2.1 - Growing the Business (2.1.1 Business growth only set 1 of 4)

Question 1

2.1.1 - Define internal growth.

Answer 1

Internal growth is when a business grows through selling more; expanding on its own without mergers or takeovers from other businesses.

Question 2

2.1.1 - Explain three methods of internal (organic) growth.

Answer 2

• New products; by innovating and developing an existing idea or improving an existing product or by conducting research and development to develop brand new products that are not currently available.
• New markets; changing the marketing mix to find new markets/segments, or by expanding overseas. This may need the marketing mix to be adapted for local customer needs. This could also include the use of an extension strategy for example.
• New technology; large organisations can benefit from investing in the latest technology to improve operations and help to increase sales or by developing new technology themselves.

Question 3

2.1.1 - Define external (inorganic) growth.

Answer 3

When a business combines with another to grow. This occurs via either a takeover or merger.

Question 4

2.1.1 - Define the term takeover.

Answer 4

Where one business buys the majority share in another, one business will take complete control of the other, following a takeover one business will no longer exist.

Question 5

2.1.1 - Define the term merger.

Answer 5

Where two or more businesses voluntarily agree to join together and operate as a combined business.

Question 6

2.1.1 - Explain the 4 ways in which mergers or takeovers can occur.

Answer 6

Mergers and takeovers can occur when firms join at different stages of production; forward vertical, backwards vertical, horizontal integration and conglomerate mergers and takeovers,

Question 7

2.1.1 - What are the key advantages of business growth?

Answer 7

+ Increase sales and provided costs rise less than the increase in revenue, then an increase in profit, which may then provide a better return on investment for shareholders.

+ Increase in market share; in the case of a merger or takeover an increase in market share can happen overnight as two businesses (or more) are now one, so their combined sales within the market will be higher. This may also increase the value of the share price (if as plc).

+ Economies of scale; as size increases, the potential to negotiate lower prices or bulk buy in order to lower costs becomes possible or by being more efficient as you grow, producing more in the same amount of time

Question 8

2.1.1 - What are the advantages of a business going through organic (rather than inorganic) growth?

Answer 8

+ A business that grows from within can retain their own company culture, and as such it’s easier to mange and control

+ Higher production means the business can benefit from economies of scale and lower average costs as such it can potentially positively impact the gross profit margins due to lower cost of sales.

+ More influence comes with more market share, the business can start setting prices for the industry

+ Organic growth is often funded internally from retained profits and as such tends to be a cheaper source of growth than a takeover or merger.

Question 9

2.1.1 - What are the disadvantages of a business going through organic (rather than inorganic) growth?

Answer 9

• This is a very high risk strategy, opening lots of stores or taking on new staff is very risky especially in markets where the business may have less experience as the business may not understand the local customers needs and wants.
• Often there is a long period between investment and return on investment and so return on investment may take some time
• Growth may be limited and is dependent on reliability of sales forecasts
• Potentially diseconomies of scale; if inefficiencies occur during the growth/set up in the new market period, where average costs rise this could in fact negatively affect profit margins.

Question 10

2.1.1 - What are the advantages of a business going through inorganic (external, rather than organic) growth?

Answer 10

+ Increase in market share; in the case of a merger or takeover increase an in market share can happen overnight, this may also increase the value of the share price

+ Economies of scale; as size increases the potential to negotiate lower prices or bulk buy in order to lower your costs becomes possible or by being more efficient as you grow, producing more in the same amount of time

of scale

+ Competition can be reduced; meaning your position as a market leader is achieved quicker and play a more dominant role in setting market prices, potentially raising your ability to charge premium prices.

Question 11

2.1.1 - What are the disadvantages of a business going through inorganic (external, rather than organic) growth?

Answer 11

• External growth can be expensive; as costs to merge or takeover can be high, especially legal costs and the paying of professionals to manage the process.
• Staff morale and motivation can be negatively affected as uncertainty over new culture, new processes and fear of redundancies can affect staff and cause efficiency to drop, which increases unit costs. This can lead to diseconomies of scale as the businesses reorganise.

Question 12

2.1.1 - Describe how economies of scale work.

Answer 12

When your costs decrease due to larger levels of production, this is because more products are being produced which means more materials are being ordered more regulalrly which means bulk orders reduce the price you pay and as such variable costs per unit are therefore reduced.

Question 13

2.1.1 - What are the advantages of business mergers?

Answer 13

+ Economies of scale. Better deals because of the increased order size, bulk-buying discounts etc.

