IB Business Management

By the end of this chapter, you should be able to:

 Define the terms economies and diseconomies of scale.

 Discuss the merits of small versus large organizations.

 Outline the difference between internal and external

growth.
 Explain different external growth methods.

 Explain the role and impact of globalization on the growth

and evolution of businesses.
 Outline reasons for the growth of multinationals
companies (MNCs).
 Evaluate the impact of MNCs on the host countries.
 There is a great difference between the scale of
operations of a small business – maybe run by only one
person – and the largest companies in the world.
 Some large companies have
annual sales that exceed the
GDP of many countries.
 In 2013, Exxon Mobil registered
sales around US$430 billions;
the GDP of Thailand, for
instance, was of US$365
billions.
 As businesses grow, how do their methods
of knowing (their customers, the
environment, their markets, etc.) change?
 Scale of operations refers to the size or volume of
output.
 When a business increases its scale of operations, it
produces more or in greater volume.
 There are risks and costs involved in the increase of the
scale of operations – buying land, buildings, machinery,
equipment, hiring more personnel – and the capital
used always has alternative uses.
 The companies expand their capacity increasing their
scale of operations to seek opportunities and gain more
market share.
 The companies also seek for benefiting of greater
efficiency.
 Do not confuse ‘producing more’ with increasing the
scale of operation.
 More can be produced from existing resources by
increasing capacity utilisation.
 Changing the scale of operation means using more (or
less) of all resources – for example, opening a new
factory with additional machines and workers.
 A greater volume of production allows a business to be
more efficient.
 Efficiency is the ability to achieve something with the
minimum use of resources.
 In business, efficiency is the
level of performance that
describes the process of
using the least amount of
inputs to create the greatest
amount of outputs.
 When a business increases its scale of operations and in the
process becomes more efficient, we say that the business has
achieved economies of scale.
 The term “economies of scale” refers to the reduction of the
average unit cost as a result of the increase in the scale of
operations.
 When a business grows in size, it
can be benefited when distributing
its costs between a greater
amount of units and therefore the
average unit cost starts to fall.
Economies of scale
 Efficiency is measured in terms of costs of production per
unit.
Total costs = Fixed costs + Variable costs

 Fixed costs are costs that do not change as production

changes (rent for example).
 Variable costs are costs that vary as production changes
(raw materials for example).
Be a thinker:
 Identify two fixed costs and one variable cost of the
classroom.
 Calculate the total cost of the classroom based on the
costs stated.
Economies of scale
 Average cost is the production cost per unit of output.
 Also known as unit cost or average unit cost.

Average cost = Total cost

Quantity produced

AC = FC + VC
Q

 As the business expands by producing a greater quantity,

variable costs increase. However, the fixed costs are spread
over the greater quantity of units produced.
 As a result, the average cost goes down. Thus, the business
becomes more efficient; it has achieved economies of scale.
Be a thinker:
 Calculate the average cost of the classroom.

 Calculate the average cost of the classroom with 30

students. Has the classroom become more efficient?
 Calculate the average cost of the classroom with 15
students. Explain the result in terms of efficiency.
 If a business orders a lot of materials from suppliers, it
may be able to get bulk purchase discounts.
 If more units are ordered from suppliers, transport costs
will be lower on average.
 As business grows, its managers are able to specialize in
certain roles, so they become experts and therefore more
efficient.
 Banks may well give a large business lower interest rates
on loans than they offer small businesses.
Be a thinker:
 Think of one type of economies of scale in the area of
marketing and one in the area of technology that a
larger business could benefit from.
 A large firm can spread its advertising and marketing
budget over a large output.
 Expensive specialist capital machinery such as robotic
technology in the production of vehicles.
 When responding IB questions about economies of
scale, make sure that you answer is applied to the
organization mentioned.
 As businesses grow in size, there is a point where they
start to experience inefficiencies that increase average
unit costs, leading to diseconomies of scale.
 Diseconomies of scale refers to the increase in long-term
average cost of production as the scale of operations
increases beyond a certain level.
 Imagine that a business expands production year on year.
 As it does, it initially achieves economies of scale. One reason
for this is that the fixed costs of rent is being spread out over a
large number of units produced.
 However, at some point in time (if growth continues), the
business will be at its maximum production level for the size of
its factory.
 The business will have to rent different or additional space to
expand production.
 The business’s rent expenses will increase significantly. The
higher rent will now be spread out over the same (or slightly
higher) number of units produced.
 With the higher rent, initially, the business will have higher
average unit cost… diseconomies of scale.
Economies and diseconomies of scale
Costs

