3.1.2 Business Growth

Question 1

What are the ways in which businesses can grow?

Answer 1

Question 2

What is organic growth?

Answer 2

Organic growth is known as internal growth and it happens when a business expands its own operations rather than relying on external takeovers and mergers.

Question 3

Where can organic growth come about from?

Answer 3

1. Increasing existing production capacity through investment in capital & technology
2. Development & launch of new products (e.g. to achieve economies of scope)
3. Finding new markets by exporting into emerging countries such as India and South Africa
4. Establish new distribution channels such as online sales platforms
5. Growing a customer base through marketing and adding new users of a product

Question 4

What are examples of companies using organic growth?

Answer 4

Question 5

What are the benefits of organic growth?

Answer 5

• Less risk than external growth - many takeovers failed to achieve expected gains
• Can be financed through internal funds (e.g. using retained profits)
• Builds on a business’ strengths (e.g. brands, customers)
• Allows the business to grow at a more sensible and sustainable rate

Question 6

What are the drawbacks of organic growth?

Answer 6

• Growth achieved may be dependent on the growth of the overall market
• Hard to build extra market share if business is already a leader
• Slow growth - shareholders may prefer more rapid growth
• Franchises (if used) can be hard to manage effectively

Question 7

What is horizontal integration?

Answer 7

Horizontal integration is between two businesses in the same industry at the same stage of production.

Question 8

What are examples of horizontal integration?

Answer 8

• Horizontal mergers in the betting industry: Ladbrokes and Gala Coral, Betfair and Paddy Power
• Waterstones bought Foyles bookshops in 2018
• In mid-2019, companies Just Eat and takeaway.com were in talks regarding a possible merger

Question 9

What are the advantages of horizontal integration?

Answer 9

1. Exploit internal economies of scale including bulk-buying, technical economies, financial economies
2. Cost savings from the rationalisation of the business – this often this involves job losses
3. Potential to secure revenue synergies by creating a wider range of products - (i.e. diversification) – this creates
   opportunities for economies of scope
4. Reduces competition by removing key rivals – this increases market share and long-run pricing power
5. Buying an existing and well-known brand can be cheaper in the long run than organically growing a brand – this can then make entry barriers into a market higher for potential rivals

Question 10

What are the disadvantages of horizontal integration?

Answer 10

1. Risk of diseconomies of scale from the enlarged businesses especially if there are clashes of management culture, problems with integrating businesses that operate in different ways
2. Reduced flexibility – the addition of more personnel and processes means the need for more transparency
   and therefore, more accountability and red tape which can slow down the rate of innovation / getting new
   products to market
3. Destroying shareholder value rather than creating it: This happens because the synergies never materialize
   despite the potential benefits of the horizontal integration. Most large-scale mergers fail to achieve the gains in shareholder value that were forecast before it happened
4. Risk of attracting investigation from the competition authorities who might be worried that a horizontal
   merger might lead to a substantial lessening of competition in a market which could then lead to a fall in
   consumer welfare

Question 11

What is vertical integration?

Answer 11

Vertical integration involves acquiring a business in the same industry but at a different stage of the supply chain. It is the merger of two firms at a different stage of the same industry or process of production or same final product

Question 12

What is forward vertical?

Answer 12

An integration of a business that is closer to final consumers e.g. a manufacturer buying a
retailer, a cannabis retailer buying a cannabis farm. A good recent example in the UK is wholesaler grocery
firm Booker buying the Budgens and Londis retail grocery chains

Question 13

What is backward vertical?

Answer 13

Business integration that is closer to the raw materials in the supply chain e.g. a manufacturer buying a component supplier. Ikea Buys Romanian and Baltic Forests to improve control of their
key raw materials

Question 14

What are the advantages of vertical integration?

Answer 14

1. Control of the supply chain – this helps to reduce unit costs and also improve the quality of inputs into the
   production (supply) process
2. Improved access to key raw materials perhaps at the expense of rivals who must then pay more for them
3. Better control over retail distribution channels + adding new channels to sales platforms to build business revenues
4. Removing suppliers and taking market intelligence away from competitors which then helps to make a market less contestable (I.e. it increases a firm’s market power)

Question 15

What are the disadvantages of vertical integration?