+ Increased revenue and market share. Increased size of the combined company increases market power and the ability to set higher prices

+ Buying technology. Sometimes it’s simply impossible for a company to create the technology it needs to sustain its growth. It can be a lot simpler to just buy it, and if you merge with a company who has it then this will potentially work out more cost efficient.

+ International Expansion. Buying a business in another country helps with cultural issues, foreign laws or language barriers for example.

Question 14

2.1.1 - What are the disadvantages of business mergers?

Answer 14

• Clash of cultures, all businesses have a slightly different culture and they may not work well together
• Possible communication problems as the business gets bigger, or if there are now too many employees
• Unreliable merger partners, a good merger will depend on trust between the businesses
• Diseconomies of scale; As a business gets larger costs will go up with problems of motivation, communication and co-ordination

Question 15

2.1.1 - Why might a private limited (ltd) company float on the stock exchange to become a public limited company (plc)?

Answer 15

Becoming a plc may enable a business to grow into a multinational corporation and operate in more than one country and as anyone can buy shares in a plc the ability to raise large amounts of capital may mean it can expand.

Question 16

2.1.1 - What are the benefits of being a public limited company (plc)?

Answer 16

+ Ability to raise capital through floating on the stock exchange, or by issuing more share capital if already a plc. This can raise large amounts of capital to aid expansion.

+ Investors continue to benefit from limited liability (as they do in a private limited company -ltd).

+ Considered more prestigious and reliable due to the size

+ Greater public awareness of the business, as plc’s tend to feature in the media far more often (usually because they are under scrutiny from many stakeholder groups)

+ May lead to becoming a multinational (MNC), which can make expansion into overseas markets much easier as you might be closer to suppliers or hire local employees to assist with getting to know local markets

Question 17

2.1.1 - What are the drawbacks of being a public limited company (plc)?

Answer 17

• The accounting and reporting procedures are far more complex, as the plc is required to publish a full set of accounts whereas a private limited company has only to publish a limited amount of financial information.
• Risk of takeover; when the public can buy shares, the business is susceptible to another individual or organisation who could acquire a majority share who would then have control.
• As plc’s are often in the media due to their size and public nature, if there are any problems or scandals this can significantly affect the share price which could cause investors to sell their shares and then the value of the company would fall.

Question 18

2.1.1 - Explain two sources of internal finance that can be used to fund growth.

Answer 18

Capital that originates from within the business.

• Retained Profit; profits that the business has earned historically that have been held back for investment into expansion
• Selling Assets; selling resources such as land or equipment that the business owns and can raise capital from.

Question 19

2.1.1 - Explain three sources of external finance that can be used to fund growth.

Answer 19

Capital that originates from outside of the business.

• loan capital; bank loans or loans from a finance company that need to be paid back with interest over a period of time.
• share capital; issuing more shares to investors
• stock market floatation; when a private limited company lists on the stock exchange to raise capital from the purchase of the company’s shares

Question 20

2.1.1 - What are the pros and cons of loan capital?

Answer 20

+ Improve cash flow; as the loan is paid back in instalments over time

+ As the capital is provided by a bank there is no loss of control like with the risk of share capital

+ Provided the business proves to be a good financial risk, or they have collateral to secure the loan (like property), large amounts can be raised.

• Time for approval; sometimes the decision can take time, unlike retained profit which is available instantly
• Interest; the larger the amount borrowed the more interest the business will have to pay, this increases the cost of the finance
• If the loan cannot be rapid and collateral was used to secure the loan, the risk of repossession occurs

Question 21

2.1.1 - What are the pros and cons of share capital?

Answer 21

+ Large amounts of capital can be raised which as expansion can be expensive can be useful to fund growth

+ No interest and does not need to be paid back so the cost of the finance is low compared with a bank loan

• Loss of control; as shareholders get votes the decision making can be affected and the business is susceptible to a takeover if majority shares are purchased by an individual or an organisation.
• Investors are looking for a return on their investment and as such will expect the share price to increase in value and also expect dividends, this may be in conflict with offering lower prices or retaining profits.

Question 22

2.1.1 - What are the pros and cons of stock market floatation?

Answer 22

+ Large amounts of capital can be raised due to listing be open to anyone

+ No interest and the value of the shares issued does not need to be repaid

• Loss of control (As all the shareholders vote on desicions)
• Costs; both legal and advertising the floatation to potential investors, can be quite high. In order to float on the stock exchange the company must have a minimum of £50 000 in equity.