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 the following external growth methods:

• mergers and acquisitions [M & As) and takeovers

• joint ventures

• strategic alliances

• franchising

• Explain the role and impact of globalization on the growth and

evolution of businesses

• Outline reasons for the growth of multinational companies (MNCs)

• Evaluate the impact of MN Cs on the host countries

Economies and diseconomies of scale Businesses tha t ex and or increase their sca le of opera tions Gill often use the larger scale to bccom more efficient . Scale of operat io ns-refers to t he size or volu me of o utp ut. When a business increases its sca le o( operatio ns, it produces mor or in greater volume. Wh en a business increases its scale of opera tions and in tl1e process beconics no re efficient, tJ1e business has ach ieved economies of scale. The term "economies of scale" refers to tbe red uction in average unit cos as a business increases in size. However, sometimes a business experien ces inefficiencies as it becomes large r. W hen this situa tion occu rs, th e J

business has achieved diseconomies of,scale, w hich refe rs to an increase in average un it cost as the business increases in size.

Efficien cy is measured in terms or rnsts of production per unir. For a m ore complete expla natio n o f the d ifferent types of cost o f prod uction, refer to Unit 5. For n ow, thin k of costs of produ ction w ith the fo llowin g formula :

Total costs = fixed cost + variable cost

Using the abbrevia tio ns TC for to tal cost, FC [o r fi xed cost a nd VC fo r variable costs, the form ula is:

TC = FC + VC

Fixed costs a re costs tha t do n or change as production changes. For example, if a business operates in a rented (leased) factory, the mo nthly rent paymen ts are the same regardless of the quamity of production of the busin ess . Variable costs are costs tha va ry as production changes.

66

BUSINESS ORGANIZATION AND ENVIRONMENT

For example, if a furniture manu[acturer expa nds prod uction, the n it wil l require mo re raw m ateria ls (wood, me ta l springs, cloth, leather, etc.) .

Further costs a re known as average costs or unit costs or average unit costs. All three refer to total cost per uni t, which can be calculated with the [ollowing [ormu la:

Average cost = t~tal cost quantity produced

Andi [ AC is average cost (Unit costs or average Unit costs) and Q is quan tity produced, the formu la beco mes:

AC = TC Q

As we saw a bove, TC refers to tota l cost, derived from adding FC and VC. Thus, average cost ca n also be ca lculated w ith the fo llowing formu la:

AC= PC+ VC Q

Expressing the fonnu la in th is way he lps to explain the concepts o f econo111ics and diseconomies of sca le. First, as the business expands by p roducing a greater quantity, variable costs increase. However, th e lixed co"SLS arc spread ov· · a grea ter q ua ntity o f u n its produced. As a resul t, the average costs go down. Tl1us. the business becomes mo.re efficient. It has achieved economies of sca le.

So metimes w hen a business expands, it starts to experience ineffi ciencies tha t increase average unit costs.J'b is situa tion refers to diseconomies of sca le. For example, imagine that a business expa nds productio n yea r on year. As it does, it in itially achieves economies o f scale . One reason fo r this is that the fixed cost o f rent is being spread out over a larger number o f units produced. However, at some point in time (if growth continu es), the business will be at its maximum produ ction level fo r th e size o f its factory. It wil l be a t 100 per cent capaci ty utiliza tion (See Unit 5) . The busin ess w ill have to acquire d iffe re nt o r additional space to expa nd produ ction .

In this scena rio, rem ember, the business is expanding year o n year. W h en acquiring d iffe rent or additiona l space - another factory or a larger factory, for exa mple - the business shou ld probably n ot acquire just en ough space for the next year o r even fo r the n ext two yea rs. It sho uld probably acq uire a signi ficantly g reater amoun t of space. Tha t way, the business ca n grow for years to come w ithout having the cost a nd disruptio n o f cha nging locations frequently.

When a business doubles its factory size, its capacity utilization w il l go down (initia lly) and its rent will increase. In our exam ple, in the old facto ry o r old space, the business had 100 per cent capacity utilization . W hen the space is doubled but production remains the same (in itia lly), capacity uti lization w ill decrease from 100 per cent to 50 per cent. The business's rent expense will increase significantly (it w ill probably double). The higher rent w ill now be spread over the sa me (or a s]jghtly higher) number o f units produced. With Lh · h igher rent, initially, the b_us.incss vvill have higher average unit cost. Thus, it w ill hav acbicved diseconom ies o[ scale .

