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1.6 Growth and evolution Flashcards
Backward vertical integration
Backward vertical integration occurs when a business
amalgamates with a firm operating in an earlier stage of
production, e.g.a car manufacturer acquires a supplier of tyres
or other components.
Conglomerates
Conglomerates are businesses that provide a diversified range
of products and operate in an array of different industries.
Diseconomies of scale
Diseconomies of scale are the cost disadvantages of growth.
Unit costs are likely to eventually rise as a firm grows due to a
lack of control, coordination and communication.
Diversification
Diversification is a high risk growth strategy that involves a
business selling new products in new markets, i.e. spreading
risks over a diverse variety of products and markets.
Economies of scale
Economies of scale refer to lower average costs of production
as a firm operates on a larger scale due to gains in productive
efficiency, e.g. easier and cheaper access to finance
Economies of
scale can help businesses to gain a competitive cost advantage
because lower average costs can mean a combination of lower
prices being charged to customers and a higher profit margin
earned on each unit sold.
External growth (or inorganic growth)
External growth (or inorganic growth) occurs when a
business grows by collaborating with, buying up or merging
with another firm.
Forward vertical integration
Forward vertical integration is a growth strategy that occurs
with the amalgamation of a firm operating at a later stagein the
production process, e.g. a book publisher merges with a book
retailer.
Franchise
Franchise refers to an agreement between a franchisor selling
its rights to other businesses (franchisees) to allow them to sell
products under its name in return for a fee and regular royalty
payments.
Globalization
Globalization is the growing integration and interdependence
of the world’s economies, causing consumers around the globe
to have increasingly similar habits and tastes
Horizontal integration
Horizontal integration is an external growth strategy that
occurs when a business amalgamates with a firm operating in
the same stage of production
Internal growth (also known as organic growth)
Internal growth (also known as organic growth) occurs when a business grows using its own capabilities and resources to increase the scale of its operations and sales revenue
A joint venture
A joint venture is a growth strategy that combines the
contributions and responsibilities of two different organizations
in a shared project by forming a separate legal enterprise.
Lateral integration
Lateral integration refers to M&As between firms that have
similar operations but do not directly compete with each other,
e.g. PepsiCo acquiring Quaker Oats Company.
A merger
A merger is a form of external growth whereby two (or more)
firms agree to form a new organization, thereby losing their
original identities.
A multinational company (MNC)
A multinational company (MNC) is an organization that
operates in two or more countries, with its head office usually
based in the home country.
The optimal level of output
The optimal level of output is the most efficient scale of
operation for a business which occurs at the level of output
where average costs of production are minimised.
The merits of small versus large organizations AO3
Benefits of being LARGE
6p
- Brand recognition
Familiarity with the brand allows large businesses to sell to a wider market. Many firms are large
and established enough to have global brand recognition. - Brand reputation
Larger firms tend to be more trusted due to their brand image and brand reputation. - Value-added services
Larger firms have the resources to provide a wider range of services, e.g. longer opening hours and
interest-free credit installments. - Lower price
Larger firms are able to offer customers greater price discounts through their ability to enjoy
economies of scale. - Greater choice
Larger firms can provide more choice, e.g. Amazon.com sells a huge range of books, toys, music and
DVDs compared to a small local book shop, toy store or music retailer. - Customer loyalty
The above benefits mean that more customers are likely to remain loyal to the business, its products
and its brands due to the perceived trust and value for money.
