Tutorial 8Solutions 15-16

8th Tutorial Growth Strategies Solutions True or False 1. Exploiting economies of scale is a reason for horizontal growth. True. Horizontal growth occurs when a firm grows at the same stage of production. Building a new or bigger production facility would be an example, as would a merger. Economies of scale are often proposed as a motive for such mergers. See section 7.3 of Begg and Ward. True/False 2. The total costs of the firm are the sum of production and transaction costs. True. The costs to the firm are the costs of using land, labour capital and enterprise, plus the costs of organising transactions with these inputs. See section 7.4 of Begg and Ward. True/False 3. Rationalisation is associated with cost cuts. True. Rationalisation is associated with cutbacks in excess resources in the pursuit of increased operational efficiencies. See section 7.3 of Begg and Ward. True/False 4. Outsourcing is an example of vertical contraction. True. Outsourcing is the purchase of inputs from another company and so represents a vertical contraction of activities. See section 7.4 of Begg and Ward. True/False 5. Horizontal growth fosters competition. False. If horizontal growth occurs through the takeover of a rival, then competition is reduced. See section 7.3 of Begg and Ward. True/False Question 1 Define horizontal, vertical, and diversified growth and outline the benefits and problems associated with each expansion activity. Students should be aware that there are three major growth strategies: Horizontal growth - the expansion of a firm’s activities at the same stage of the production process. Vertical growth - the expansion of the firm up or down the value chain incorporating more than one stage of the production process. Diversified growth - the expansion of the firm’s activities into related or unrelated markets. Horizontal growth promotes revenue enhancements by not only having a bigger market share but also being able to potentially influence prices. Through the merger or acquisition of a rival, the elasticity of demand must fall and the potential to raise prices increases. Moreover, through economies of scale and the positive effects of learning average costs can fall. Vertical growth is often motivated by considerations of production costs, whereby consecutive stages of the value chain could be merged if production and transaction costs have the potential to be reduced. Diversification can be mainly conduced to explore economies of scope - synergy effects- and to build a portfolio of activities that will enable the firm to spread the financial risk. For more detail refer to sections 7.3-7.5 in Begg and Ward. Question 2 Define the concepts of transaction costs. Transaction costs are the costs associated with organising the transaction of goods or services. When goods or services are traded, the costs of organising the transaction can range from low to very high. Question 3 Let Y be the level of output of good y and Z the level of output of good z. Write down the condition under which producing jointly y and z guarantees economies of scope. There are economies of scope if a firm can produce several product lines at a given output level more cheaply than a combination of separate firms each producing a single product at the same output level. Hence, there are economies of scope if the cost of producing both y and z separately, C(Y)+C(Z), is greater than producing y and z jointly, C(Y+Z). 1