Key terms

Fixed costs

costs which do not change

according to the amount of

goods or services produced

by the business.

Variable costs

costs which increase or

decrease according the

amount of goods or services

produced

As businesses grow, how do

their methods of knowing

(knowing their customers,

knowing the business

environment, knowing their

markets, etc.] change? Are

these changes for the better,

or worse? How are they

different?

Figure 1.6.l shows Lhis progression.

Costs

0

average

~ costs

/ : ~ economies diseconomies

of scale of scale

Optimum production

Quantity

produced

1.6 GROWTH AND EVOLUTION

Figure 1.6.1. Progression from economies of scale to diseconornies of scale

As the business grows, it produces mo re oug)Ut and initially Lhe average costs go down. Cfhc business becomes more eLficicnL After the poin t" of lowest average costs, the business is at "optimum production". In our example using rent as the chief fixed cost, o ptimum production would a lso be the point w here the business is at 100 per cent capacity uti lization. As the business continues to expand, it starts to become m ore inefficient. Average costs sta rt to rise. The minimum point of the average cost curve is the optimum level of production . At chat point, average costs are at the lowest and profits are at their maximum.

Efficiency is not relaLecl to production a lone. A.business ca n become more efficie n t if it can lower average unit costs, regardless of the area o the business in_ whjch tb savings per u ni t occu r.

Table 1.6.1. Internal economies of scale ( efficiencies that the business itself can make]

Type Explanation Example

Technical Bigger units of production can reduce Operating a container ship with one crew, fuel bill

costs because of the law of variable and berthing fee is cheaper than running two or more

proportions - the increase in variable smal ler vessels.

costs spread against a set of fixed costs. Similarly, the A380 passenger airline will be cheaper

to operate than two tradit ional long-haul aircraft; an

articu lated lorry will be cheaper to operate than two or

three smaller vehicles.

Managerial A bigger business can afford to have Managers specializing by function, such as production,

managers specializing in one job as marketing, finance, and HR, as opposed to having a

opposed to t rying to do everything. "general" manager, can typically work with greater

efficiency.

Financial Bigger businesses are less risky than Banks and other financia l institutions charge lower

smaller businesses. rates of interest on loans or overdrafts to businesses

they consider safe.

Marketing Bigger businesses can direct more Only large business can afford sponsorship of major

effective marketing campaigns. sporting events such as the Olympic Garnes, the Super

Bowl orthe Football World Cup, which are especial ly

higher y ielding promotions per dollar, pound or euro.

6?

68

BUSINESS ORGANIZATION ANO ENVIRONMENT

Purchasing Big businesses can gain discounts by Supermarkets such as Wal-Mart or Tesco buy large

bulk buying - buying in large quant it ies. quantit ies of food at very low prices from farmers.

Risk bearing Big businesses can afford to produce Pepsi Co owns a number of different brands such as

a bigger product range and in doing so Pepsi, Gatorade, Tropicana, Lipton's Teas, Quaker Oats,

spread the risk of one product fai ling - and Lays.

hedging their bets.

Table 1.6.2. External economies of scale ( efficiencies that the business achieves

because someone else has expanded]

Type Explanation Example

Consumers A shopping mall increases the number of A shopping mall, an international airport, and a

potential of customers as more people go to the business park or zone all requi re servicing and

mall compared to an independent shop because maintenance as well as their core business.

of the ease of one-stop shopping. So, a whole

range of other businesses benefits from someone

else building the infrastructure.

Employees Labour concentrations - some cities or Hollywood is famous for having many actors

geographic areas concentrate on certain and others ski lled in various aspects of fi lm and

industries or sectors. Individual businesses te levision production.

located in those areas and operating in the London is a major banking centre, where industry that has the concentration can often numerous professionals in financial services live benefit from lower recru iting and training costs. and work.

As we have noted, however, if a business expands too much, then it can acbjeve diseconomies of sca le in the sa me a rea.

Table 1.6.3. Internal diseconomies of scale (inefficiencies that the business itself can make]

Type Example

Technical A container ship can be too big to berth in a harbour, an airplane too big to land at smaller airports, or a lorry too

large to drive on minor roads.

Managerial Businesses may have "over-specialized" managers who cannot [or will not] work outside their area of

expertise or for everyone's benefit, which often occurs in the investment and commercial banking sectors.