Economies of Diseconomies of
scale scale

Optimum Output
production
 Communication breakdowns can arise in larger
organizations.
 Decision making slows down as more people become
involved, causing inefficiency and lost market
opportunities.
 Often workers in large organizations feel they have no
influence or importance and lose interest in working
effectively. Motivation of workers falls and productivity
drops causing costs to rise.
Be a thinker:
 What would happen if 35 students were interested in
studying Business Management?
 If the school decided to open another classroom, would
the average cost be affected? Explain your answer.
Be a thinker
Explain what economies and diseconomies of scale may
occur for:
 The local newspaper shop

 An airline.
 If in the exam you are asked to consider the most
appropriate scale of operations in a given situation, you
will need to assess the following factors:
◦ The shareholders’ objectives
◦ The capital available
◦ The market size where the organization operates
◦ The number of competitors
◦ The possibility of economies of scale
 Not all businesses want to expand. Many businesses
simply prefer to remain small.
 Some business owners do not want the headache of
growing their business or managing a large business.
 Many businesses offering high-end products and service
businesses prefer to stay close to their markets and their
clients.
 In the legal sector, around the world many small law firms
prefer to serve a small group of familiar clients.
 In accountancy, countless small accounting firms serve
the needs of small businesses everywhere in the world.
 More personalized and flexible
service – competitive advantage.
 Greater sense of exclusiveness.
 Lower sales but possible greater
profitability.
 More manageable levels of debt.
 Fewer skills needed.
 Friendlier work environment
where everyone knows each
other.
 More effective communication.
 Market with limited competition.
 Greater status.
 Greater chance of surviving.
 Less dependent on one product
or one market.
 Benefits from economies of scale.
 More control of the market.
 Career opportunities for the
workforce.
 Owners can increase their wealth.
 Less risk of being acquired.
 Also known as organic growth.
 Growth through the existing operations – the business
uses its own resources.
 The growth is usually slow and stable.
 Although it can take a long period of time, the business
can grow without taking too much risk.
 The growth is usually self-funded using the retained
profit. However, the business might ask for a bank loan to
invest in the expansion of its properties (offices, factories,
stores, etc.) or buying new equipment and machinery.
 A business expands simply selling more products or
developing its product portfolio.
Possible internal growth strategies
 Cutting prices, even if profits fall in the short run.

 Reduce the cost of production and therefore reduce the

price (but not the profit) and gain more market share.
 Increasing sales force by recruiting more sellers and/or
opening more establishments.
 Investing in more advertising.
 Fast growth method and of greater risk.
 Instead of selling more of its own products, the
business expands by establishing certain agreements to
work with another company.
 Usually requires a significant external financing.
 Although the risk is greater, the reward is that the
company can increase its market share and reduce
competition quickly.
 Integration
 Joint ventures
 Strategic alliances
 Franchising
 Occurs when two businesses become one.
 If two companies join forces and form a bigger combined
business we call it a merger.
 If one business takes over the other we would generally
say that this was an acquisition or takeover.
Integration can take place in four ways:
 When two businesses in the same industry are integrated
we call this “horizontal integration”.
 If a business integrates with another business back in the
chain of production we call this “backward vertical
integration”.
 If a business integrates with another business forward in
the chain of production we call this “forward vertical
integration”.
 “Conglomeration” occurs when two businesses in
unrelated lines of business integrate. This is also known
as diversification and occurs mainly to reduce overall
corporate risk.
Forward vertical integration

Horizontal integration

Conglomeration
 Merging or buying a competitor, supplier, or customer
can help increase the pace of growth.
 Integration has many advantages for businesses,
including economies of scale, complementary activities,
and control up or down of the chain of production.
 However, M&As can be costly and typically include, in
addition to the cost of the business being acquired, high
legal and consulting fees.
 Sometimes when one company acquires or combines with
another company, a culture clash occurs.
 Occurs when two businesses agree
to combine resources to achieve a
specific goal over an established
period of time.
 As a result, an independent project
is created with inputs from the two
companies.
 After the period of time is over, the
two firms may decide to extend the
time period, dissolve the project or
incorporate it into one the two
companies.
 Although the agreement can be temporary or long-term, there
is a transfer of specialized skills.
 The specialized skills can be of infrastructure, technology,
knowledge, experience, distribution, etc.
 Sometimes, one of the partners
starts to play the dominant role
and ends up eventually buying
the other one.
 A joint venture is an agreement
between two companies to work
together in a specific project
creating an independent
business division.
 (2004-2008)

