3.1.2 Business growth Flashcards
Why do businesses want to grow?
Firms usually grow to increase their profit, which can be achieved by:
- Increasing economies of scale
- Increasing market share and reducing competition
- Expanding into new markets
-synergy effect : it describes a situation where the combined performance of two or more businesses or assets is greater than the sum of their individual parts.
- pursuit of mangerial objectives
However, firms may also want to grow due to:
- Product diversification
- Status of running a large firm
- Easier access to finance
Circumstances encouraging business growth
- A gap in the market created by changing consumer tastes and technology.
- Finance - Business growth can be financed by a parent company (cross-subsidisation).
- If barriers of entry can be put in place by a firm. For example, if a firm can secure a patent quickly.
- If a firm was able to ‘make the first move’, then economies of scale create a barrier to entry.
Circumstances preventing business growth
- Poor management
- Lack of finances to meet demand
- Small market without the ability to reach economies of scale
- Nature of the business means that small, close customer
service is more effective – inability to ‘scale-up’ the business. - CMA may block a takeover or merger.
Organic growth (and an example)
Where a firm’s market share is increased by reinvesting profits, innovation, improving productivity and launching products into new markets.
For example, increasing output by building a larger factory, hiring more workers, and increasing the amount of raw materials used.
Advantages of organic growth
- The firm has control over exactly how this growth occurs.
- Can be financed by retained profits.
- Builds upon a business’ strengths.
- Allows the business to grow at a more sustainable rate.
- More likely to be able to monitor and avoid the principal-agent problem.
Disadvantages of organic growth
- May find it more difficult to respond to changes in market.
- Can be more expensive.
- Growth achieved may be dependent on the growth of the overall market.
- Harder to build market share if business is already a leader.
- Slow growth – cannot progress without retained profit or borrowing.
- Rivals may opt for M&As and grow more quickly … could even buy your firm!
Inorganic growth
Where a firm’s market share is increased as a result of takeovers and mergers.
Instead of trying to defeat rival firms, inorganic growth involves purchasing rivals. Although competition authorities (such as the CMA) can block mergers and acquisitions.
Takeover
When one firm buys another firm, which becomes part of the first firm.
Merger
When two firms unite to form a new company.
Advantages of inorganic growth
- Quicker than organic growth.
- Cheaper than organic growth.
- Easy way to gain experience and expertise in a new area of business.
Disadvantage of inorganic growth
Competition authorities (such as the CMA) can block mergers and acquisitions.
Horizontal integration
Mergers take place between companies at the same stage of the production chain.
Advantages of horizontal integration
- Larger market share
- Larger base of customers
- Increased revenue
- Reduced competition
- Increasing synergies
- Economies of scale
- Reduced production costs
Disadvantages of horizontal integration
- Reduced economic growth
- Regulatory scrutiny
- reduced consumer choice
- risk of diseconomies of scale
Real-life examples of Horizontal Integration
- Disney purchased Pixar (both animation studios).
- Morrisons and Safeway in 2004 (both supermarkets).
- Nike and Umbro (both sports brands).
- Iberia and British Airways (both airlines).
- Orange and T-Mobile (both phone network providers).
Vertical integration
Firm merges with another company that is involved in a different stage of the production process.
Forwards vertical integration
When a firm takes over another firm that is further forward in the production process (closer to the consumer). E.g. Cadbury buying a chocolate shop.
Backwards vertical integration
When a firm takes over another firm that is further back in the production process (closer to the raw materials). E.g. Cadbury buying a cocoa farm.
Advantages of vertical integration
- Economies of scale
- Expands geographically
- Efficiency
- Differentiate from competitors
- Securing a supply chain
Disadvantages of vertical integration
- Established distribution channels may be affected
- Could lead to a monopsony
Real-life example of vertical integration
Apple purchased a chip-manufacturing company (backwards) and opening up retail stores (forwards).
Conglomerate merger
Firms from different industries merge. E.g. Ford and a dairy farm.
Conglomerate mergers allow firms to diversify and spread their risk – if one part of the new firm does badly, this can be compensated for by profit from another part of the firm.
A conglomerate merger will also allow a firm to use profits generated by one product to invest in another.
Advantages of conglomerate merger
- Gain synergies
- Diversification
- Improves customer base
- Economies of scale
Disadvantages of conglomerate merger
- No past experience
- Shift in focus
- Diseconomies of scale
Real-life examples of conglomerate merger
- Amazon purchased Whole Foods (a US supermarket company).
- Virgin – with Media, Airlines, Banking
- Co-operative group – with Food, Banking, Funerals
- Unilever
Disadvantages of growth
- If two firms merge there will be a duplication of staff, such as marketing, finance and HR. It’s therefore likely that some of this staff will be made redundant.
- The merged firms may have different or incompatible objectives that will need to be resolved
- A firm can put itself in a lot of debt in order to raise the finance necessary to complete a takeover.
- The new, larger firm may suffer from diseconomies of scale.
Benefits of business growth on consumers
- A larger firm may benefit from economies of scale which could lead to price reductions for consumers.
- The combined creativity of two firms working together may lead to the production of better quality products.
Negatives of business growth on consumers
- Consumers will have less choice if two or more firms merge.
- The reduction in competition caused by firms merging may also lead to higher prices for consumers.
- Two merged firms may produce less output than two separate firms, which will lead to price increases.
How do governments monitor mergers?
Typically via a competition authority (the CMA in the UK).
For example, a merger can lead to the creation of a monopoly, which will have advantages and disadvantages for consumers. If a government decides that a merger is unfair to consumers, then it can take action to block the merger.
Reasons for mergers/takeovers
- Increase market share
- Spread risk
- Lower costs of production (through economies of scale)
- Eliminate competition
- To acquire tangible (e.g. infrastructure) and intangible (e.g patents) assets
- To acquire a new customer base
- Quick expansion of firm
- Access to new market
- Overcoming barriers to entry
- Increase profits
- To create synergies
Tangible assets
Physical assets e.g. Labour, machines, buildings
Intangible assets
Not physical assets. E.g. Distribution rights, trademarks and patents.
Synergy
“Whole is greater than the sum of its parts”.
- When workers, firms and other economic agents work together effectively, synergy is created. This leads to innovation and higher productivity (than if they were apart). | If a merger is successful, it can bring synergy to both firms.
