synergy is defined as the whole being greater than the sum of the parts when two or more operations are combined. Synergy brings about both greater output and efficiency. By operating under the A.S. Watson group name, all subsidiaries can benefit from improved corporate planning, communication, marketing, distribution and production processes. Hence, the group can benefit from huge economies of scale across the whole of its diversified operations.
Award 1–2 marks if some understanding of synergy is shown, although the answer might lack explanation or application to A.S. Watson Group.
Award 3–4 marks for a clear definition of synergy with an explanation of how A.S. Watson Group might benefit from it. There is appropriate application of business management terminology and relevant use of examples.
(c) A.S. Watson Group may continue to strive for growth, despite its already enormous size, for several reasons, including:
Greater economies of scale to further reduce unit costs, thus improving its competitiveness and profitability
To gain greater monopoly/market power and to be in a better position to compete against its closest rivals
Expanding into non-Asian economies to benefit from an even larger customer base, and to spread its risks
Any other relevant reason that is examined in the context of A.S. Watson Group.
Award 1–2 marks for a generalized answer that is descriptive or lacks application. There is some understanding shown.
Award 3–4 marks if there is an examination of the reasons for A.S. Watson Group’s long-term growth strategy, but the answer may lack sufficient detail or substance.
Award 5–6 marks if there is a thorough examination of the reasons for A.S. Watson Group’s pursuit of growth as part of its long-term strategy. Appropriate business management terminology has been used with reference to the case study.
Question 4
Answer
(a) Organic growth, or internal growth, can be defined as the growth of an organization when a business grows using its own capabilities and resources to increase the scale of its operations and sales revenue.
Award 1 mark for a vague answer that displays some understanding of the term ‘organic growth’.
Award 2 marks for an answer that shows a clear understanding of the term ‘organic growth’, with an appropriate example used.
(b) Methods of organic growth that Poundland might have used include:
Effective pricing strategy – selling every product for £1 or less has attracted a huge number of customers to its stores, especially following the prolonged recession from 2008
Effective promotion and marketing strategies used to entice customers to Poundland
Selling a wider range of products helps to attract more customers away from more established retailers such as supermarkets
Capital expenditure used to improve the physical environment and customer experience at Poundland stores
Offering better perceived value for money to customers
Accept any other reasonably argued method of organic growth, described in the context of Poundland.
Award 1–2 marks for a vague answer that lacks detail and/or depth, but with some understanding shown.
Award 3–4 marks if there is a good description of two methods of organic growth that Poundland might have used. Relevant examples and business management terminology are used.
(c) Whether organic growth is desirable for a business such as Poundland depends on several factors, including:
Candidates should consider the advantages of organic growth such as: – Better control and coordination, e.g. Poundland focuses on organic growth in Ireland, the Netherlands and the UK – Relatively inexpensive, which is part of the reason for Poundland’s annual growth in profits of up to 29% – Maintains corporate culture – Less risky
However, there are also potential drawbacks of organic growth, such as: – Dilution of control and ownership – A possible need to restructure the organization – Diseconomies of scale – Slower growth as organic growth is slower than external growth
Candidates may also consider the relative benefits of inorganic (external) growth, and should be credited accordingly.
Award 1–2 marks for a generalized answer that lacks detail or is presented in a list-like manner without sufficient explanation.
Award 3–5 marks if there is sufficient examination of some reasons why organic growth might be desirable for businesses. The answer might also lack depth and appropriate use of business management terminology. At the top end, there is relevant application to the case study.
Award 6–7 marks if there is a good discussion that considers the extent to which organic growth is desirable for a business such as Poundland. Appropriate examples are used, with suitable use of business management terminology. There is evidence of critical thinking.
Question 5
Answer
(a) An acquisition, or takeover, occurs when a company buys a controlling interest in another firm, i.e. it buys enough shares in a target business to hold a majority and controlling stake.
Award 1 mark for a vague definition that shows some understanding of the meaning of the term ‘acquisition’.
Award 2 marks for a clear definition that shows a good understanding of the meaning of term ‘acquisition’, including a relevant example.
