7.6 Specific Benefits of Inorganic (External) Growth Flashcards
What is Inorganic (External) Growth?
It is the growth that occurs as a firm engages in mergers and takeovers.
What is Horizontal Integration?
It is when firms combine at the same point of the production process.
What is Vertical Integration?
It is when firms combine at different stages of the production process; either forward (closer to the consumer) or backward (further away from the consumer).
What are the traditional benefits of business growth?
Higher profit, economies of scale, new market opportunities and managerial rewards.
What are the traditional problems of business growth?
Diseconomies of scale, new regulations, lower standards, and greater scrutiny.
What are the specific benefits of inorganic growth?
- Bringing in specialist staff.
- Rationalization.
- Monopsony power.
- Monopoly power.
- Diversification of product range
6.Taking away intermediary selling and buying.
Benefits: Businesses can benefit from bringing in specialist staff
Businesses can benefit from bringing in specialist staff. This is because mergers and takeovers allow for the transfer of highly skilled and specialist staff into a company. As a consequence, productivity can rise, reducing costs of production and increasing profit margins whilst also successfully managing the process of growth over time.
Benefits: Businesses can benefit from the process of rationalisation
Through mergers or takeovers, businesses can benefit from the process of rationalisation. This is where reorganisation of the production process occurs in order to improve efficiency. Synergies between the two companies can be found and in the case of vertical integration, more control of production process can be obtained. Consequently costs per unit can be lowered with competitive pricing adopted to gain market share in a demanding business environment.
Benefits: Inorganic growth can result in monopsony power
Inorganic growth can result in monopsony power. This is where the creation of one much larger company provides price making buying power and thus the ability to drive down prices of its suppliers. As a consequence, costs of production will be lower with the monopsonist benefitting from higher profits, dynamic efficiency and the ability to discount prices for consumers to gain market share in a competitive selling market.
Benefits: The creation of one larger firm can result in monopoly power
The creation of one larger firm can result in monopoly power. This is through a merger or takeover that enables the newly created firm to enjoy market share of at least 25%; furthermore the sheer size of the firm, brand awareness and economies of scale it will experience itself creates a significant barrier to entry to allow this power to continue over time. As a consequence, this firm could have the ability to restrict output and charge higher prices, making large supernormal profit in the long run.
Benefits: Businesses can diversify their product range
Businesses can diversify their product range. Through horizontal or vertical integration, it is possible that new products can be added to a production line allowing for greater diversification. As a consequence, the business can boost their consumer base with a larger product offering and also spread risk over a larger range of output benefitting from risk bearing economies. Once more with higher profits being made, loss making products can be cross subsidised allowing for the benefits of diversification to remain.
Benefits: Inorganic Growth can take away from intemediary selling and buying
Inorganic growth can take away intermediary selling and buying. Through vertical integration, a business will have far more control of their entire production process from initial raw material acquisition to manufacturing and then retail. Consequently the costs of selling to and buying from third party intermediaries will disappear, increasing profit margins and raising quality through the entire production process.
Con: If businesses merge, there could be differences in managerial objectives
If businesses merge, there could be differences in managerial objectives, which create internal problems in the firm. For example managers can easily differ on exact methods of profit maximisation; cost cutting methods, price and non. price strategies or on the exact business objective itself. Consequently, with a confused and non-cohesive management strategy, the business will lack coordination creating a diseconomy of scale, reducing productive efficiency and driving up unit costs.
Cons: Businesses may get into financial difficulty
Specific Problems/Evaluation of Inorganic (External) Growth
Businesses may get into more financial difficulty as they grow and expand inorganically. This is because loans may have been taken to finance a takeover and/or to pay for the regulatory procedures and restructuring of a merger. As a consequence excessive debt will be built up creating balance sheet instability and problems with accessing finance in the future. Furthermore if the business attempts to payoff debts by cost cutting or implementing risky pricing decisions, consumer loyalty could be harmed creating long term damage to profitability and reputation.
Con: There is a risk that mergers or takeovers can result in redundancies
There is a risk that mergers or takeovers can result in redundancies. This is because as two firms become one, there could be duplication of staff or a business strategy to cut costs and increase efficiency which will lead to a reduction in the workforce size. These workers will therefore be impacted negatively through a loss in income and worsening of living standards but the firm may also have to bear extra legal costs of redundancy payments.
