1. A firm can expand its boundaries through horizontal expansion by acquiring other firms in the same industry, or through vertical expansion by acquiring firms upstream or downstream in the supply chain. 2. International expansion allows firms to access new markets and resources but introduces additional risks and costs related to operating in foreign countries with unfamiliar conditions. 3. Mergers and acquisitions are a form of inorganic growth that can create shareholder value through operating or financial synergies, but managers must carefully evaluate deals to avoid overpaying or taking on too much risk.

1. Boundaries of Firm
NABANITA DE
State Aided College Teacher(SACT-1)
Charuchandra College, Kolkata
West Bengal, India
denabanita2015@gmail.com

2. Right Size of Business
• Narrow View: Right no of employees in the
organization.
• Broad View: Not just employees but also
management, right no of capital & establishments
like office, factorises etc.
In Economics this issues are mainly economics of Scale
and economies of scope.
Some companies have huge no of employees and some
have smaller. So one cannot have a thumb rule on
right sizing the no of employees.

3. • Adam Smith( the father of Economics) has commented that DOL is limited
by the extent of the market. DOL leads to AC reduction and the concepts
refers increasing returns to scale.
• But if there is no buyer even at a low price there is no justification of
capacity expansion. So the demand must justify the capacity expansion.
Thus main determinant of expansion is market and demand .
A firm can increase its boundaries in two directions are
1. Horizontal expansion—acquisition of Compaq by HP
2. Vertical Expansion: It works in two ways.
a) When a steel plant acquires coal mines and engages in coal production
means backward integration.
b) when the steel plant starts producing finished steel products like railway
lines or train wheels firms makes forward integration.
Capacity Expansion by the manager

4. Economies of Scale
Sources of economies of scale:
If an increase in the of the firm leads to decline in per unit cost
of production this is known as economies of scale.
a) Indivisibility.
b) Choice of appropriate technology.
c) Better inventory management.
d) Spread of advertisement cost.
e) Advantage of umbrella branding
f) Learning curve

5. Real and Pecuniary Internal Economies of Scale
• Real economies of scale– When increase in output leads to saving in
average input use, it is called real economies of scale.
• When increase in output leads to saving in expenditure by advantages of
lower price, it is called pecuniary economies of scale.
• Real economies of scale can arise in the area of production; marketing and
supply chain management and transport and storage.
• Production economies of scale--This saves use of input in relative sense.
• a) marketing and supply chain economies of scale.
• b) Managerial economies of scale.
• Transport and storage economies: Doubling length and width of the
storage room needs double input use but storage space is increased four
times.
• Pecuniary economies of scale– Large production and large purchase of
inputs offer price advantage. Large firm may get lowest rate of interest
from bank while borrowing from bank, lower rates for advertising, lower
transportation rates, lower logistic rates & hotel rates.

6. External Economies of Scale
• With the expansion of industry, certain specialized firms also
come up for utilizing the by-products and using the waste
materials. Similarly, these units may come up for supplying
raw material, tools etc; to the firms in the industry.
• Moreover, they can combine together to undertake research,
etc; whose benefit will accrue to all firms in the industry.
Thus, a firm benefits from expansion of the industry as a
whole. These benefits are external to the firm, in the sense
that these that these arise not because of any effort on the
part of the firm, but accrue to it due to expansion of industry
as a whole. All these external economies help in reducing
production costs.

7. Diseconomies of Scale
• While increase in the size of the firm often leads to decline in
AC of production, there are also possibilities that larger size
results in increase in average costs. These are called
diseconomies of scale
• Sources of diseconomies of scale.
a) Higher labour cost in a big enterprise
b) Managerial problems
c) Thinning of the connection between individual effort and
profitability
d) Complacency effort.