(b) Winner from Geely’s takeover of LTI include:
Geely itself for being able to buy an iconic and global brand for just £11.4 million ($18.6 million)
LTI itself as the business had already gone into administration after 5 years without making any profits, so the takeover offered the company a lifeline
Employees whose jobs were safeguarded as production remained in the UK and those rehired following job losses imposed by LTI
Geely employees in Shanghai who build taxis for the left-hand drive market.
Losers from Geely’s takeover of LTI include:
Owners and shareholders of LTI who were forced to sell their business following 5 years without making any profits
Senior managers at LTI are likely to lose their jobs or have less input/control following the takeover and an organizational restructure
Employees during the takeover would have faced huge uncertainties and experienced anxiety, stress and perhaps health problems.
Award 1–2 marks for a vague answer that lacks depth/detail. The answer might appear as a list of unexplained points.
Award 3–4 marks if both winners and losers are examined, although the answer might lack some depth. There is limited use of business management terminology and/or poor use of examples from the case study.
Award 5–6 marks if both winners and losers are examined in depth. There is good use of examples from the case study and there is proficient use of business management terminology.
(c) The driving forces behind Geely’s strategic move to acquire LTI include:
An opportunity to purchase a globally recognized and iconic brand (the London black taxi) A bargain price of ‘just £11.4 million ($18.6 million)’ for acquiring the LTI company
Geely could be seen as a ‘white knight’ in taking over a company that had gone into administration with huge job losses
The opportunity to grow the business in Shanghai and possibly other areas of China To gain access to a market that was not previously exploited by Geely
To grow and diversify Geely’s product portfolio of motor vehicles
Accept any other reasonable driving force, discussed in the context of Geely
Award 1–2 marks for a generalized answer that lacks detail or is presented in a list-like manner.
Award 3–5 marks if there is sufficient explanation, but the answer might not be written in the context of Geely and/or the answer lacks depth.
Award 6–8 marks for a good discussion that considers the driving forces behind Geely’s strategic decision to acquire LTI. There is good use of business management terminology and notable application of the stimulus material in the case study.
Question 6
Answer
(a) The term ‘integration’ is the collective term for mergers and acquisitions (M&As), where there is an amalgamation of two or more firms to form a new larger organization, such as the integration of Pixar and Disney.
Award 1 mark for a vague definition that shows some understanding of the meaning of integration.
Award 2 marks for a clear definition that shows a good understanding of the meaning of integration, including a relevant example.
(b) Potential problems experienced by businesses during an acquisition include:
Loss of control – there may be some conflict surrounding the loss of control, e.g. Pixar executives having less of a say than Disney executives
Culture clash – the way that Pixar and Disney employees work and the different cultural norms within the organizations may create some tension and therefore barriers to the acquisition
Takeovers can be hostile in nature and this further presents problems for any acquisition
Redundancies – there will need to be effective change management (and perhaps crisis management) in dealing with potential redundancies caused by the takeover
Any other appropriate problem that is accurately examined.
Award 1–2 marks for a vague answer that lacks depth/detail. There might only be consideration of one potential problem.
Award 3–4 marks if two potential problems are explained, although the answer might lack some depth at the lower end. There is limited use of business management terminology and/or poor use of examples.
Award 5–6 marks if two potential problems are examined in depth. There is good use of examples (perhaps from the case study) and there is proficient use of business management terminology.
(c) Disney might choose to acquire other firms, such as Pixar, in order to benefit from external growth. These benefits include:
Increased sales revenue and more revenue streams Increased market share
However, for a coherent discussion, there should be consideration of the potential drawbacks of Disney’s takeover strategy
Award 1–2 marks for a generalized answer that lacks detail or is presented in a list-like manner.
Award 3–5 marks if there is sufficient explanation, but the answer might not be written in the context of Disney or if there is a one-sided (unbalanced) argument provided.
Award 6–8 marks for a good discussion that considers the benefits of Disney’s takeover strategy. There is also consideration of some of the pitfalls and evidence of evaluation/critical thinking at the upper end.