(2009)
(2001-2012)

(2007)
(1999-2009)

(1996-2012)

(2003)
 The companies can generate greater sales without losing their
legal existence or their identity.
 The companies can provide different areas of expertise to
create a stronger combination in the market.
 The transfer of skills can benefit any of the parts in the future.
 The costs and the risk are
shared.
 The parts could expand rapidly in
different markets and exploit
them better with the new project
rather than doing it
independently.
 The management styles and the cultures could be so different
that would not allow the parts to adapt appropriately.
 Sometimes the desired results are not achieved.
 The companies realize that they could have achieved the
objectives without the need of sharing the profits with the
other company.
 The failure of one of the parts could put in risk all the project.
 Like in any partnership, disagreements can arise between the
parts.
 Occasionally, the disagreements can be so severe that could
affect the effectiveness of the partnership and even generate
the termination of the agreement.
 Collaboration between two or more parties to pursue market
opportunities, while remaining independent organizations.
 Partners may provide resources such as products, distribution
channels, manufacturing capability, project funding, capital
equipment, knowledge, expertise, or intellectual property.
 A company can finance highly specialized courses in a
university to increase the supply of suitable personnel for the
firm.
 A company can join forces with a supplier to design and
produce components that will be used in a new line of products.
Similarities:
 Two or more businesses can take part of the agreement.

 The parts involved remain independent.

 The purpose is to seek a common benefit.

Differences:
 There is no transfer of resources.

 An independent project is not created.

 The relationship is more fluid.