The merits of small versus large organizations AO3
Benefits of being SMALL
7p
- Cost control
Large scale operations can mean that a firm encounters diseconomies of scale due to problems of control, coordination and communication. Owners of small firms might not want to expand
since they could face higher unit costs as their organizations grow. Growth can also require extra borrowing costs and/or a dilution of ownership and control. - Financial risk
Since the costs of running a large global business are huge (such as the costs of research and development, marketing or recruitment and training), the financial risks are also high. By contrast,
owners of small businesses can better manage and control their finances. - Government aid
Financial support in the form of grants and subsidies can be offered to small businesses to help them start up and to develop. Funds for training may also be available for small businesses that
provide employment opportunities in the local community. - Local monopoly power
Small businesses may enjoy being the only firm In a particular location, e.g. a local restaurant, a franchised petroleum retailer and a small convenience store located in a remote town. Large
businesses may be reluctant to locate in remote areas (see Unit 5.4) so this provides an opportunity for smaller firms to establish themselves in the area. - Personalised services
Smaller firms are more likely to have the time to devote to individual customers. For example, staff at a small local convenience store can get to know its customers better as staff are not pressurised by high sales targets. By contrast, large supermarkets rely on a high number of customers being
served with some using self-checkout services. - Flexibility
Small businesses tend to be more flexible and adaptive to change. For example, if a sole trader runs a beauty salon that is rather unsuccessful, then the business might be changed to something
completely different, such as a children’s toy shop. Large businesses have large financial commitments and conflicting stakeholder objectives (see Unit 1.4) which combine to reduce their
ability to change. - Small market size
Some businesses, such as a local hair salon or private tuition firm, are unlikely to attract the attention of large firms due to the very limited size of the market. Large corporations may not find
it financially worthwhile to compete with these small local firms, thereby allowing them to thrive.
Reasons for growth
4p + main point
• To reap the benefits of larger scale production, i.e.
economies ofscale.
• To gain a larger market share and market power (see Unit
4.1). This also allows the firm to charge higher prices (see
Unit 4.5) yet gain more profit at the same time.
• Growth is a means of survival as competitors are also
likely to strive for growth. Businesses need to ‘run faster
to stay still, i.e.grow to compete with their growing rivals.
• To spread risks by diversifying into new markets rather
than focusing only on one specific market. If there are
detrimental changes in a particular market, then having
operations in other markets might help to safeguard the
firms survival.
Ultimately, the reasons for seeking growth can be summarised
as the desire for businesses (especially those in the private
sector) to gain more profit in the long run.
The role and impact of globalization on the growth and evolution of
businesses
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8 Opportunities
- Globalization considerably increases the level of competition.
The Internet has also reduced costs for many industries, thereby reducing barriers to entry and attracting competition. For example, in many countries Expedia.com has successfully competed with
more established travel agencies. - Meeting customer expectations becomes increasingly more demanding. Businesses must now meet the ever greater customer demands for quality, customer service, price and after-sales care in order to have any competitive
advantage. Pressure groups and the media have provided another perspective on the potential threats of
globalization. - Increased customer base
Multinationals and e-commerce businesses in particular benefit from the increased customer base that globalization brings. With China and India both embracing changes in the global business environment, there are vast opportunities for businesses that trade with the world’s two most populous
countries (around 35%of the world’s population). - Economies of scale
Businesses that are able to build a
global presence can benefit from economies of scale,such
as the advantages of global marketing economies and
risk-bearing economies (see Unit 1.6).These present clear
opportunities for business growth. - Greater choice of location
Globalization presents
multinational companies with greater choice of location. Like many other global businesses, Apple chose to outsource production in China due to the relatively low costs of labour and rent. Apple’s products are ‘Created in California and assembled in China’. The increased choice of location can therefore help to reduce a firm’s costs of
production. - External growth opportunities Mergers, acquisitions, strategic alliances and joint ventures allow businesses
to grow at a faster pace than if they were to expand organically. Globalization enables businesses to have more
choice in their expansion plans. - Increased sources of finance Globalization presents many more opportunities for seeking external sources
of finance to fund business growth and evolution. - First-mover advantage
A business
that is able to expand overseas before its rivals may also gain
a first-mover advantage as it establishes itself and builds up a
loyal customer base.
Reasons for the growth of multinational companies (MNCs)
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5p
• Increased customer base
An increased customer base allows businesses to increase their sales turnover by expanding internationally. For example,many businesses (such as KFC,Starbucks, and Walmart) have expanded into China to benefit from the huge customer base. International
brand recognition can also be enhanced by using global marketing strategies.
• Cheaper production costs
Many MNCs expand overseas to benefit from cheaper production costs, especially inexpensive labour. For example, the relatively high cost of labour in Germany,
partly due to the imposition of minimum wage legislation, has meant that businesses such as Adidas, BMW and
Volkswagen have production facilities overseas with cheaper labour.
• Economies of scale
As production levels increase, MNCs are able to benefit from economies of scale. MNCs might also want to locate
overseas to benefit from the host country’s infrastructure, such as its road, telecommunication and port networks.