Financial Sometimes big businesses with large amounts of"surplus" cash make poor investments. Poor decisions

occur because the businesses do not think through the consequences of investment choices - Singapore

Airlines bought a 49% stake in Virgin Atlantic for US$ 965 mill ion in 1999 but in 2012 sold its stake to

Delta Airlines for US$ 360 million.

Marketing Sometimes big businesses can make big marketing mistakes. In the 1990s, Hoover offered free flights to anyone who spent more than US$150 on a vacuum cleaner. Hoover did not realize that, for many

people, an expensive vacuum cleaner was worth buying if it included a free flight anywhere in the world!

When Hoover refused to honour the deal, the courts ordered the company to pay US$ SO million in

compensation to customers. Weakened by this expense, Hoover was acquired by a competitor, Candy.

Purchasing Large businesses often buy too much stock, which can be costly if the capita l funds used to purchase

the stock are greater than the cost savings from buying in large quantities. Stock can also become spoilt ,

obsolete or unfashionable. The first stock market crash was as a result of too many tu lips being bought by

Dutch traders in the 17th century.

Risk bearing In 2005 eBay bought Skype in the hope of broadening its range but in 2011 sold it to Microsoft.

1.6 GROWTH ANO EVOLUTION

Table 1.6.4. External diseconomies of scale [inefficiencies that the business

achieves because someone else has expanded]

Type Example

Employees If one geographic region becomes too concentrated on one

economic activity, typically a shortage of skilled workers in

the industry wil l occur. For an individual business this re lative

shortage of skilled workers means that the business wil l have to

pay higher wages than before to attract and retain skilled workers.

The merits of small versus large organizations Not all businesses want to expand. Many busin esses simply prefe r to

rema in sma ll. Som e business owners do not wa n t th e headache of growing their busin ess o r managing a la rge business.

Man busi n esses offerin g high-end products (h igh-qualiLy, specia lized prodlLcts) a nd service businesses prefer to stay close to their markets a nd thei r cl ie nts. For example, among th e man y tent manufacture rs, on ly a few make "porta ledges", w h ich are portable hanging tents used b y big-wall climbers. Serving this nich e ma rket m eans that th e m anufacturers stay close to the ir small pool of customers and remain entrenched in th e culture of big-wall climbing.

Many professional firm s also prefer to s tay sma ll. In the legal secto r, some law firms a re large multinational compan ies, but a ro und th e world ma ny small practices ex ist, their lawyers preferring to serve a sma ll group o f fam iliar clients. In accountancy, four major firms serve clients arou nd the world - the so-called Big Four. However, coumless small accouming firms serve the n eeds of sm a ll businesses everywhere in the world.

Advantages of being a big business These are so me of the advantages o f be ing a big business:

• Survival - large firms have a greater chance of surviving. Th ey a re less like ly to fa il and less like ly to be take n over by a n o ther firm.

• Economies of scale - large firms typically enjoy economies of scale, wh ich translate into greater profits, higher returns, and a healthier balan ce sheet.

• Higher status - large fi rms have greater status than smaller ones. However fash ionable some clothing brands may be, working for a larger firm such as Abercrombie & Fitch or Benetton can provide status to em ployees and can motivate managers a nd other employees.

• Market leader status - McDonald's is the market leader in fast-food restaura nts in most of the industrial worl d. All by itself, M cDonald's can shape market habits, giving it a competiti ve advantage.

• Increased market share - la rge com panies tha r b ave a large market sha re can con trol the market by detcJJn ining pricc.s a nd d eciding which services will be th e ind ustry sta ndard.

This 'portaledge' tent is an example of

a niche market product

69

70

BUSINESS ORGANIZATION AND ENVIRONMENT

Advantages of being a small business • Greater focus - because customers do nor expect smal l business to

"be a ll things to a ll people", small businesses can focu s investments wh ere they want and w he re they be lieve the greatest pro fi tability lies. They may have lower profits than la rger businesses but often they ha ve g reater profitabil ity a nd high er re wrns o n investment.

• Greate r cachet - sma ll businesses som etimes have more cachet, a greater ·l'.ns a f exclusiveness, tha n larger businesses. As a result, some sma ll businesses a re able to cha rge m o re for thei r goods and services, leading to h igher profi t margins.

• Greater motivation - having more prestige ca n motivate managers and other employees. Sometimes, as well, employees are motivated by the idea that they matter to the business. Very large businesses sometimes have a hard time conveying the sen se that all em ployees matte r.

• Competitive advantage - being sm all, providing a mo re pe rsonalized se rvice, and being fl exible can give a competitive advantage.