 More companies involved in the alliance, more complicated the
processes of coordination and decision-making.
 Without a legal existence, the alliance could have a weaker
strength in the market than a legally-established company.
 The parts do not benefit from any transfer of knowledge,
keeping the specialization in each organization.
 The parts cannot take advantage of the economies of scale that
other forms of growth provide.
 Partnered with Barnes and Noble in 1993 to provide in-
house coffee shops, benefiting both retailers.
 Partnered in 1996 with Pepsico to bottle, distribute and
sell the popular coffee-based drink, Frappacino.
 An alliance with United Airlines has resulted in their
coffee being offered on flights with the Starbucks logo on
the cups.
 Buying a franchise is paying for the right to sell the
products of another company.
 It is becoming increasingly popular for business that want
to expand globally.
Source: Entrepreneur Franchise 500
 Becoming a franchisee (the person buying the rights) is a
way of reducing the risk of business failures by using the
tried and tested ideas and products of an already
successful business.
 The franchisor (the business selling the rights to a
franchisee) will provide a package of services in return for
an initial fee and a regular royalty payment (usually based
on a proportion of sales revenue).
 Use of the company’s brand name and image.
 Advertising campaigns to promote the brand.
 Materials and equipment for the franchisee to use in
production or ready-made goods or services to sell.
 Training – initially to start the business and later to
successfully manage it.
 An exclusive area in which to sell, especially in the case of
dealer franchises such as car retailers or gas stations.
 Fast way to gain access to other markets.
 Use of local knowledge and experience.
 Do not take the risk and responsibility of managing the
franchise.
 Generates more profits.
 Loss of control of the daily management of the business.
 The corporate image and reputation can be affected if one
franchise fails or does not operate appropriately.
 Greater chance of success: only around 6% of franchises fail in
the first two years, compared to up to 50% of other types of
new business.
 Reputation and customer loyalty: a successful franchisor
probably already has a reputation that ensures a loyal
customer base.
 Experience and knowledge: the support of training and
research provided by the franchisor could give the business a
competitive edge.
 Financial costs: the initial fee and ongoing royalty payments
are a financial drain that a sole trader would avoid.
 Loss of independence: as a franchisee, you are not entirely
your own boss with the franchisor making key decisions about
location, marketing, employment and so on.
 Dependence on the success of the franchisor: if the
franchisor’s support is poor or their brand fails, there is little
that the franchisee can do to make their business a success.
Globalization: The growing integration,
interdependence and general connectedness of the
world through markets, labor mobility and capital
transfer.
 Globalization is the process by which the world’s regional
economies are becoming one integrated global unit.
 It has had significant impact on businesses’ growth and
evolution.
 In terms of intensity, scale, speed, and economic value of
goods and services being exchanged, global
interdependence today is on a completely different order
of magnitude from that seen in earlier periods or
circumstances.
 Current globalization is being characterized by a relatively
small number of extremely large “post-national”
businesses.
Globalization can have a significant impact on the growth of
domestic businesses for the following reasons:
 Increased competition: large foreign businesses can force
domestic producers to become more efficient as the
domestic consumer has more choice.
 Greater brand awareness: domestic producers have to
compete with big brand names and so need to create
their own unique selling point (USP).
 Skills transfer: foreign businesses must use some local
knowledge which will lead to a two-way transfer of
knowledge and skills.
 Closer collaboration: domestic producers can create new
business opportunities.
 Have factories in more than one
country.
 Operate, own and control
resources outside their country of
origin.
 Key mover of foreign direct
investment in countries around
the world.
 An organization that only has
sales offices abroad would not be
considered a multinational
business.
 Often generate more revenues
than the country they operate in.
 Saturation of domestic markets.
 Wanting to move closer to their global customers.
 Wanting to benefit from lower labor costs.
 The lower tax rates in other countries allowing for
greater retained profits.
 Monetary and non-monetary incentives from
governments.
 Exploiting colonial power to grab markets abroad.
 The opportunity to be closer to raw materials and
energy sources.
Four factors have allowed multinational companies to grow
so rapidly and with such a reach.
 Improved communication: not only ICT but also transport
and distribution networks.
 Dismantling of trade barriers: allowing for easier
movement of raw materials, components and finished
products.
 Deregulations of the world’s financial markets: allowing
for easier transfer of funds and also tax avoidance.
 Increasing economic and political power of the
multinational companies: which can be of enormous
benefit especially in middle- and low-income countries.
 Economic growth
 New ideas
 Skills transfer
 More choice of products
 Short-term
infrastructure projects
Advantages
 Profits being repatriated
 Loss of cultural identity
 Brain drain
 Loss of market share
 Short-term plans
Disadvantages
 In Bhopal, India, in 1985 Union Carbide operated a
chemical plant that leaked toxic gases and killed
thousands of local residents. It seemed that safety
standards were not rigorous enough as the business
had minimized costs.
 “McDonaldization” is the term given to the impact of
fast food outlets in countries where obesity was
previously almost unheard of. This has an effect on
health costs and also on cultural values.
 Some people also think that multinationals are
“footloose”.
 They have no long-term loyalty to a country and will
put out if there are negative changes in the external
environment, for example if the government
increases tax rates, or if better locations emerge.
 Multinationals create employment, but usually the
type of work they provide is low level and the wages
are low.
 The work is very low skilled and is also poorly paid.
 In many cases, the wages paid are at least equal if
not better than the local rates.
 Most small companies have plans to grow their business
and increase sales and profits.
 However, there are certain methods companies must
use for implementing a growth strategy. The method a
company uses to expand its business is largely
contingent upon its financial situation, the competition
and even government regulation.
 Some common growth strategies in business include
market penetration, market expansion, product
expansion, diversification and acquisition.
 Some businesses have grown so large that their
decisions can have a major impact on some national
economies.
 The growth in the number and size of multinational
companies has been a major consequence of
globalization.
 Ethical issues are raised by the ability of these
companies to take decisions that can act against the
interest of the governments of the countries they
operate in – such as paying tax on all global operations
in the lowest tax country they are based in.
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University Press
 Lominé, L., Muchena, M., and Pierce, R. (2014). Business
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Press
 Clark, P. and Golden, P. (2009). Business and management
Course Companion. Oxford, United Kingdom: Oxford
University Press
 Gutteridge, L. (2009). Business and Management for the IB
Diploma. Oxford, United Kingdom: Oxford University Press
 Thompson, R. and Machin, D. (2003). AS Business Studies.
London, United Kingdom: Harper Collins Publishers