UNIT 3: BUSINESS BEHAVIOUR – ALTERNATIVE
COMPLETE NOTES
How to Use These Notes
• Each section starts with the key definition (AO1 –
knowledge).
• Then a step-by-step analysis chain (AO3 – analysis).
• Then evaluation points (AO4 – evaluation) highlighted
with EV:.
• Finally example for application (AO2).
Theme 1: Business Growth & Objectives
1.1 Sizes & Types of Firms
Key definitions
• Unlimited liability – owner personally responsible for all
debts. Risk: personal bankruptcy.
• Limited liability – shareholder’s loss limited to investment.
Encourages investment.
• Private limited company (Ltd) – shares sold privately, often
to family/friends. No public stock market listing.
• Public limited company (PLC) – shares traded on stock
exchange. Can raise large capital but risk of takeover.
, • Principal-agent problem – managers (agents) pursue own
goals rather than shareholders’ (principals’) profit
maximisation.
Analysis chain: Principal-agent problem
1. Separation of ownership (shareholders) from control
(managers).
2. Shareholders want profit maximisation → higher dividends
& share price.
3. Managers have their own objectives: revenue maximisation
(linked to salary, status), job security, expense perks.
4. Information asymmetry: managers know more about firm’s
opportunities than shareholders.
5. Outcome: managers may choose lower profit, higher
revenue, or excessive growth.
6. Solution: performance-related pay, share options,
non-executive directors, threat of takeover.
EV: Principal-agent problem is worse in large PLCs with
dispersed shareholding. In family-owned Ltds, owners are often
managers → problem reduced. Takeover threat only works if
market is contestable.
Example: In the 2010s, Marks & Spencer’s managers pursued
expansion into food while clothing profits fell – shareholders
argued this was not profit-maximising.
1.2 Business Growth
Key definitions
, • Organic growth – expanding through firm’s own activities
(new stores, products, markets).
• Horizontal integration – merger with firm at same
production stage (e.g., two car makers).
• Vertical integration (backward) – merger with a supplier.
• Vertical integration (forward) – merger with a
distributor/retailer.
• Conglomerate integration – merger with unrelated
business.
Analysis chain: Why firms grow
1. Economies of scale → lower LRAC → higher profit margins
or lower prices.
2. Increased market power → ability to raise price without
losing all customers.
3. Risk diversification (especially conglomerate) – if one
market fails, others continue.
4. Managerial motives – salary, power, prestige positively
correlated with firm size.
5. Access to finance – larger firms get cheaper loans (lower
risk).
EV: Growth is not always beneficial. Diseconomies of scale can
raise costs beyond the benefits. Conglomerates often trade at a
discount (conglomerate discount) because investors prefer
pure-play companies. Some firms stay small intentionally
(boutique, niche, lifestyle business).
Example: Amazon – organic growth (new products), horizontal
(Whole Foods – actually vertical forward), conglomerate (Twitch).
, 1.3 Demergers
Key definition
• Demerger – splitting a single business into two or more
independent firms.
Analysis chain: Reasons for demerger
1. Value creation – diversified conglomerate may trade at
discount because investors can’t easily value each part.
Demerger unlocks value.
2. Focus – each new firm can concentrate on core
competencies without cross-subsidy.
3. Regulatory pressure – competition authority may require
demerger after a merger is found anti-competitive.
4. Efficiency – different divisions have different optimal
strategies (e.g., one needs high R&D, one needs
cost-cutting).
5. Raise cash – selling a division can repay debt or fund
investment.
Analysis chain: Effects of demerger
• Shareholders – receive shares in multiple companies; may
gain higher total market value.
• Managers – clearer responsibility; may lose synergies (e.g.,
shared HR, purchasing).
• Workers – possible redundancies if duplicate roles
eliminated.
• Consumers – possibly more competition if demerged firms
operate in same market; possibly less if they specialise in
different niches.