• Less competition - sometimes a market is so small (a true n iche marker) that big businesses do no t even wa nt to consider getting involved. This situation o ften m ea ns a market w ith limited competition.

The difference between internal and external growth Businesses w ith growth as a strategy have two broad o ptio ns LO

choose from :

• inLcrnal (organic) growth

• externa l (fost-track) growth .

Jnternal growth is often known as organic g rowth beca use iL o ccurs slowly and steadily a nd occurs o ut o[ the existing operations of the business. Although it may ta ke a lo ng time, a business ca n grow this w ay with ou t taki ng many r isks. The business e xpa nds by simply selling more products o r by developing its product range. Althougb m ost businesses that are grow ing rn re rna lly stil l h ave ro borrow money from banks for m ajor capita l outlays, such as to upda te or expand property, p la nt, a nd equ ipmem, most of tbe expansion from interna l grow th is self-financed using reta ined profits.

External growth is a quick and riski e r m ethod of growth than interna l growth. Instead of selli ng more ol,i_ts own producrs itself, the business expands by enterin ,, into so me type of arra ngement to work w ith a;1othc.r business, such as:

• • • •

a m erger and acq u isitio n o r takeover (1vl &- A)

a joiJl venLUre

a strat egic a lliance

a fra nch ise .

1.6 GROWTH ANO EV OLUTIO N I Externa l growth usually requi res sign ificant ex te rnal AnJncing. Altho ugh the risks a re greater, the potentia l rewa rds are that th e business ca n increase marke t sha re and decrease competition very q uickly.

External growth methods The re a re many ways of ex panding externa lly but some of the most commo n are as fo llows:

M &As This type o f ex pa nsion occurs w hen two business become integrated, either by joini ng togeth er and form ing a bigger combin ed business -a m erger - o r by one business rak ing over rhe o ther - an cquisition . When the acqu isition is unwa nted by the company being acquired, the te rm typically used is "ta keover" o r "hosti le takeover".

One result of a merger, acqu isition, o r takeover is the same: on e bigger business . However, the underlying business reason fo r the integra tion can va ry. In gene ra l, integra tion occurs for one o f the fo llowing four reaso11s, a lth o ugh th e p rocess is very d iffere nt.

Integra tion can happen in fo u r ways:

• Horizontal integratio n occu rs w hen the two businesses integrated ar · not merely in the same industry broad ly bur actua ll y · 1 the same line of business and in the same cha in o r production (as o u tli ned in Unit 1. 1). Th e I ta lian ca r ma ke r Fiat's acq uisition o r Ch rysler Mo tors was a n exam ple of h orizontal integration.

• Backw ard vertical in tegration qccu rs w hen one business inu:g rates w ith a nothe r business fu rth er back (a t a n ea rl ier stage) in the cha in of production. 13ackward vertica l .integra tion usua lly occurs wh en a business wants to proteCL its supp ly chain. In 2008, for example, Sta rbucks bought a coffee ma n u factu rer, The Clover Brewing System, to make su re Sta rbucks had control over processi ng the coffee beans.

• Forward vertical integration occurs w he n o ne business int egrates further forwa rd (to a la te r stage) in the chain of produ ction. folWard vertical integration usually occurs w hen a business wants Lo ensure a secure o utl et for its p roducts. fo r example, in 2002 the Walt Disn ey Corpora tion (D isney) m erged w ith the major US te levision broadcasting a n d m ultimed ia company, America n Broadcasting Corpora tion (ABC) . The combined fi rm, Disney- ABC Television Group, en sures tha t Disney has a secure televisio n a nd m ulti media o utle t for its prod ucts (and provides ABC wi th an add itiona l supplie r o f high-q uality programming) .

• Conglomeratio n occu rs wh en two businesses in unrelated lines o f busin ess integra te . Th is type o f in tegratio n is also known as diversification and occu rs for n1any reasons but mainly to reduce overall corporate risk . fo r example, the Ind ian com pa n y Tata Group h as amo ng its man y businesses Ta ta Chemicals, Ta ta Steel, Ta ta Television , Ta ta Motors and Taj Ho tels. H a ny one of the businesses -the che m ica l busin ess o r the steel busin ess - were to fa il, Tata Group wou ld still have successfu l businesses in o the r ind ustries.

INNOVATION When two businesses are

integrated, they find themselves

sharing ideas, people and

resources.

How might this encourage

innovat ion?

