Business Growth

Why do businesses grow?

Profit motive

Businesses grow to make more profit by increasing revenue. Selling more to more people often means profits increase.

The valuation of a company's share is often influenced by how it is expected to do in the future (ie how much profit it is likely to make). When it is projected to do well, share prices increase, and it is valued more highly on the stock market. This provides incentive for companies to increase profits, doing well on the stock market increases investment and raises more money.

Cost motive - economies of scale

When firms are larger, relative costs are smaller. This is because some costs are fixed, so if you are a larger company, producing larger output, the cost per unit will decrease.

e.g. If a T-shirt factory's main cost is the £10,000 to rent to factory each month, and it produces only 1000 shirts a month, each shirt costs £10 to make. But if it scales up and produces 100,000 shirts a month, each shirt will only cost 10p to make.

This decrease in unit cost helps increase profit margins at a given market price for the company.

Market power motive

Larger companies have more power in the market, so are more able to set market prices.

e.g. Apple

Market dominance.

Risk motive

Larger companies are more able to diversify production into different markets or countries. This may manifest itself in multiple product lines or overseas branches. Operating in multiple markets reduces risk for the business, because it is no longer relying on a single market or even single product, so if sales fall in one market, growing demand in another market may compensate for this.

This can also mean the business is more likely to take future risks, as there is already enough revenue to fall back on if the venture fails.

Managerial motives

The motive for managers to want to expand a business is that in larger companies, owners do not have as much control over managers, so they have more influence in the company. Managers do not get the share of the profit that owners do, they get a wage, so do not operate by the same incentives. Managers want prestige and power, whereas shareholders and owners want more money. This misalignment in incentives is known as the principle agent problem.

More here and here

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