• Suppliers – lose bargaining power (no longer dealing with
one large buyer).
COMPLETE NOTES
How to Use These Notes
• Each section starts with the key definition (AO1 –
knowledge).
• Then a step-by-step analysis chain (AO3 – analysis).
• Then evaluation points (AO4 – evaluation) highlighted
with EV:.
• Finally example for application (AO2).
Theme 1: Business Growth & Objectives
1.1 Sizes & Types of Firms
Key definitions
• Unlimited liability – owner personally responsible for all
debts. Risk: personal bankruptcy.
• Limited liability – shareholder’s loss limited to investment.
Encourages investment.
• Private limited company (Ltd) – shares sold privately, often
to family/friends. No public stock market listing.
• Public limited company (PLC) – shares traded on stock
exchange. Can raise large capital but risk of takeover.
, • Principal-agent problem – managers (agents) pursue own
goals rather than shareholders’ (principals’) profit
maximisation.
Analysis chain: Principal-agent problem
1. Separation of ownership (shareholders) from control
(managers).
2. Shareholders want profit maximisation → higher dividends
& share price.
3. Managers have their own objectives: revenue maximisation
(linked to salary, status), job security, expense perks.
4. Information asymmetry: managers know more about firm’s
opportunities than shareholders.
5. Outcome: managers may choose lower profit, higher
revenue, or excessive growth.
6. Solution: performance-related pay, share options,
non-executive directors, threat of takeover.
EV: Principal-agent problem is worse in large PLCs with
dispersed shareholding. In family-owned Ltds, owners are often
managers → problem reduced. Takeover threat only works if
market is contestable.
Example: In the 2010s, Marks & Spencer’s managers pursued
expansion into food while clothing profits fell – shareholders
argued this was not profit-maximising.
1.2 Business Growth
Key definitions
, • Organic growth – expanding through firm’s own activities
(new stores, products, markets).
• Horizontal integration – merger with firm at same
production stage (e.g., two car makers).
• Vertical integration (backward) – merger with a supplier.
• Vertical integration (forward) – merger with a
distributor/retailer.
• Conglomerate integration – merger with unrelated
business.
Analysis chain: Why firms grow
1. Economies of scale → lower LRAC → higher profit margins
or lower prices.
2. Increased market power → ability to raise price without
losing all customers.
3. Risk diversification (especially conglomerate) – if one
market fails, others continue.
4. Managerial motives – salary, power, prestige positively
correlated with firm size.
5. Access to finance – larger firms get cheaper loans (lower
risk).
EV: Growth is not always beneficial. Diseconomies of scale can
raise costs beyond the benefits. Conglomerates often trade at a
discount (conglomerate discount) because investors prefer
pure-play companies. Some firms stay small intentionally
(boutique, niche, lifestyle business).
Example: Amazon – organic growth (new products), horizontal
(Whole Foods – actually vertical forward), conglomerate (Twitch).
, 1.3 Demergers
Key definition
• Demerger – splitting a single business into two or more
independent firms.
Analysis chain: Reasons for demerger
1. Value creation – diversified conglomerate may trade at
discount because investors can’t easily value each part.
Demerger unlocks value.
2. Focus – each new firm can concentrate on core
competencies without cross-subsidy.
3. Regulatory pressure – competition authority may require
demerger after a merger is found anti-competitive.
4. Efficiency – different divisions have different optimal
strategies (e.g., one needs high R&D, one needs
cost-cutting).
5. Raise cash – selling a division can repay debt or fund
investment.
Analysis chain: Effects of demerger
• Shareholders – receive shares in multiple companies; may
gain higher total market value.
• Managers – clearer responsibility; may lose synergies (e.g.,
shared HR, purchasing).
• Workers – possible redundancies if duplicate roles
eliminated.
• Consumers – possibly more competition if demerged firms
operate in same market; possibly less if they specialise in
different niches.
• Suppliers – lose bargaining power (no longer dealing with
one large buyer).
