1AS.3 SIZE OF BUSINESS

http://goo.gl/8NMvEW

MEASUREMENTS OF BUSINESS SIZE

MEASURING BUSINESS SIZE Government might want to give assistance to smaller businesses thus they need a

measurement of size. Investors in a firm may wish to compare size of business with close competitors,

compare rate of growth. Customers may want to deal with large firms assuming they are stable and less

likely to cease production.2 problems with these and other requirements for a way of measuring size:1. Several different ways of measuring and comparing business size and they often

give different comparative results. A firm might appear large by one measure and small by another.

2. There is no internationally agreed definition of what a small, medium or large business is, but the number of employees is often used to make this distinction.

DIFFERENT MEASURES OF SIZE

1. Number of employees2. Sales turnover3. Capital employed4. Market capitalisation5. Market share

Different measures of size1. Number of employees This is the simplest measure. A shop with just the owner or family are small. A firm employing many staff is likely to be large.Example: There are 2 soft drink firms in the same town. One uses traditional

methods of production, using 108 people to make 300,000 litres of drinks a week. The other is totally automated and produces one million litres a week with just 10 staff.

Different measures of size2. Sales turnover Total value of sales made by a business in a given time period. This is often used when comparing firms in the same industry. It is less effective when comparing firms in different industries. This measure is needed to calculate market share.

Different measures of size3. Capital employed The total value of all long-term finance invested in the business. Larger the business the greater the value of capital needed for

long-term investment, or greater they amount of capital employed.

2 firms employing the same number of staff may have different capital equipment.

The latter will need expensive diagnostic and eyesight measuring machines.

Different measures of size4. Market capitalism This can be used only for businesses that have shares ‘quoted’

on the stock exchange. Market capitalism = current share price x total number of shares

issued Share prices change everyday, this form of comparison is not a

very stable one.Example: A temporary but sharp drop in the share price of a company

could appear to make it much “smaller” than this measure would normally suggest.

Different measures of size5. Market Share Sales of the business as a proportion of total market sales. This is a relative measure. If a firm has a high market share, leaders in the industry and

comparatively large. When the size of a total market nis small, high market share will not

indicate a very large firm. Total sales of business x 100 Total sales of industry

Significance of Small Businesses

The significance of small and micro-businesses

Small businesses will employ few people and will have low turnover compared to other firms.

Small firms are important to all economies, encouraging the development of small businesses can have the following benefits: Job creation. Small businesses are run by dynamic entrepreneurs, new ideas for consumer

goods and services. Competition small firms create for larger firms. Small firms often supply specialist goods and services to important industries

in a country. by being able to adapt quickly to the changing needs of large firms, small businesses increase the competitiveness of the larger organisations.

The significance of small and micro-businesses

All great businesses were small at one time. Small firms that expand will benefit from large scale organisations in the future.

Small firms may enjoy lower average costs than larger ones and this benefit could be passed on to consumers too.

business category

Employees Sales turnover Capital employed

Medium 51-250 10m-50m euros 10m-34m eurosSmall 11-50 2m-10m euros 2m-10m eurosMicro 10 or fewer Up to 2m euros Up to 2m euros

European Union Classification of business size

The significance of small and micro-businessesGovernment assistance for small businesses used in many countries includes:1. Reduced rate of profit tax, this will allow small company the chance to retain

more profits in the business for expansion.2. Loan guarantee scheme – government funded scheme, guarantees repayment of

a certain percentage of the loan if the business fails.3. Information, advice and support will be provided through the Small Firms Agency

of the Department of Trade and Industry.4. In economically deprived areas governments finance small workshops which are

rented to firms at reasonable rents.Other aid designed to help firms include: Lack of specialist management expertise. Problems in raising short and long term finance. Marketing risks from a limited product range. Difficulty in finding reasonable and suitable premises.

Advantages and Disadvantages of Small BusinessesAdvantages Can be managed and controlled by

the owner. Often able to adapt quickly to meet

changing customer needs. Offer personal service to customers. Find it easier to know each worker,

many staff prefer to work for smaller more ‘human’ businesses.

If family-owned the business culture is often informal, employees well-motivated and family members perform multiple roles.

Disadvantages May have limited access to sources of

finance. Owner has to carry a large burden of

responsibility if unable to afford to employ specialist managers.

May not be diversified, greater risks of negative impact of external change.

If family-owned, the original owner may restrict innovation, family rivalries, and keeping control may take priority over business expansion.

Advantages and Disadvantages of large businessesAdvantages Can afford to employ specialist

professional managers. Benefit from the cost reductions

associated with large-scale production. May be able to set low prices that

other firms have to follow. Have access to several different

sources of finance. May be diversified in several markets

and products so that risks are spread. Are more likely to be able to afford

research and development into new products and processes.

Disadvantages May be difficult to manage, especially

if geographically spread. May have potential cost increases

associated with large-scale production. May suffer from slow decision making

and poor communication due to structure of large organisation.

May often suffer a divorce between ownership and control that can lead to conflicting objectives.

Internal Growth

Business GrowthThere are a number of reasons for potential growth: Increased profits – if the aim is profit, then owners will want to

expand to make the business more profitable by achieving higher sales.

Increased market share – gives the business higher market profile and greater bargaining power with suppliers and retailers.

Increased economies of scale. Increased power and status of the owners and directors – e.g.

opportunities to influence community projects and government policy will increase if the business controlled by the owners or directors is large and well known.

Reduced risk of being a takeover target – a larger business may become too large a target for potential ‘predator’ company.

