3.1.2 - Business Growth Flashcards
Two way business can grow
. Internal / Organic Growth
. External Growth (i.e. merger)
Organic Growth meaning
Firm increasing its size through investment in factors of production (e.g. capital, labour, etc.) without any mergers
Define Merger
Two firms joining together under common ownership.
Name three types of Mergers
. Horizontal Merger
. Vertical Merger (Forward vertical integration and Backward vertical Integration)
. Conglomerate Merger
Define Horizontal Merger
Merger between two firms in the same industry at the same stage of production
E.g. two bakeries
Define Vertical Merger
Merger between two firms in the same industry at different production stages. Two types:
. Forward Vertical Integration : Involves a supplier merging with one of its buyers. E.g. Car manufacturer buying car dealership
. Backward Vertical Integration : Involves purchaser buying one of its suppliers
Define Conglomerate Integration
Merging of two firms with no common interest
E.g. Car company purchasing tobacco company
Advantages and Disadvantages of Vertical Integration
ADVANTAGES :
. With backward vertical integration, firms have improved access to key raw materials. This can time when sourcing suppliers, which decreases average costs. Furthermore, suppliers can charge higher prices to competitors, which reduces competition.
. Reduces risk as there is some diversification
. Forward vertical integration increases market control. If a supplier bought a firm that bought its products, it could decide what price to sell the products, in what markets and the quality of the goods.
DISADVANTAGES :
1.) There is little expertise in the industry they took over. This can lead to poor management of factors of production such as labour and capital. This can lead to productive inefficiency, which means average costs rise. An increase in cost of production shifts supply to the left from S1 to S2. This would lead to a fall in consumer surplus, due to higher prices.
2.) Difficulties merging two firms into one firm as it is time consuming and expensive. Furthermore, costs arise due to extra layers of management needed to control the new firm. This increases cost of production.
. Use disadvantages from horizontal intergration
Advantages and Disadvantages of Horizontal Integration
ADVANTAGES :
1.) Reduction in average costs due to economies of scales. Economies of scales are caused by greater specialisation of labour and reduced costs by bulk order
2.) Reduces competition by taking out a competitor and having greater market share. Greater market share allows more control price control, which can increases revenue, thus profitability for goods.
3.) Merger likely to be more successful than vertical merger as a business grows in a market where it already has expertise
DISADVANTAGES :
1.) Firms overpay for the firm they take over and the share price of the firm tends to fall
2.) Difficulties merging two firms into one firm. Costs arise due to extra layers of management needed to control the new firm
3.) Key workers in the firm that has been taken over may leave if there are changes to management as they feel unappreciated. This increases cost of production as firms will need to replace and train workers, shifting supply to the left, thus reducing consumer surplus
Furthermore, the average human capital will also be lower , meaning that labour productivity will not be as high, which would lead to productive inefficiency, thus increasing cost of production.
4.) Lack of diversification increases risk because demand for a good or service may depend on trends or consumer confidence. For example, in a recession demand will be low thus reducing quantity purchased, which reduces revenue and profit. This reduces producer surplus as demand shifts to the left.
Advantages and Disadvantages of Conglomerate Integration
ADVANTAGES :
. Reduces risk - by buying another firm in a different market (diversifying), the firm is not so dependent of the ups and downs or trends of one market
. Useful for firms with no growth in their current market
DISADVANTAGES :
. Firms are going into another market with no expertise. This can lead to poor management of the factors of production such as labour and capital such as machinery. This can lead to productive inefficiency, which means average costs rise.
Constraints on Business Growth
1.) Regulation : Government regulation prevents business growth. E.g. UK government regulates the number of pharmacies in a local area.
Competition law, which prevents monopolies can restrict growth as any merger which creates a company with more than 25% market share is forbidden from taking place
2.) Size of market: Some markets are very small due to relatively low demand from consumers meaning they don’t mass produce goods as they will not be bought. This limit business growth
E.g. the market for cricket balls is lower than market for coffee. This can prevents growth of a business
3.) Owner Objectives: Not all owners want to grow a firm as they are happy with their profits. Some owners do not want to grow a firm as it can result in extra work and extra risk
4.) Access to Finance : Firms can finance growth through retained profits or loans. If firms cannot make enough profit, they will not have enough retained profits to grow. Additionally, banks will not be willing to loan to smaller firms. As a result businesses cannot invest into factors of production and grow
Another word for merger
Integration
Conglomeration
Advantages and Disadvantage of Organic Growth
ADVANTAGES :
1.) Integration of a firm is time consuming, expensive and risky with the majority of firms having their share prices falling the in long term so organic growth is more cost efficient.
2.) Debt will not rise because organic growth is funded through reinvestment of retained profits rather than borrowing. Therefore, growth is sustainable and growth is not affect in the long term. If growth was the result of loans, it could hinder growth by increasing cost of production in the long term due to debt payments. This would increase price level and shift demand to the left, reducing producer surplus
3.) Control of the company remains within the same organisation. It’s the same managers and workers that control growth. This means that workers are less likely to be made redundant unlike an integration. This reduces cost of production as lese money is needed or redundancy payments
DISADVANTAGES :
1.) Organic growth may be too slow for directors who wish to maximise their salaries and bonuses.
2.) Without mergers, the size of growth is limited. This is as growth need reinvestment through retained profits. This means that economies of scale won’t be exploited.