8. Horizontal and Vertical Expansion
• When firm expands in the same line of business and increases production
of the same good, it is horizontal expansion.
• When firm starts producing input used in the production of its present
good or starts producing the good in which its present production item is
used as input, it is called vertical expansion.
• In the first case, when firm produces the input for its present good, it is
called upstream expansion or backward integration. Raw material is the
top most stage and hence it is upstream. Similarly, final good is the
downstream.
• There are several advantages of vertical expansion and integration. There
are several issues of vertical market failure, and in these cases vertical
expansion is gainful.
• First of all, there is hold-up problem in which the seller of input may take
advantage of the market power of input supply.

9. Continued….
• Secondly, there may be uncertainty in the supply of input. If there is
uncertainty in supply, it is economically meaningful to produce the input in
the own firm.
• Thirdly, if the product is new or in the context of life cycles of product the
product is young, the input market may not be developed.
• Fourthly, on account of market power the input supplier may charge a
high price. if the firm finds out that producing the input is cheaper, it is
economically justified to produce the input by the firm.
• Finally, Williamson (1975, 1985) points out that some products are
relationship-specific, in the sense that the value of these products is
higher inside a particular relationship than outside of it. This can be a
justification for downstream/forward integration.
• Thus, it is argued that vertical integration allows a firm to save on
transaction cost.
• The policy of vertical expansion /integration is not always justified. The
decision of vertical integration is risky because it is not very easy to
reverse the decision of self-producing the input or self-using the product
of the firm.

10. Horizontal Integration
• Horizontal integration through merger of two firms leads to increase in
concentration in the market. The Herfindahl index in this market is used. If
now two firms merge in this industry and the share of the merged firm is
equal to the sum of their previous market shares, the new Herfindahl
index will be used. This is the reason the competition regulator may not
look at the horizontal merger very favourably.
• If there is a merger between a high cost firm and low cost firm, the social
welfare may rise despite increase in concentration( Oz Shy, 1995). This
type of merger is likely to reduce consumer welfare but social increases by
increase in production efficiency that outweighs fall in consumer surplus.
• If the market is not at all monopolistic with presence of several small
firms, the merger between two small firms may be allowed, provided
regulator is convinced that it improves production efficiency. So as a
manager when think about merger/acquisition, this should never be for
the sake of increasing market power of the firm but increase own
production capacity and enjoy benefit of economies of scale.

11. Diversifications
• In the modern corporate world, there are a large number of very large
firms. Most of these engage in a wide variety of activities and produce
several goods together that seem only slightly related.
• Some of Indian diversified enterprises are Grasim, AB Nuvo, Voltas , etc.
Prominent names of US diversified companies are GE, Motorola, 3M while
Hitachi, and Toshiba are examples of diversified Japanese companies. It is
known that many diversified companies are not only successful, they are
also renowned. This fact indicates that diversification can create value and
efficiencies.
• The first advantage of such growth is to take advantage of economies of
scope and scale.
• One important term that can be used in context of diversification is
synergy. It implies that the value of two activities can increase, provided
they are carried out together rather than separately. The concept of
synergy if often used in the context of mergers and acquisitions.

12. Economies of Scope(EOS)
• When a firm enjoys economies of scale, it can reduce the AC of production
by increasing the production of a single good or service. Production of this
particular good is the main area of activity of this firm.
• A similar but different concept is economies of scope.
• EOS imply that the firm can produce two/more goods together at a lower
cost than when two firms produce these two goods separately. EOS imply
that diversification of activity by a firm in production of more than one
good is cost saving.
Factors behind economies of scope
i) Efficient utilization of fixed input—like managerial input
ii) Synergy--used in context of mergers & acquisition
iii) Better opportunity to utilize its man power more efficiently
iv) Diversification- to reduce risk.