?1

?2

BUSINESS ORGANIZATION AND ENVIRONMENT

Another reason that a business may diversify is to have complementary seasonal activity. If a business that does m ost of its sales in the summer months purchased a business that had most of its sales in winter months, the new, combined enterprise would not have long periods of inactiv ity.

Integra tion has many advantages for busiocsse~ includi ng--econnm ies o f sca le, complem e nta ry activ ities. and conuol up or dow.J1 the chain o f product ion. However, M & As can be costly and typically include, in addition to the cost of the business be ing acqu ired, high lega l and consultin g fees . Sometimes w he n one compa ny acquires or combines with anothe r company, especia ll y if th e takeover is hostile, a cu lture clash occurs. Employees from the two companies do not work well together.

Joint ventures Jo int ve ntures occur when two businesses agree to combine resomces lo r a specific goal a nd overc1 finite period o f time. As a resul, , sepa rate b usiness is created with fund ing by the two "parent" businesses. Afte r the defined time period is over, the new business is e ither dissolved o rincorporated into one o f the parent businesses, or the two parent firms decide to exte nd the time frame. Altho ugh a joint venture may be temporary in nature by open ing up new a reas of business, considerable tra nsfer o f specialist skills can occur. This transfer of skills, knowledge, a nd expertise could benefit -eithe r party in th e future. Sometimes in a joint venture one of th e partners begins to pla y a dominant role and then bu ys o ut th e other.

Examples o f joint ventures include Sony-Ericsson (2001-2012 ), Channel Tunnel Group-France-Manche ( 1985-J 994), New Zealand Post-DHL 2004-20 12), and BMW - Brilliance (formed in 2003 a nd ongoing) . Joint vcutures hav ::the advan tage that the two fLrrns typically enjoy greater sa les, but ne ither loses its legal existence o r its identiLy. Joint ven tures a lso have the ad va ntage that thc two businesses fo rm ing the joint vc_11ture ca n bring diffe rent a reas of expert ise, in combination wi th w h at the othe_r business brings, to create a pow<::rfu l combina tion . However, sometimes joint ventures do no t produce the desi red outcome o r a company rea lizes that it could have accomplished what the joint venture is doing w itho ut having to share the profits with the other com pany. At least conceptually (tho ugh not a lways lega lly} , a joint ventur · is a pa rtnership. All 12a nnerships run the rislctha t a disagreement between partners w ill occur. ometimes a disagreement may be so severe tha t the effectiveness o f the pa rtnership is compromised or the partne rship (or joint venture) breaks apart.

Strategic alliances Strategic a lliances a re similar to joint ventu res beca use they involve businesses collabo ra ting for a speci fied goa l. Howeve r, strategic a lliances differ fro m joint ventu res in several fundamental ways:

• More than two businesses may be part of the a lliance. Strategic alliances o ften, tho ugh no t a lways, invo lve mo re than two businesses. In the a irline industry, the Star Alliance has 27 a irlines, including Singapore Airlines, Lufthansa, South Afri ca n Ai rways and United, in the a llia nce.

The Channel Tunnel, which links the UK and France, was built as part of a joint venture

1.6 GRO WTH ANO EVOLU TI ON

• No new business is created . No new legal enti ty comes into existen ce but rather a sLra tegic a lliance is typica lly an agreem en t to work Logeth er for mu tua l benefit.

• Individual businesses in the alliance remain independent. The existing businesses may agree to sha re resou rces bu t they rema in indepen dent and often oth erwise compeLe against each o ther.

• Strategic alliances are moreJluid than joint ventures. rn <1

srrategic alliance, m embership ca n change w ithout destroying th e a ll ia nce.

All of these strengt hs are also weaknesses. The more businesses that a re involved in a strategic all iance, the more cha llenging coordinatio n and agreemem becomes. Wi th ou t lega l e xistence, the a lliance has less [orce than a lega lly extant enterprise. Individual businesses may gain benefit from the all iance (presumably they think they will, o therwise why woul d they join the allia nce? ). However, remain ing independent means that the ind ividual businesses do not get the capital strength of legal merger w ith othe r enterprises, n o r do Lhey enjoy economies of scale that o ther fo rms of cxt~al g rowth 11 rovidc . Lastly, g reater Oujdit y of members a lso means th a t th e all ia nce lacks stabilLty.

Franchises Franchising, another form o f external growth, is becoming i1icrea singly popular fo r bu sin esses tha t want to expand globa lly. Fra nchising in volves th e following:

• An original business, known as the franchisor, that developed the business con cept a nd prod uct, then sells to oth er businesses the right to offer the concept and sell the product.