Answer 15

1. Vertical mergers will have fewer economies of scale because most of the production is at different stages of
   production.
2. Mergers can often create new problems of communication and coordination within the bigger more disparate firm. It can lead to diseconomies of scale where the new bigger firm is more inefficient.

Question 16

What are conglomerates?

Answer 16

A conglomerate has acquired a large number of diversified businesses.

Question 17

What are examples of conglomerates?

Answer 17

The world’s biggest conglomerates include
businesses such as General Electric, Honeywell International and 3M in the United States, Siemens from Germany and Philips (Netherlands). Samsung – the electronics giant - also makes military hardware, apartments, ships and Samsung also operates a Korean amusement park.

Question 18

Why do many mergers and takeovers fail?

Answer 18

1. Huge financial costs of funding takeovers including deals that have relied on loan finance - this leaves a big
   debt overhang after the deal which incurs heavy interest costs
2. Integrating systems – companies might have different technology systems that are expensive or impossible
   to marry e.g. eBay & Skype
3. Many mergers fail to enhance shareholder value because of clashes of corporate cultures and key
   personalities
4. The business may suffer a loss of customers and skilled workers post acquisition (a loss of human capital)

Question 19

What happens in a joint venture?

Answer 19

• Joint ventures occur when businesses join together to pursue a common project
• The businesses remain separate in legal terms
• Joint ventures are becoming common as firms want to benefit from collaborative work in reaching a mutually agreed strategic target e.g. a joint-research project to share fixed costs of higher risk research

Question 20

What are recent examples of joint ventures?

Answer 20

• Vodafone & Telefónica agreed to share their mobile network
• BMW and Toyota co-operate on research into hydrogen fuel cells and ultra-lightweight materials
• Google and NASA developing Google Earth

Question 21

What are constraints on business growth?

Answer 21

Question 22

How can regulation constrain business growth?

Answer 22

• Growing businesses winning significant market share may come to attention of the competition authorities
  e.g. Amazon, Uber and Google
• In the UK, the Competition and Markets Authority (CMA) may decide to block a merger between two firms if
  they find sufficient evidence that the merger/takeover would lead to a substantial lessening of competitive
  pressure in a market

Question 23

How can competition constrain business growth?

Answer 23

• In contestable markets, there is always the threat of entry from rival firms; technological change has in many
  cases had the effect of reducing barriers to entry into markets.
• Firms that are dominant in an industry but operating inefficiently and charging monopoly prices may find that
  challengers firms are able to enter the market and compete away some of their market share and their
  supernormal profits.

Question 24

How can finance constrain on business growth?

Answer 24

• Many small-medium sized enterprises (SMEs) run up against finance constraints including limited access to
  loans and risks and costs of raising equity in capital markets
• In the aftermath of the Global Financial Crisis, commercial banks are more risk-averse when it comes to lending to businesses. In the UK, many small and medium sized enterprises complain that they cannot access loan finance at affordable interest rates. Commercial banks may charge a “risk premium” when lending to SMEs

Question 25

How can the size of the market constrain on business growth?

Answer 25

• Businesses achieving success in local or niche markets may find limits to scalability. There is simply not enough
  regular consumer spending. Other businesses successfully leverage their brand to enter new markets
• Niche markets target smaller groups of consumers, they are often highly profitable because suppliers can
  charge a premium price, but have limited opportunities for economies of scale to be exploited

Question 26

What are additional constraints on growth excluding regulation, competition, finance and market size?

Answer 26

1. Human capital weaknesses / skills shortages – e.g. businesses may struggle to recruit the skilled personnel
   that they need be it in complex financial services or in the construction industry
2. Bureaucracy and red tape – as businesses grow so too does the legal requirements e.g. auto-enrolment of
   staff into a pension scheme, filing regular tax returns (including VAT) and meeting health and safety
   requirements