13. Problems of diversification and unplanned expansion
• In the real world, there exists both big conglomerates that diversification
has only positive sides. There are always risks involved in diversification
and expansion and therefore the decision to expand or go for merger or
acquisition has to be very carefully made.
• First of all diversification may be made by the management for the sake of
prestige and status earning . [Jensen(1986) has called this motive as
empire building. That exercise may be risky]. Diversification towards
unrelated areas may result in the resources being spread thinly over a
number of activities.
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14. Merger & Acquisition
• A firm can expand by acquiring /taking over another firm /by merging with
another firm. This growth is called inorganic growth, compared to organic
growth, which is self expansion of a business.
• In merger or acquisition , it is expected that a combination of two
businesses would create greater shareholder’s value than if they are
operated separately. This creation of value takes place either through
operating synergy(OS) or through financial synergy(FS).
• OS takes place through economies of scale and economies of scope. FS
reduces the cost of capital.
• Merger and acquisition leads diversification. If activities and profitability
of two firms are uncorrelated, by the rule of diversification the merged
entity can stabilize its rate of return or stabilize its rate of growth.
• M & A have a few risks. There is imperfect information about the company
to be acquired. Therefore, competition among several firms to take over
may involve the problem of “Winner's curse" of auction theory. Secondly ,
the managers of the acquiring firm may be overconfident and thus bids
high.

15. International Expansion
• The MNCs dominate the modern day international trade . More than 60% of
the International trade is generated by the MNCs. The firms are involved in the
foreign market not just by way of export and import but also by licenses and
franchises and also by FDI.
• When a firm deals in a foreign market it faces a few difficulties. These arise
from treading in an unfamiliar territory.
• But since many foreign firms are observed to successfully function in foreign
countries there must be advantages that may outweigh the disadvantages of a
foreign firm, compared to a local firm. Hymer (1960) points out that these
advantages in the areas of production, innovation, marketing and finance are
specific to their ownership by the foreign firm.
• These advantages may arise from better technology, better production or
better inventory management, brand, patents and economies of scale etc.
In some cases licensing or franchising may take away the ownership advantage of
MNFs. The technology may be copied and after the expiry of the licenses, the
local firm may emerge as a competitor. The MNF may itself likes to produce
the good/service. This advantage can be called internalization advantage.

16. Continued……
• John Dunning(1981), attempts to integrate a variety of strands of thinking.
The firm must have some firm specific ownership advantages along with
country-specific advantages in order to make an entry into foreign market
and set up foreign production plant. These advantages can be with regard
to firm specific brand, knowledge, human capital or firm specific
management. These advantages ownership advantages that empower a
firm to capture foreign market.
• But foreign market can be catered either by own production or by
production by some domestic firm., which produces the output by virtue of
franchises or licenses from the original firm. But if the firm has to guard its
firm’s specific knowledge from being copied, it enjoys internalization.
advantage in case of own production.
• But in some cases it is better to produce the good in foreign land itself.
Such decision to make foreign investment and produce the good in the
foreign land itself. Such decision to make foreign investment and produce
abroad is driven by country specific or localization advantages
• Thus the foreign investment in this approach is explained by an eclectic
approach that combines ownership specific advantages, internalization
specific advantages and location specific advantages.

17. Continued…..
• The foreign Direct Investment(FDI)in situations where foreign investment(FI) helps
the firm to serve the foreign market better can be called market-seeking FDI. FI is
made also to develop an export base in the foreign country with the help of
resources available in that place of investment. For example Japanese investment
in china are made in order to utilize the cheap labour of china. These investments
are resource-seeking FDI. There may also be strategic reason for foreign
investment. China invests in African countries for strategic reasons.
• Only considering cost of inputs etc. is not enough to decide about foreign entry.
The transactions cost of business varies from country to country, depending on
political, social, governance, taxation environment.
• MNC often purchase existing foreign firms in order to acquire ownership specific
advantages and to sustain or advance its global competitive position. When Tata
Motors acquires JRL, the motive is to make entry into global market with a
strategic brand acquisition. This is termed as strategic asset/capabilities seeking
FDI. Success of such strategic decision depends on a lot on the price that the firm
pays for the boom and ended up paying high price. (Swaminathan Aiyar, 2015) ,
Business Managers should be aware of risk and find the suitable time for
investment.