• Bu sinesses, known as the franchisees, buy the right to offer the conce(lt a nd sell the. product. In other words, the franch isee se lls th e -products developed o rigina lly by the fra nchis6r. The fran ch isee usually a lso has LO be consistent w ith , a nd in some instances identica l to, th e origina l business concept developed by the franchisor.

A business that sta rts LO fra nch ise is the franchisor. Franchising is o ften a rapid form o f growth beca use the fra nchisor does nor actua ll y have to 1rod uce a n ything new. Instead, the busin ess (the franchisor) se lls that righ t to o th e r businesses (theJ:rand1isees). Franchisees can be individ uals, pa rtnershi ps, o r companies. Franchisin g is proving particu larly attractive as a means to grow globally. Th e franch isor has a host or home coumry. The franch isor ca n then sell LO other businesses in th e othe r places where it wams to expand - as long as it finds buye rs of the concept of th e enterprise. The lranchisees typically have know ledge of locahnarke ts, loca l condit ions, a nd local cultures. Fran chisees a lso know loca l languages, which is especially h elpful if the franch iso r wa nts to grow in ma ny countries of the world.

There are ma ny examples of franchises in many di ffe rent a reas of business, incl uding:

• McDon alds - fast food

• Budget - car h ire

?3

74

BUSINESS ORGANIZATION AND ENVIRONMENT

• Hilton - hote ls

• Kum a n - educa ti on

• Blockbuster - e ntertainme nt

• Wokinabox - fast food

• Spar - food sto res

• Benetton - cloth es

• Bod y Sho p - cosm eti cs

• Eda - fas t food .

The cost of the fra nchi se comes in two pa rts. First, the franchisee must pay for rh e fra nchise itself - essen ti a ll y a right to operate a business offering the fra n ch iso r's concep ~ d product. Then the franchi.sec: mus typica lly pay roya ltits - a percentage o sales or a flat fee - w hich goes to the fr anchisor. Both t h e fra n ch iso r a nd th e fra nchisee ha ve specifi c respo nsibili ties in th e ir re lat io nship . These respon sib il ities va ry somewhat acco rdi ng to ind iv idual business concepts a nd industries. For exam ple, McDo na ld's franchisee agreem ents wo uld no t be exactly th e sa m e as those of Yum! Brands (KFC, Taco Bell , and o th er resta ura n ts), nor exactly the sa m e as th e franchise agreement fo r Enterprise Rental Cars. However, in genera l, th e di visio n of respo nsib ilities be tween fra nchisor and fra nchisee a re

as follows.

The franchisor will provide : The franchisee""Wil l:

• the stock • employ sta ff

• the fi LI i ngs • set p r ices

• th e unifo rms • set wages

• sta ff tra in ing • pay a n agreed roya lty on sa les

• lega l and fi na ncial he lp • crea te loca l promotio ns

• globa I advertis ing • sell o nly the prod ucts of the

global prom otio ns fran chiso r

• • advertise locally .

Which pa rLy provides th o utl e t and wh ich party p rovides the sta rt-u p costs can va ry cons id e rabl y-accord ing 10 th e strength of th bra nd . Some brands, s uch--as McDona ld's, ar especially s tron . Onl y very ra re ly does a M cDo n a ld 's resta urant close. A n ew McDona ld's res ta urant is a lm ost certa in im m edia te ly to have strong nam e recogni tio n an d hig h sa les, so th franc hisor is in a s1rong posit io n LO d ictate the te rm s o f ow ning a Mc":Do na ld's franchise. Ot her bra nds have less m a rket powe r. ln those c ircu m stances, the fra nchi so r may have less ba rgain ing st rengt h when settin g th e righ ts a nd responsibili ties of the fran chisor an d fra n chisee .

For businesses (rega rdless of lega l organ iza tio n) , acq u ir ing a franch ise has m any adva ntages and d isadvantages compa red to developi ng their

An outlet of Spar in Berlin, Germany

1.6 GROWTH AND EVOLUTIO N

own business model. For the franchisee, advantages a nd disadvantages a re as follows.

Advantages

• The product exists and is usual ly well know n.

• The formal for selling th e product is established.

• The set-up costs a re reduced .

• The franchi see has a secu re supply of stock.

• The fra nchisor ca n provide lega l, financia l, manageria l, and tec-Oica l help.