The host country may offer better quantity and quality of land in terms of the amount of space and/or the cost of land. There could also be financial incentives from the
host country’s government that help to reduce production costs whilst allowing the MNC to expand.
• Protectionist policies
By producing within a particular country, MNCs can usually avoid any protectionist policies that the country might impose (Tarifss, quotas, restrictive trade practises). This is why many Japanese
motor vehicle manufacturers, including Toyota, Honda and Nissan, have set up factories in the European Union
and North America.
• Spreadinf of risks
MNCs are able to spread risks. Unfavourable market conditions in one country or region might not damage
the overall business if it can spread risks internationally. Natural disasters (such as tsunamis), terrorist acts (such as
the 9/11 attacks) and diseases (such as swine flu and mad cow disease) have affected different areas of the world.
Over-specialization in any one of these regions could have led to a serious dent in profits for these businesses.
The impact of MNCs on the host countries
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4 advantages
- MNCs create jobs In the host country.
Although some MNCs have been criticised for paying ‘low’ wages to staff in poorer countries, MNCs tend to offer higher
pay than local firms in these countries.
2. MNCs help to boost the host country's gross domestic product (the value of a country's annual output) by creating consumption expenditure (since more people are in paid employment) and by boosting export earnings for the host country, thereby improving its standards of living
- MNCs have Introduced new skills and technology in production processes to host countries, e.g. Japanese firms have introduced the models of kaizen, kanban and andon (see Unit 5.3) to Western economies. With new ideas in management thinking and technology transfer, the efficiency of production
In the host country is raised - MNCs intensify competition in the host country. This should lead to greater efficiency to the benefit of domestic customers. Also, it can be argued that without the threat from MNCs,
domestic firms do not necessarily have the incentive to be innovative or to respond to market forces.
.
The impact of MNCs on the host countries
AO3
4 disadvantages
- MNCs are capable of causing unemployment in the host country as they can pose a threat to domestic businesses. Competition can be good if it causes local firms to improve their efficiency, but it can also be a setback if it means that
domestic firms are unable to compete and end up making people redundant or even having to close down. - Whilst MNCs can create wealth in a host country, the profits are repatriated to the home country. There is also a degree
of insecurity as MNCs are increasingly footloose (see Unit 5.4), i.e. they are not tied to a specific location so can change
at very short notice for cost advantages.
3. Anti-globalization groups are concerned about the social
responsibility of MNCs in their attempt to grow and exploit the planet’s scarce resources. Host nations are often unable to control the actions of large MNCs, due to their sheer market power, e.g. Walmart’s sales revenues exceed the GDP of Indonesia, the world’s fourth most populous country.
- Due to fierce competitive pressures,
domestic firms might be forced into reducing prices to remain competitive. Technology transfers present a further threat as domestic firms might
not have the finance to compete, so they become prone to takeover bids or collapse outright.
External (inorganic) growth
5 benefits
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main disadvantage
• External growth is a faster way to grow and evolve, e.g.
it is quicker for a supermarket to merge with or acquire
another supermarket than to buy or rent land to open new
outlets.
• It is a quick way to reduce competition. Bytaking over a
rival, for example, a firm is able to eliminate a competitor.
However, such strategies can be prohibited by the
government because the lack of competition might not be
in the best interest of the general public.
• It can bring about greater market share and market power
(see Unit 4.1).
• Working with other businesses means sharing of ideas.
Inorganic growth can therefore generate new skills,
experiences and customers.
• External growth can help a firm to evolve, thereby
spreading risks across several distinct markets. Hence,
such firms can benefit from risk-bearing economies of
scale.
The main disadvantage of external gro\vth is the huge costs,
which tends to be higher than that needed for internal growth.
Takeoverbids can be especially expensive. Disney’s takeover of
Pixar (see Question 1.6.6) cost $7.4 billion - that’s about the
same value as Coca-Cola’s annual profits!
4 methods of external growth
1. mergers and acquisitions (M&As) and takeovers 2. joint ventures 3. strategic alliances 4. franchising.
mergers and acquisitions (M&As) and takeovers
AO3
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4 types of integration
A merger takes place when two firms agree to form a new
company, such as the merger between Hewlett-Packard and Compaq (2001)
A takeover (or acquisition) occurs when a company buys a
controlling interest in another firm, i.e. it buys enough shares in
the targetbusinessto hold amajority stake.Toenticeshareholders
of the target company to sell their shares, the offer price is likely
to be well above the stock market value of the shares.
e.g. Google acquired YouTube for $1.65 billion in 2006
- horizontal
- vertical
- lateral
- conglomerate M&As
mergers and acquisitions (M&As) and takeovers
degree of success 3p
The degree of success of M&As depends on several factors.