Question 7
Answer
(a) A joint venture is a method of external growth that involves two or more businesses agreeing to split the costs, risks, control and rewards of a business project by setting up a new (separate) legal entity. For example, Sony and Ericsson came together in 2001 to establish Sony Ericsson as a new business.
Synergy is defined as the whole being greater than the sum of the parts when two or more operations are combined. Synergy brings about both greater output and efficiency. By operating as Sony Ericsson, the newly formed company can benefit from improved corporate planning, communication, marketing, distribution and production processes. In particular, Sony benefits from its partner’s technological knowledge in the communications industry whilst Ericsson benefits from Sony’s consumer electronics expertise.
Award 1–2 marks if there are some omissions or lack of clarity in the definitions. Appropriate examples/ application may be missing.
Award 3–4 marks if both terms are correctly defined. At the top end, examples related to the case study should be used.
(b) A merger between the two companies may not be appropriate because:
Sony and Ericsson would have to lose their (separate) corporate identities; something that neither organization was prepared to do. Sony, for example, produces a broad range of consumer products and not just mobile phones. By merging with Ericsson, Sony might lose its status as a leading manufacturer of consumer electronics products – something the company was not willing to do.
Mergers are far more expensive and cumbersome (in an administrative sense) than joint ventures.
Joint ventures have a very high success rate. By contrast, mergers of firms in completely different sectors can create huge problems for the restructured organization.
Any other relevant reason why a merger between Sony and Ericsson (rather than a joint venture) may not have been appropriate.
Award 1–2 marks if there is a generalized answer, which might lack depth and/or substance or if only one reason is explained. There is no or little application shown.
Award 3–4 marks for a detailed explanation of why a merger between Sony and Ericsson would probably have been inappropriate. For maximum marks, there is good reference made to the case study and appropriate use of business management terminology.
(c) Benefits of a joint venture to Sony and Ericsson include:
The joint venture allows both companies to retain their separate corporate identities (consumer electronics for Sony and telecommunications for Ericsson).
Synergies – for example, Sony can benefit from Ericsson’s expertise in tele- and data communications systems, whilst Ericsson can benefit from the marketing power of Sony.
Risks are reduced – for instance, Sony does not need to invest in an industry that it has no expertise in because the investment costs and risks are shared with Ericsson.
Increased market power – the joint venture provides both firms with a presence in the market, thereby allowing Sony Ericsson to establish itself in an industry with intense competition and high entry barriers.
High probability of success – the joint venture is built on a philosophy of trust and cooperation and the desire for both firms to succeed in establishing the new organization. By contrast, a merger or acquisition may have easily failed due to management conflict and culture clashes.
Any other relevant reason that is examined in the context of Sony Ericsson.
Award 1–2 marks for a generalized answer that lacks detail or is presented in a list-like manner without sufficient explanation.
Award 3–5 marks if there is sufficient explanation of some benefits of a joint venture but the answer might not be written in the context of Sony Ericsson. The answer might also lack depth and appropriate use of business management terminology.
Award 6–7 marks if there is a good examination that examines the benefits of the joint venture to both Sony and Ericsson. Appropriate examples are used, with suitable use of business management terminology.
Question 8
Answer
(a) Pizza Hut may have decided to use franchising as its main growth strategy due to the benefits of franchising, which include:
Franchising is a quick method of external growth, allowing Pizza Hut to become the world’s largest pizza chain
It allows Pizza Hut to reap financial benefits (franchise fee and royalty payments) without directly risking their own capital in the expansion plans
Franchising tends to be less risky than organic growth It is also a relatively cheap method of external growth
Franchisees are screened and carefully selected (they should have a proven record of success) so there is minimal risk for Pizza Hut
Since the franchisee has the incentive to be successful, this is more likely to facilitate Pizza Hut’s expansion plans.
Award 1–2 marks for a vague answer that lacks detail and/or depth, but with some understanding shown.
Award 3–4 marks if there are good explanations of two reasons why Pizza Hut might have used franchising as its main method of growth. Relevant examples and business management terms are used.
