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9708 · 7.7

Growth and survival of firms — practice questions

Practice and worked examples for 9708 Growth and survival of firms. Short previews only — attempt the full question in MarkScheme against the official scheme.

Worked example 1

Firm A (supermarket chain) is considering three growth options:

(i) Opening 20 new stores using retained profits (ii) Taking over Firm B, another supermarket chain (iii) Taking over Firm C, a logistics company

(a) Classify each option. (b) Evaluate one advantage and one disadvantage of option (ii).

Show solution outline

(a) (i) Internal (organic) growth — reinvesting profits to expand capacity in the same business.

(ii) External horizontal merger — takeover of a rival at the same production/distribution stage in the same industry.

(iii) External vertical merger (backward) — takeover of a supplier/distribution partner in the supply chain.

(b) Option (ii) — horizontal takeover:

Advantage: Economies of scale — combined purchasing power, shared IT systems, and reduced average costs. Also increased market share immediately.

Disadvantage: Competition authority may block the merger if it creates excessive market power, harming consumers through higher prices or less choice. Integration of two large organisations also risks diseconomies of scale (management coordination problems).

Worked example 2

An industry has five firms with the following market shares: Firm A (30%), Firm B (20%), Firm C (15%), Firm D (10%), and Firm E (8%). The remaining 17% of the market is shared by many small firms.

(a) Calculate the 3-firm concentration ratio (CR3) before any merger. (b) Suppose Firm B and Firm C decide to merge to form a new company, 'Firm BC'. Calculate the new CR3 after the merger. (c) Explain why this merger might be a cause for concern for competition regulators.

Show solution outline

(a) Calculate the pre-merger CR3: The 3-firm concentration ratio is the sum of the market shares of the three largest firms.

  • The three largest firms are Firm A (30%), Firm B (20%), and Firm C (15%).
  • Calculation: CR3 = 30% + 20% + 15% = 65%.
  • Answer: The initial 3-firm concentration ratio is 65%.

(b) Calculate the post-merger CR3: First, determine the market share of the new merged firm, Firm BC.

  • Calculation: Market Share of Firm BC = Market Share of Firm B + Market Share of Firm C = 20% + 15% = 35%.

Now, list the new market shares of the largest firms:

  • Firm BC: 35%
  • Firm A: 30%
  • Firm D: 10%
  • Firm E: 8%

The new top three firms are Firm BC (35%), Firm A (30%), and Firm D (10%).

  • Calculation: New CR3 = 35% + 30% + 10% = 75%.
  • Answer: The new 3-firm concentration ratio is 75%.

(c) Reason for regulatory concern: The merger increases the 3-firm concentration ratio from 65% to 75%. This is a significant increase in market concentration. Regulators would be concerned that this horizontal merger substantially reduces competition in the market. The new, larger 'Firm BC' would have a market share of 35%, making it the market leader. This increased market power could lead to higher prices for consumers, less choice, and create higher barriers to entry for new firms. Therefore, the competition authority would likely investigate the merger to assess its potential impact on consumer welfare.

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