What this lesson teaches
I can explain the strategies firms use to raise revenue or cut unit costs: growth, pricing, price discrimination, innovation, marketing and collusion.
Syllabus 9570, 2.2.3(a). Firms' Decisions and Strategies: Firms make decisions and engage in pricing, cost and product differentiation strategies aimed at raising revenue and/or lowering unit costs. These include:; growth, diversification and shut-down; price competition; third degree price discrimination; innovation, research and development; marketing; collusion with other firms
Make a guess
A bakery chain whose shops are busiest at weekends starts a weekday catering service. What is the main benefit?
- Its costs must fall, because it is now bigger.
- Its income becomes steadier, because the busy times differ.
- It gains control of the catering market by using its brand.
Show the answer
Its income becomes steadier, because the busy times differ.
Diversification spreads risk. If one business has a quiet spell, the other may still earn.
Firms grow to gain economies of scale and market power, and diversify to spread risk.
Firms can grow internally, by expanding their own operations, or externally, by merging with or taking over another firm.
Growth can bring economies of scale, stronger buying power and more market power. It can also bring diseconomies of scale and heavy borrowing.
Diversification means moving into new products or markets. It spreads risk: if demand falls in one market, the firm still earns in others.
Many Singapore firms grow by expanding overseas, because the domestic market is small.
- Internal growth
- Expanding its own operations.
- External growth
- Mergers and takeovers.
- Diversification
- Spreads risk across markets.
Worked example: A bakery adds catering
A bakery plans to add a catering service. Catering demand peaks on weekdays, while its shops are busiest at weekends.
- The two businesses have different busy periods, so income is steadier.
- It can buy ingredients for both in bulk, a purchasing economy of scale.
- But catering needs different skills, vans and staff, so costs and management effort rise.
- Growth is worthwhile only if catering's extra revenue exceeds these extra costs.
Watch out for this
Diversification always lowers costs.
Its main benefit is spreading risk. It can raise costs if the firm has to learn new skills and manage unfamiliar markets.
Check your understanding
Why might a firm diversify into a new market?
- To cut its average cost by making more of the product it already sells.
- To focus on fewer products, so managers can specialise in what they do best.
- To spread risk, so a fall in demand in one market hurts it less.
Show the answer
To spread risk, so a fall in demand in one market hurts it less.
Right. Earning in several markets makes income more stable.