Economics

1. Economics Chapter 6 Ownership, Expansion and Integration of Firms

2. Firm • Definition • A firm is a unit that makes decisions regarding the employment of factors of production and the production of goods and services • Types • Public enterprise – owned by the government • Private enterprise – privately owned

3. Public enterprise • 2 kinds of management • Managed by the government • Directly run by the government • Department under governmental structure • E.g. The Hong Kong Police Force, The Fire Service Department, The Water Supply Department… • See reference: Organisation Chart of the Gov’t of HKSAR http://www.gov.hk/en/about/govdirectory/govchart/index.htm

4. Public enterprise • 2 kinds of management • Managed by the public corporations • Established with government funds • Managed by government-appointed directors • Operation funds come from service charges • E.g. The Airport Authority of Hong Kong, Hospital Authority, Hong Kong Art Centre, Urban Renewal Authority 8 universities… • See reference: Government and Related Organisationshttp://www.gov.hk/en/about/govdirectory/govwebsite/index.htm#p7

5. Characteristics of public enterprise • Management • Directly by government • Managed by the public corporations • Capital • Receiving capital from the government • Independent account • Public corporations are responsible for the success or failure to their own business. • Provision of lowly-priced services and facilities to the public • Might not be aiming at profit maximization • Services or facilities provided might be free of charge • Provide services or facilities which are necessary to the society but not be given by private sectors • E.g. Police Force to keep social orderHousing Department to provide lowly-priced public housingWater Supplies Department to provide stable and reliable water supply

6. Characteristics of public enterprise • Advantages • Provision of necessary services to the citizens, more stable living environment • Lower the living cost • Disadvantages • Not aiming at profit maximization  no response to market changes  lack incentive to modify (lower the cost or improve management) • Mismatch with market demand / price, violate the postulate of maximization • High cost of complaints

7. Private enterprise • Forms of business ownership • Sole proprietorship • Partnership • Limited company

8. Main differences

9. Legal entities • An independent entity with rights and obligations like an ordinary individual. • To sole proprietorship and partnership • the owner of the firm needs to bear all obligations from any legal dispute • can’t initiate or receive lawsuit • To limited company • the company bears the legal obligation • owner(s) of the firm need not to be legally responsible • Can initiate or receive lawsuit

10. Liability • Limited liability • Owner is liable to the amount of investment he has in the firm. • Illustration:1. An investor invested $100,000 into the Firm A2. The firm applied debt from Bank L3. When time was due, Firm A couldn’t pay for the debt.4. Bank L demanded Firm A liquidation, assets were sold to pay for the debt.5.The investor needed not to pay for more, his $100,000 investment will be the upper limit of his loss.[ In conclusion: The investor loses $100,000 in maximum.]

11. Liability • Unlimited liability • Owner(s) of sole proprietorship and partnership is/are liable to all debts of the firm. • Illustration:1. An investor invests $50,000 into the Firm B2. The firm applies debt (let say $200,000) from Bank M.3. When time is due, Firm B can’t pay for the debt.4. The investor needs to sell the assets of the firm (let say $100,000).5. If not enough pay for the debt, the investor needs to sell personal assets (let say $50,000).6. If still not enough, the owner goes bankrupt.[ In conclusion: The investor loses more than $50,000.]

12. Types of ownership • Sole proprietorship • Single owner • No independent legal entity. • Unlimited liability. • Advantages: • Simple set-up procedure • Registration: Inland Revenue Department • Quick decision making • No requirement of information disclosure • All profit belongs to the sole owner • Disadvantages: • Limited ways of / Difficulties in fund raising • Unlimited liabilities • Bear all legal obligations • Lack of continuity • Death • Retirement • Ownership transfer • Bankruptcy of owner

13. Types of ownership • Partnership • 2 or more owners • No independent legal entity. • Unlimited liability. • Advantages: • Simple set-up procedure • Registration: Inland Revenue Department • Quick decision making (comparing with limited company) • Sharing risk and work, or benefit from division of labour (experience sharing) • No requirement of information disclosure • Disadvantages: • Slower decision making (comparing with sole proprietorship) • Limited ways of / Difficulties in fund raising • Unlimited liabilities • Bear all legal obligations • Lack of continuity, as if one of the partners… • Death • Retirement • Ownership transfer • Bankruptcy of owner