- First, the level of planning involved is crucial. A clear rationale
of the benefits of the merger or takeover must be communicated
to key stakeholder groups to win their support. - Success also
depends on the aptitudes of senior leaders of the two firms
involved. Conflict can easily lead to the demise of M&As.
Managers need to exert their negotiation skills and be able to
handle the added pressures and responsibilities that they will
face.
3.Finally, regulatory problems can also present a barrier to
success. The government can step in to prevent M&Astaking
place in order to prevent the business from having too much
market power, if this is deemed to be against the best interest of
the general public.
Benefits of mergers and acquisitions
- Greater market share
The integrated firm is likely to benefit
from having greater market power and a larger customer base. - Economies of scale
Larger scale operations help to lower
unit costs, thus improving the firm’s competitiveness and/or profit margins. - Synergy
The integrating firms have access to each other’s resources, such as distribution channels, new technologies,
human resources and management know-how. Hence they are able to better use their combined resources to boost
productivity and profits - Survival
M&As are a fast method of growth to protect the survival of a business. As a defensive strategy, it allows the new
firm to be in a stronger position to compete with its rivals. - Diversification
Some M&As allow firms to diversify their
product mix.This allows them to benefit from a larger customer base and reduced risks.
Drawbacks of mergers and acquisitions
- Redundancies
Job losses are likely to occur due to cost
savings in M&As, e.g. the new business will not need two finance directors. - Conflict
There are potential disagreements and arguments between the firms involved in M&As, so conflict is inevitable. - Culture clash
People and processes will need to adapt to the desired corporate culture of the newly formed organization.
This may entail changes to the firm’s core values and mission statement. Staff might also need time to adapt to new methods
of working. - Loss of control
The original owners or management team
will lose some degree of control as the new board of directors will need to be restructured. - Diseconomies of scale
The larger firm might suffer from
increased bureaucracy and longer channels of communication, leading to less effective decision-making. - Regulatory problems
Governments may be concerned
with, and hence prevent, M&As if they create a monopoly with too much power.
joint ventures (AO3) 8 advantages
- Joint ventures allow organizations to enjoy some of the benefits of mergers and acquisitions (such as higher market share) but without having to lose their corporate identity.
- Synergy
The pooling of experiences,skills and resources of the collaborating firms should create synergy. - Spreading of costs and risks
Financial costs, risks and losses are shared in a JV thereby helping to reduce
the financial burden on any single organization. JVs also allow firms to diversify their products, also helping to spread risks. - Entry to foreign markets
JVs are used by companies to enter foreign countries by forming an agreement with local firms. National laws make JVs the only option for businesses wishing to enter some foreign markets, e.g. many foreign firms have entered China and India by forming JVs with local Chinese and Indian businesses. - Relatively cheap
JVs are relatively cheap
compared with the costs of a hostile takeover (which are often unknown). It is also easier to pull out of a JV if necessary. - Competitive advantages
Competition can be reduced by forming a JV. Companies cooperating in a JV are unlikely to directly compete with each other, yet their
pooled resources make them a stronger force against their rivals. Their collective size could also mean that further
economies of scale can be enjoyed. - Exploitation of local knowledge Firms that expand via international JVs can take advantage of each other’s local knowledge and reputation. This might not be the case with mergers or acquisitions which are exposed to potential problems of overseas expansion (such as differences in business etiquette, cultural values, language and traditions).
- High success rate
Joint ventures tend to be friendly
and receptive. The parties pool their funds and resources, sharing responsibility for their mutual benefit. This positive attitude ismorelikely to lead to the success ofa JV.
By contrast, takeovers often fail due to their unfriendly and hostile nature.
drawbacks of JVs and strategic alliances
[have similar drawbacks]
(AO3)
3p
- Partners in a JV have to rely heavily on the resources and goodwill of their counterparts.