Disadvantages

The franchisee:

• has unlimited liability fo r the fran ch ise

• has to pay roya lties to the fran chisor

• has no control over w ha t to sell

• has n o co ntrol over supplies

• makes all th e global decisions.

Fra nch isors a lso have adva ntages and disadvan tages.

Advantages

The franchisor:

• gains quick access to wide r ma rke ts

• makes use of local knowledge and expertise

• does not assume the risks and liability of running the fran chise

• gains more profi ts and the sign-up fees.

Disadvantages

The franchisor:

• loses some control in the day­to-day running of the business

• can see its image suffer if a franchise fails or does not perform properly.

Do som e franchisees eventua lly become tired of the control of the pa rent company? Pe rhaps, but by then, the operators of the franchise may have eno ugh expertise to start the ir own independent business. On the o ther hand, many franchisees, even if tired of th e control of the franchisor, enj oy the grea t profitability that ca n com e with a successful franchise. Regard less, fo r the fra nchisor, sellin g fra nchises is an easy and fast way to break into new markets with a minimum of difficu lty a nd risk a nd is a way to gain an advan tage ovex i ts com peti to rs.

The impact of globalization Globalization has had significant impa ct on businesses' growth and evolution. Globaliza tion is the process by w hich the world 's regional economies are becoming on e inregraLcd global unit. The process is not w h olly new. The Roman Empire, the Silk Road, the Age of Exploratio n, the Brit ish Empire and other historica l exa mples and pe ri ods saw some degree of econo mic global interdependence. Neve rtheless, inc· the Seco nd World War, th e phenomenon known as "globalizalio11" is different from earl ier fo rms of interdependen ce.

First, ju st in te rms of in tensity, sca le, speed, a,nd economic va lue o f goods and services being exchanged, globa l interdependence today · on a

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completely different o rder o f magnitude from tha seen in earlier peri ods or ci rcu 111s1,rnces.

Second, curren t glo baliza t io n is being characte rized by a re lati ve ly small numbc.r of exr rem ely large "post-n a tional " businesses. Post ­n a tio nal mea ns tha t, a l tho ugh the.se compa nies have a home or record (the "home" o ffice is legall y regis te red in o ne country), 1h businesses a re othe rwise rra nsnational; apa rt from the lega l ho me of record , th ese businesses con sider no place the ir ho me o r every place their hom e . They w ill do business where ve r they can m a ke a p ro fit. Loya lties a re to th e company itself, and to its profits, and not to an y country.

Globa lization can have a sig nificant impact o n the growth o f domestic businesses for th e fo llo wing reaso ns:

• ncreased competition - large fore ign businesses can force do mesti c produce rs to become more e fficien t as th e domestic con sum e r has more choice. "G reate r e ffi ciency" can m ean low er­cost goods and services for cons ume rs . Howe ver, one wa y that businesses become m o re effi c ie n t is by slowing th e g rowth in w ages o f its w o rkers a nd e x tracting g rea ter p rod uctivity o ut o f them.

• Greater brand aware ness - domestic produce rs h ave ro compete with big b rand names and so n eed to create their own unique selling point (USP). So m etimes they do this by emphasizing the local o r national origins of their products compared to the "fo re ign " p roducts so ld by mu lt inationals and global firms. Regardless, c rea ting a USP, even if fo rced 10 do so, can make ma ny businesses m ore competitive and effici ent.

• Skills transfer - fore ign businesses, no matte r how big, must use some loca l kn owledge : a t least some o f their workforce must be local , wh ich will lead to a two-way tran sfer of knowledge and skills. The multina tional o r globa l fi rm w ill learn fro m th e workers hi red in pa rticula r countries, w hile th ose workers can learn new approaches a nd develop new ski lls.

• Closer collaboration - whethe r through jo int ventu res, fra nchises, or strategic a lliances, do mestic producers can create new business o pportuni ties.

Reasons for the growth of multinational companies A mu lti na tio nal co mpan y is a busin ess tha t o pe rates in more tha n o n e country o r is legally registered in m o re than o ne country. The connotation of the wo rd "multinatio na l" may be global or opera ting in m a ny countries, but m u ltina tional has a narrower m ea ning . A sm all compa ny operating in the small countries o f Luxembourg and Belgium is a mu ltina ti onal, whereas a la rge compan y registe red in a nd opera ting on ly in the United States is no t.

M ultinationa l companies ace. the biggesr type o f business a nd in fact they o ften ge nera te m o re revenu es than the country they o pera te in .