(b) Franchising as a growth strategy has its potential problems:
There is risk in relying only on franchising; with such a large network of franchised restaurants, coordination and oversight of these (independently owned) stores becomes increasingly difficult. The organization may subsequently suffer from diseconomies of scale.
Independent franchisees can potentially harm the image and reputation of Pizza Hut as a whole company.
Mergers and acquisitions, although more expensive, can be a faster method of growth for Pizza Hut.
Rival businesses, such as Pizza Box and Pizza Express, also use franchising as a method of growth; so Pizza Hut will need to pursue other growth strategies to maintain its status as the leading chain of pizza restaurants.
Award 1–2 marks for a generalized answer that is descriptive or lacks substance. There is some understanding shown.
Award 3–4 marks if there is an examination of potential problems of franchising, but the answer might lack detail and/or application to Pizza Hut.
Award 5–6 marks if there is a thorough examination of the potential problems of franchising (as a method of growth) for Pizza Hut. Appropriate business management terminology has been used with reference to the case study.
Question 9
Answer
(a) Sales revenue can be defined as the proceeds from selling goods and/or services, per time period. For example, McDonald’s restaurants receive money from customers who purchase fast food. This money is used to pay for the running of McDonald’s, and any funds left over is classed as profit.
Award 1 mark for a vague definition that shows some understanding of the meaning of sales revenue. Award 2 marks for a clear definition that shows good understanding of the meaning of sales revenue.
(b) Possible problems created by the critics of McDonald’s include:
McDonald’s being blamed for fueling or causing child obesity
The negative publicity could damage its corporate image
There could be a decline in the global sales of McDonald’s, especially from concerned parents
Possible negative impacts on human resources (staff recruitment, staff morale and staff retention)
Award up to 2 marks for each potential problem that is outlined in the context of McDonald’s, up to the maximum of 4 marks.
(c) Possible reasons for the growth in McDonald’s global sales include:
A favorable economic climate in USA, Russia, Japan and Europe thereby boosting its global sales.
A revamped menu (salads and other healthier options) thereby helping to attract a broader range of customers.
Changing customer perceptions of the food at McDonald’s by publishing and publicizing nutritional information about its products.
Continued growth through its franchise expansion strategy means that McDonald’s continues to have a greater global presence, thus helping to raise its sales revenues.
Any other relevant reason that is explained in the context of McDonald’s.
Award 1–2 marks for a vague answer that lacks depth/detail. There might only be consideration of one possible reason.
Award 3–4 marks if two plausible reasons are explained, although the answer might lack depth at the lower end. There is little, if any, application or use of relevant examples.
Award 5–6 marks if two likely problems are examined in depth. There is good use of examples, written in the context of McDonald’s and there is proficient use of business management terminology.
(d) The extent to which the fast food industry might be considered as being globalized depends on the relative strengths of the arguments put forward. On the one hand, fast food could be considered to be highly globalized as an industry because:
The rapid expansion and presence of restaurant chains throughout the world, such as McDonald’s, Burger King, Pizza Hut and KFC, have meant that fast-food is available in almost every country.
McDonald’s record global sales and revamped menus around the world also suggest that fast-food is a globalized industry.
As a cultural export, the American burger and fast-food meal is a huge earner for multinational companies from the USA.
The most well-known fast-growing multinational companies all use franchising as a method of growth, meaning that such organizations can produce and sell the same foods and drinks simultaneously in different countries.
On the other hand, the fact that even the most ‘globalized’ fast-food chain has to adapt its menus to local tastes suggests that the fast-food industry not so globalized. In addition, growing public concerns over the nutritional value of fast-food meals also suggests that firms such as McDonald’s have yet to fully exploit the benefits of globalization.
Award 1–2 marks for a vague and generalized answer that might appear in bullet-point form with no or little development.
Award 3–4 marks if the answer is one-sided or lacks detail in areas, with minor or no reference made to the case study.
Award 5–6 marks if there is an examination of the extent to which the fast food industry might be globalized, although the answer lacks evaluation of the issue. Appropriate application is evident.
