Managing Issues Caused by Growth (AQA A Level Business): Revision Note

Economies of scale

• As a business grows, it can increase its scale of output generating efficiencies that lower its average costs (cost per unit) of production

  • These efficiencies are called economies of scale

  • Economies of scale help large firms to lower their costs of production beyond what small firms can achieve

Economies of scale

• With relatively low levels of output, the businesses' average costs are high

• As the business increases its output, it begins to benefit from economies of scale, which lower the average cost per unit

• At some level of output, a business will not be able to reduce costs any further

  • This point is called productive efficiency

• Beyond this level of output, the average cost will begin to rise as a result of diseconomies of scale

Types of economies of scale

• Internal economies of scale occur as a result of the growth in the scale of production within the business

  • The firm can benefit from lower average costs (AC) generated by factors from inside the business

Types of internal economies of scale

Diseconomies of scale

• Diseconomies of scale occur when a company grows too large, making it difficult to manage and control its operations

  • It may face challenges in coordinating its various departments, managing its workforce, or maintaining quality control

  • The cost per unit increases as a result of these inefficiencies

Common diseconomies of scale

Managing diseconomies of scale

• A business can manage or reduce diseconomies of scale in a range of ways

1. Decentralise decision-making

   • By organising operations into divisions or profit centres, each with its own managers and targets, the business can speed up decisions

2. Invest in communication systems

   • Planning software can give managers instant access to data from across the firm

   • Clear, shared information reduces coordination errors and prevents the slow communication that often increase overhead costs.

3. Strengthen employee motivation and culture

   • Introducing schemes such as performance-related pay, team-based goals, flexible working and regular feedback sessions keeps staff engaged in a large organisation

   • Higher motivation lowers absenteeism and labour turnover, helping the business maintain productivity even as the workforce grows

Economies of scope

• Economies of scope occur when it is cheaper, on average, for one firm to produce a range of different goods or services together than to make each of them in separate, stand-alone businesses

• Savings come from sharing resources such as buildings, distribution networks, research teams or marketing across several products

Examples of economies of scope

Synergy

• Synergy is the extra value created when two businesses combine their resources so that the joint result is greater than the sum of what each could achieve alone

  • The gain might come from lower costs (cost synergies) or from higher sales (revenue or product synergies)

Examples of synergies

• However, synergies may be difficult to establish and maintain for several reasons

  • Cultural clashes

    • Synergy relies on people sharing ideas, data and resources

    • If the two workforces have very different ways of working, they may resist sharing or simply misunderstand each other

    • Projects may stall and expected savings may never materialise

  • Integration costs

    • Bringing systems, brands or supply chains together often costs more than projected

    • New IT links, training, redundancy payments and legal fees can spiral, reducing cost savings or extra sales that were expected

Overtrading

• Overtrading happens when a business tries to grow faster than its working capital resources can support

  • It may accept more orders than it can manage, open sites by borrowing heavily or take over other businesses without careful evaluation

• Cash is tied up in stock or unpaid invoices, but wages, suppliers and interest must still be paid on time

• The result is a cash flow squeeze that can force the firm to borrow at high cost, sell assets in a hurry or, in extreme cases, fail

Recent examples of overtrading

Carillion Plc	Covivilaity Plc
The construction company signed many large contracts with payment terms stretching beyond 120 days Up-front costs on these projects drained cash faster than income arrived, creating a severe cash flow problem It entered liquidation in 2018 , owing £7 billion with only £29 million in cash	Between 2013 and 2017 the drinks wholesaler/retailer bought several rivals, pushing annual sales above £1.6 billion but stretching its cash flow A surprise £30 million tax bill in early 2018 could not be paid, and the company entered administration within weeks

Ways to avoid overtrading

1. Cash-flow planning

   • If the cash flow forecast shows a future shortage, the business should slow its growth by delaying opening a site, ordering less stock, or postponing recruitment

2. Arrange short-term finance as a safety net

   • A business could look to secure an overdraft or short-term loan before taking on large new orders

   • With credit already approved, the business can cover wages and materials even when customers pay later than expected

3. Tighten cash control

   • Bring cash in faster by issuing invoices promptly, chasing late payments and asking for deposits on large jobs

   • Delay cash outflows by negotiating longer payment terms with suppliers and leasing expensive equipment instead of buying it outright

   • Hold less stock by placing smaller, more frequent orders so less money is tied up in inventory