1.6 GROWTH AND EVOLUTION

For example, Table 1.6.5 shows a compariso n of the w o rld's leading countries and businesses in terms of GDP and sales revenues.

Table 1.6.5. The world's leading countries and businesses - GDP and sales revenues

Rank Economy US$ millions Rank Economy US$ millions

1 United 14,991,300 18 Turkey 774,983

States

2 China ?,318,499 19 Switzerland 659,308

3 Japan 5,86?,154 20 Saudi Arabia 5?6,824

4 Germany 3,600,833 21 Sweden 539,682

5 France 2,??3,032 22 Poland 514,496

6 Brazil 2,4?6,652 23 Belgium 513,661

? United 2,445,408 24 Norway 485,803

Kingdom

8 Italy 2,193,9?1 25 Royal Dutch 484,489

Shell

9 Russian 1,85?,??0 26 Exxon Mobil 452,926

Federation

10 India 1,84?,977 2? Wal-Mart 446,950

Stores

11 Canada 1,?36,051 28 Austria 41?,656

12 Spain 1,4?6,882 29 South Africa 408,23?

13 Austra lia 1,3?9,382 30 BP 386,463

14 Mexico 1,153,343 31 Sinopec Group 3?5,214

15 Korea, Rep. 1,116,24? 32 United Arab 360,245

Emirates

16 Indonesia 846 ,832 33 Thaila nd 345,6?2

1? Netherlands 836,0?4 34 Denmark 333,616

Source: Adapted from World Bank & Fortune Global 500, 2011

Four factors have a ll owed multinatio nal com panies to grow so rapid ly and w ith such a reach:

• Improved communications - not on ly ICT bu t also transport and distribution networks

• Dismantling of trade barriers - allowing for easier movemelll of raw ma te ria ls, compo nents a nd finished products

• Deregulation of the world's financial markets - allowing for easic.r tra nsfer o f fu nds and also tax avoidance

• increasing economic and political power of the multinational companies - which can be o f enormo us benefi t especially in middle- and Low- income coumr ies.

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The impact of multinational companies on the host countries Multina tio nal compa nies can have both positive and negative impacts on the host (domestic) countries in which they operate.

Advantages for the host country include: Disadvantages for the host country include:

• economic growth - multinational companies • profits being repatriated - the multinational can boost the domestic economy by providing companies may pay into the local tax system but the employment, developing a local network of suppliers, bulk of their profits will be rerouted away from the host and paying taxes and providing capita l injections. country.

• new ideas - multinational companies may introduce • loss of cultural identity - the appeal of domestic new ways of doing business and new ways of products, ways of doing business, and even cultural norms interacting socially. may suffer. This is especially important forthe younger

generations who are more likely to buy global brands.

• skills transfer - multinational companies may help • brain drain - many highly skil led employees may develop the skills of local employees. Domestic look to work for the multinational company in another businesses can benefit from starting their own country. business with the skills learned.

• more choice of products - the domestic market will • loss of market share - as multinational companies benefit as the variety of products wil l increase. take over more of the domestic market, domestic

producers may suffer.

• short-term infrastructure projects - multinational • short-term plans - multinational companies may not companies often help to bui ld infrastructure [for plan on staying for a long time - if lower-cost producers example roads to the factory, schools for workers' can be found elsewhere, they may move out at short children]. notice.

Revision checklist ✓ An econom y of sca le occurs when the costs of a business go dow n

as the business grows. For example, if a publisher prints 7000 books they might be able to negotiate a ch eaper p rice for paper than if they only printed 500.

✓ The reverse of this is a diseconomy of sca le - wh ere Lhe cost goes up as the business gets la rger i.e. Lhe business becomes less efficient.

✓ Small o rgan izations might benefi t from greater focus, greater cachet and motivation, competitive advantage and less competitio n.

✓ Large organ izations m ight benefit from economies o f scale, market­leader status, and high market share.

✓ Interna l (or o rganic) growth is the gradual expansio n of a business from within.

✓ External growth can be q uicker and riskier. A business might experience Lhis son of growth through a merger with anothe r compan y or an acquisition, through a joinL venture of through franch ising.

✓ Multinatio na l compa nies (MNCs) operate in more than one country.

✓ Due to improved communication a nd less restricting regu lations, Lhe number a nd size o f MNCs has grown rapidly in recent years.

✓ MNCs h ave both positive and negative effects on Lhe countries in wh ich th ey operate.