Internal Growth

Expansion of a business by means of opening new branches, shops and factories. (organic growth)

Different forms of growth can be grouped into internal and external growth.

Example of internal growth: a retailing business opening more shops in towns and cities.

This growth is slow with only a few branches opening in a year. It can avoid problems of excessively fast growth which tends to

lead to inadequate capital and management problems associated with bringing 2 businesses together with different attitudes and culture.

Business Expansion

Business Expansion

Internal growthExternal

growth through integration

Mergers Takeovers

External Growth

Business expansion achieved by means of merging with or taking over another business, from either the same or a different industry.

This is often referred to as ‘integration’ as it involves bringing 2 or more firms together.

This leads to rapid expansion. There can be conflict between 2 managers and conflicts of

culture and business ethics.

Types of integration Advantages Disadvantages Impact on stakeholders

Horizontal integration with firms in the same industry and at same stage of production

Eliminates one competitor.Possible economies of scale.Scope of rationalising production.Increased power over suppliers.

Rationalisation may bring bad publicity.May lead to monopoly investigation if the combined business exceeds certain market share limits.

Consumers now have less choice.Workers may lose job security as a result of rationalisation.

Vertical integration forward integration with a business in the same industry but a customer of the existing business.

Business is now able to control the promotion and pricing of its own products.Secures a secure outlet for the firm’s products- may now exclude competitors’ products.

Consumers may suspect uncompetitive activity and react negatively.Lack of experience in this sector of the industry- a successful manufacturer does not necessarily make a good retailer.

Workers have great job security, business has secure outlets.There may be more varied career opportunities.Consumers may resent lack of competition in the retail outlet due to withdrawal of competitor products.

Types of integration Advantages Disadvantages Impact on stakeholders

Vertical integration backward integration with a business in the same industry but a supplier of the existing business.

Gives control over quality, price & delivery times of suppliers.Encourages joint research & development into improved quality of suppliers of components.Business may now control suppliers of materials to competitors.

May lack experience of managing a supplying company.Supplying business may become complacent due to having a guaranteed customer.

Possibility of greater career opportunities for workers.Consumers may obtain improved quality & innovative products.Control over suppliers to competitors may limit competition & choice for consumers.

Conglomerate integration, integration with a business in a different industry.

Diversifies the business away from its original industry & markets.This should spread risk & may take the business into a faster growing market.

Lack of management experience in the acquired business sector.There could be a lack of clear focus & direction now that the business is spread across more than one industry.

Greater career opportunities for workers.More job security because risks are spread across more than one industry.

Synergy and Integration Merger – an agreement by shareholders and managers of 2 businesses

to bring both firms together under a common board of directors with shareholders in both businesses owning shares in the newly merged business.

Takeover – when a company buys over 50% of the shares of another company and becomes the controlling owner of it. It is often referred to as ‘acquisition’.

Synergy – literally means that ‘the whole is greater than the sum of parts’, so in integration it is often assumed that the new, largely business will be more successful than the two, formerly separate, businesses were.

Synergy and Integration

When 2 firms are integrated the argument is that the bigger firm created in this way will be more effective, efficient and profitable than 2 separate companies. Why is this?

1. 2 businesses may be able to share research facilities and pool ideas that will benefit both of the businesses. This is only likely to be the case if the 2 firms deal with the same technology.

2. Economies of operating large scale of business, such as buying supplies in large quantities, should cut costs.

3. New business can save on marketing and distribution costs by using the same sales outlets and sales teams.

Synergy and Integration

Many mergers and takeovers fail to gain true synergy and shareholders are often left wondering what the purpose of the integration really was.

Reasons why business integration has not increased shareholder value:

1. Integrated firm is actually too big to manage and control effectively – diseconomy of scale.

2. Little mutual benefit from shared research facilities or marketing and distribution systems if the firms have products in different markets.

3. The business and management culture- the approach each company takes to environmental issues. May be so different that the 2 sets of managers & workers may find it difficult to work effectively and cooperatively together.

Potential problem from rapid growth

How this affects the business Possible strategies to deal with problem

Financial Business expansion can be expensive.Additional fixed capital and working capital will be required.Takeovers can be particularly expensive.These factors could lead to negative cash flow and an increase in long-term borrowing.

Use external sources of finance when possible, retained profits.Raise finance from share issues When proposing a takeover, offer shares in the new business rather than making a cash offer to the shareholders of the target business.

Managerial Existing management may be unable to cope with problems of controlling larger operations.There may be a lack of coordination between the divisions of an expanding business- a real problem for integrating businesses. The original owner or boss of the business may find it difficult to adapt to being leader and manager.

New management systems and structures may be required. A policy of delegation and empowerment of staff should reduce pressure on top staff.Decentralisation e.g. allows national divisions reasonable autonomy, could provide motivated managers with a clear local focus.Original owner may need to decide which are the most important areas of the business to remain heavily involved with, and relax control over other.

Potential problem from rapid growth

How this affects the business Possible strategies to deal with problem

Marketing The original marketing strategy may no longer be appropriate for a larger organisation with a wider range of products.Growth from national to international markets may not succeed if market strategies are not suitably adapted.

Adopt focused marketing strategies for each specific product or each country operated in – if this is what the results of market research indicate is essential.

Loss of control by original owners Most likely to occur if a sole trader takes on partners or if a private limited company converts to a public one.

Almost an inevitable consequence of changing legal structure to gain additional capital. But original owners could try to remain as directors.