Award 7–8 marks for a two-sided argument with a justified conclusion of the extent to which the fast-food industry might be considered as a globalized one. There is good application to organizations such as McDonald’s. Appropriate examples and business management terminology have been used.
Question 10
Answer
(a) Globalization can be defined as the growing integration and interdependence of the world’s economies. It has led national economies to integrate towards a single global economy, where consumers have ever- increasingly similar habits and tastes, and a blurring of traditional national cultures.
Award 1 mark for a vague definition that shows some understanding of the meaning of globalization.
Award 2 marks for a clear definition that shows a good understanding of the meaning of globalization, possibly including relevant examples.
(b) Knowledge and awareness of local cultures can be argued to be important aspects of successful global businesses because:
They can prevent inappropriate, offensive and embarrassing strategies being adopted in overseas markets.
A lack of awareness and understanding could mean firms fail to secure deals or contracts with overseas clients.
It can help to communicate the correct messages to different customers in different regions of the world.
Hence, it is likely that knowledge and awareness of local cultures are increasingly important, although the globalization of and access to information (media coverage) has reduced the culture gap that may have existed previously. Furthermore, other issues are also important for global businesses to be successful, such as knowledge and awareness of local business laws. In essence, an awareness and understanding of the business context, the people involved and the ethics of different parts of the world should facilitate more successful deals for global businesses. Such an awareness and understanding can ultimately give an organization a competitive advantage in an ever-competitive business world.
Award 1–2 marks for a generalized answer that lacks substance or is presented in a list-like manner.
Award 3–5 marks if there is a sufficient explanation, although the answer lacks some detail. At the lower end, the answer might be simply descriptive with a lack of depth.
Award 6–7 marks for a thorough discussion of the view that knowledge and awareness of local cultures are an important feature of successful global businesses. There is appropriate use of business management terminology, application of relevant examples and evidence of critical thinking.
Question 11
Answer
(a) A multinational business is an organization such as Carlsberg that operates in two or more countries, usually with its Head Office based in the home country (Denmark in this case). As Carlsberg has operations in Russia and Eastern European countries, it is a multinational business.
Award 1 mark if the answer outlines the meaning of a multinational business.
Award 2 marks if the answer uses evidence from the case study to suggest why Carlsberg is a multinational business.
(b) Reasons for Carlsberg’s decision to expand overseas include:
To increase its customer base – Carlsberg’s traditional Western European markets are stagnant and therefore the company is seeking to expand to new (and possibly larger) markets such as Asia.
Economies of scale – A larger degree of beer production is likely to reduce the average costs of production for Carlsberg as it benefits from marketing, financial and technological economies of scale.
Asia and Eastern Europe may present opportunities for Carlsberg to employ a cheaper labour force and to cut its production costs.
Avoid protectionist measures – Carlsberg could get around protectionist measures such as tariffs, quotas and administrative trade barriers by locating directly in countries imposing such obstacles. Eastern European and Asian countries belong to different regional trading blocs from Denmark, so expanding its operations in these markets can resolve potential conflicts.
To spread risks – Carlsberg might wish to expand overseas to reduce the financial risks of their established markets facing decline, perhaps due to a regional economic decline, stagnant markets or changing habits and trends. By contrast, operating in new markets could present many opportunities for the Danish beer company.
Another other relevant reason that is explained in the context of Carlsberg.
Award 1–2 marks if the answer explains why Carlsberg chose to expand in overseas markets, although the response might lack of depth and clarity. Appropriate examples/application might be missing.
Award 3–4 marks if two reasons are clearly explained as to why Carlsberg chose to expand in overseas markets. At the top end, examples related to the case study are used, and there is good application of business management terminology.
(c) The market for beer may have become globalized due to driving forces such as:
Sponsorship deals from beer producers, such as Carlsberg, have marketed beer on an international scale.
Beer as a Western European cultural export has made inroads across Russia, Eastern Europe and beyond.
MNCs, such as Carlsberg, expanding into overseas markets have introduced beer in these new markets, such as Myanmar.