- There is also likely to be a
dilution of the brands, yet firms spend huge amounts of money trying to develop their own brands (see Unit 4.5). - Finally, whenever firms work together on a project, there is always the possibility of organizational culture clashes, which can lead to operational problems for the joint venture.
strategic alliances (SA)
AO3
Typically, there are four key
stages to the formation of a strategic alliance:
- Feasibility study - Investigate and establish the rationale, objectives and feasibility of the SA.
- Partnership assessment - Analyse the potential of different partners, such as what they have to offer to the alliance
in terms of both human and financial resources and expertise. - Contract negotiation - Negotiations take place to determine each member’s contributions and rewards, thus forming a mutually acceptable contract.
- Implementation - Operations are initiated commitment to the contract from all parties.
strategic alliances
3 reasons for
- The main purpose of strategic alliances is to gain synergies from the different strengths of the members of the alliance by pooling their resources (to benefit from each other’s expertise and financial support).
- also gain from economies of scale by operating on a larger scale.
- Customers are also likely to benefit from the added value services under
a strategic alliance, such as the convenience of access to wider
channels of distribution (see Unit 4.5)
E.g. Two airlines both with half-empty
aircraft could directly compete or they could collaborate by
using a single full aeroplane to cut staff and fuel costs and split
the profits for mutual benefit.
franchising
AO3
Benefits for franchisor
5
- The company can experience rapid growth without having to risk huge amounts of money as the franchisee pays for the outlet itself. Hence, it can be cheaper than internal growth.
- It allows the company to have a national or international presence without the higher costs of organic growth or M&As
(as the franchisee helps to finance the expansion). - The franchisor benefits from growth without having to worry about running costs such as staff salaries, purchase of stocks, recruitment and training.
- Franchisors receive royalty payments from the franchisee, usually set as a percentage of the sales revenues. They can also charge a ‘membership’ (joining) fee to their franchisees.
- Franchisees have more incentives to do better than salaried managers, thereby increasing the chances of success for the
franchisor.
franchising
AO3
Benefits for franchisee
5
- There are relatively lower start-up costs because the business
idea has already been developed by the franchisor (such as
market research and product development). - It is in the best interest of the franchisor to ensure that the
franchise succeeds, so it will provide added-services to
franchisees, e.g. training and advice on financial management. - The franchisee is likely to benefit from large scale advertising
used by the franchisor, i.e. franchisees receive’free’advertising
and promotion, also helping to reduce their costs. - Franchisees can have greater awareness of local market
conditions and needs, further boosting their chances of success. - There is relatively low risk since the franchisor has a tried and
tested formula so the chances of business success are high.
franchising
AO3
Drawbacks for franchisor
3
- There is a huge risk in allowing others to use the franchisor’s
name. Unsuccessful franchisees can damage the reputation of
the whole franchise business. - It can be difficult to control the daily operations of franchisees
and to get them to meet the quality standards set by the
franchisor. - Although franchising is faster than internal growth, it is not as
quick as M&As.
Franchisees cannot simply use their own initiative to try out new
ideas as they are regulated by the franchisor.This constrains the
entrepreneurial talents of the franchisee.
Buying a franchise can be very expensive, yet there Is no
guarantee that this investment will ever be recouped.
Franchisees have to pay a significant percentage of their
revenues to the franchisor.
franchising
AO3
Drawbacks for franchisee
3
- Franchisees cannot simply use their own initiative to try out new
ideas as they are regulated by the franchisor.This constrains the
entrepreneurial talents of the franchisee. - Buying a franchise can be very expensive, yet there Is no
guarantee that this investment will ever be recouped. - Franchisees have to pay a significant percentage of their
revenues to the franchisor.
Unit 2 growth business strategies:
mnemonic FUBED
• First-mover advantage This is the strategy of being the first in a market. This allows the business to establish market share, a good reputation and a loyal customer base before other firms have a chance to launch their products.
• Unique selling point (USP) Offering products that have a USP makes a product stand out from other products
that are available on the market.
• Branding A well-established and recognised brand provides huge opportunities for business growth in local
and international markets.
• Economies of scale These enable a business to benefit from lower unit costs of production by operating on a
larger scale. Lower average costs help to give the firm a price advantage.
• Diversification This strategy involves the business selling new products in new markets to spread its risks (see Ansoff s Matrix, Unit 1.3). It enables the firm to gain
revenue from an untapped market (as it is new to the industry), despite being a potentially high risk strategy.