14. Types of ownership • Limited Company (Ltd. Co.) • Private limited company • Public limited company • Common features • Complicated set-up procedures • To Companies Registry: Memorandum and Articles of Association • To Inland Revenue Department: Business registration • Ownership • Divided into a number of shares • Decision making by voting • Shareholders ( w/ > 50% shares, absolute control)

15. Types of ownership • Common features • Structure • Ownership ≠ Management • General meeting  Vote for decision • Board of directors  Formulates policies, supervises operations & ensures the resolution of general meeting • Legal entity • The company itself is a legal entity • Lasting continuity • Death of one owner does not mean end of company • Ended unless liquidation • Limited liability • Information disclosure • Must be audited by authorized accountants

16. Types of ownership • Private vs. Public limited company

17. Ways for Ltd. Co. to raise capital • Debts from financial institutes • Bank loan • Loan from financial companies • Payment: Interest • Issuing shares (both Private and Public Ltd. Co.) • Selling of ownership • Investors buy the shares of the companies • Share companies’ profit • Payment: Dividends • Issuing bonds (only Public Ltd. Co.) • Bonds to creditors as certificates • A bond is a statement of debt info.: Amount / interest rate / due date • Payment: Interest • Borrower = Bond issuer • Lender (Creditor) = Bondholder

18. Bond

19. Bond

20. Shares vs. Bonds

21. Pros and Cons

22. Return and Risk Once you want to invest: • Expected rate of returns Shares > Bonds > Bank Deposit > Cash • Risks Shares > Bonds > Bank Deposit > Cash ∴Risk  Return Risk  Return

23. Expansion • Expansion • Enlarge the scale of production • Aim at achieving economies of scales • Ways of expansion • New branches • New products • New business

24. Integration • Integration • Take over or merge with other companies • Aim at achieving economies of scales • Types of integration • Horizontal • Vertical • Lateral • Conglomerate

25. Integration • Horizontal Integration • Merge with another firm producing the same type of products • Reasons: • Defeat competitor, more market share • Same product  Lower cost of production • New market • Example: • A mobile service company takes over another mobile service company • Cases: • Cathay Pacific took over Dragonair (2006) • Sony & Ericsson (2005) • HP took over Compaq (2002) • IBM took over Lotus (1995) • Panasonic and Rasonic (1994)

26. Integration • Vertical Integration • Merge with another firm in different stage of production • Backward integration • Another firm in the preceding/earlier stage of production • Reason: • Ensure the supply of resources or services • Lower the cost of supply of resources • Example: A clothing company takes over a button company • Cases: • Dairy Farm and Nestle • Reliance Industries (Garment producer): from textiles into polyester fibres and further into petrochemicals. • Esso+Exxon+Mobil: SeaRiver Maritime, a petroleum shipping company.

27. Integration • Vertical Integration • Merge with another firm in different stage of production • Forward integration • Another firm in the next stage of production • Reason: • Ensure the channel of product and service sales • Lower the cost of information from market • Example: • A clothing company takes over a retailer • Cases: • Cathey Pacific & Hong Kong Air Cargo Terminals Limited • Vodafone Airtouch PLC took over Mannesmann (Germany)

28. Integration • Lateral Integration • Merge with another firm producing related nut not directly competing products • Reason: • Risk diversification • Lower the cost of sales of products and services (market economies, R&D economies) • Example: • A garment company takes over a shoe factory • A mp3 player factory takes over a headphone factory • Cases: • Citigroup & Travelers Group (1998) • China Strategic Holdings(中策集團) & Primus Financial Holdings Limited (博智金融控股) suggested acquisition over AIG Nan Shan Life Insurance Company, Ltd. (南山人壽) (2009)

29. Integration • Conglomerate Integration • Merge with another firm with different business • Reason: • Risk diversification • Lower the cost of sales of products and services (market economies, R&D economies) • Example: • A garment company takes over a toy factory • Cases:

30. The motives of expansion General motives • Economies of scale •  scale of production   Lower the production •  market share   profit • Simplify structure • Reorganizing business • Efficiency in management • Flexible allocation of resources • Cut down over-abundant expenditure • Acquisition of technology • New technology • R & D • Acquisition of brands • Takeover the brand from other firms • Save time and cost to develop new brand

31. The motives of expansion Specific motives