In striving to achieve growth, multinational companies such as Carlsberg have expanded operations in overseas markets thereby helping to make beer a globalized product.
Intensive competition in the beer industry may also have fuelled Carlsberg’s presence in international markets.
The liberalization of trade around the world may have led to beer exports being made available across the globe.
Increased travel and tourism leading to beer being made available on air flights and in hotels, bars and restaurants around the world.
Media exposure, e.g. football and the wide publicity of alcohol in movies/TV/music videos/internet.
Any other relevant reason explained in the context of Carlsberg and/or the beer industry.
Award 1–2 marks if the answer outlines one or two factors that may have led to the globalization of the beer market, or if the answer appears as an unexplained list of factors. Appropriate examples/application might be missing.
Award 3–4 marks if two reasons that may have led to the globalization of the beer market are clearly explained. Relevant examples related to the case study are used, with appropriate application of business management terminology.
(d) There are potential threats to Carlsberg operating in overseas markets, which include:
A lack of local knowledge and local culture can create problems, e.g. religious views on drinking, or using sexual innuendos to promote drink/alcohol
Diseconomies of scale may arise for Carlsberg if it is unable to control its costs of overseas expansion
Regulatory issues and problems in setting up Carlsberg’s overseas operations
Varying political and economic conditions in foreign countries can limit the extent to which Carlsberg can prosper overseas, e.g. the need to have a local partner (joint venture) agreements in certain countries such as India, China and Myanmar
Competing with a well-established local producers (e.g. China’s Tsingtao Beer) can also limit the success of Carlsberg’s overseas operations
Greater demands on and scrutiny of Carlsberg’s corporate social responsibilities, especially in less economically developed countries or countries that have a more reserved approach to alcohol/drink
Greater uncertainties and risks due to overseas expansion, e.g. the impact of exchange rates on costs, prices and profits
Issues regarding human resources, e.g. national cultures, varying expectations, and language and communication issues
Any other relevant/potential threat that is examined in the context of Carlsberg.
Award 1–2 marks for a generalized answer that is descriptive or lacks application. There is some understanding shown.
Award 3–4 marks if there is some examination of the threats for Carlsberg’s growth strategy in overseas markets, but the answer might lack detail or substance.
Award 5–6 marks for a thorough examination of the potential threats (problems) in Carlsberg’s pursuit of growth in overseas markets. Appropriate business management terminology has been used with reference to the case study.
Question 12
Answer
(a) The term ‘multinational company’ refers to any business organization that operates in two or more countries. For example, Microsoft (USA), Marriott Group (USA), DHL (German) and Ericsson (Swedish) all operate within the UAE.
Award 1 mark if the definition shows some understanding of the term multinational company.
Award 2 marks if the definition shows a good understanding of the term ‘multinational company’, with the appropriate use of an example.
(b) Globalization might affect the location of multinational companies in a number of ways, including:
Foreign countries often provide significantly cheaper labour and other factors of production.
Some countries such as the UAE offer low taxes, political stability and high gross domestic product per capita to attract foreign direct investment.
MNCs such as Microsoft, Marriott Group, DHL and Ericsson have existing operations in foreign countries, so this boosts the confidence for other businesses yet to invest in these places.
Places like Dubai attract a large number of tourists, which can lead to more customers buying the firm’s products.
MNCs can spread their risks by locating in overseas markets. Declining sales in the domestic economy could be offset by rising sales in other parts of the world.
By operating within a specific country, MNCs are able to avoid protectionist measures imposed on foreign firms.
By operating on a much larger scale across the world, MNCs are able to exploit the varying kinds of economies of scale.
Award 1–2 marks for a generalized answer that lacks detail or is presented in a list-like manner without sufficient explanation.
Award 3–4 marks if there is sufficient examination of some of the benefits to MNCs that operate in foreign countries. The answer might lack depth and appropriate use of business management terminology.
Award 5–6 marks if there is a good examination of the benefits to MNCs operating in foreign countries such as the UAE. There is suitable use of business management terminology and application of relevant examples.
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