Inorganic Growth Flashcards
What is inorganic growth?
When businesses grow by joining together. This can be achieved by takeover or merger.
Both mergers and takeovers are corporate methods that aim to improve the performance of a business.
Merger
A merger is where two or more businesses join together to operate as one.
They are conducted with the agreement of both/all companies.
The companies don’t lose its identity.
They can help to cut costs and cope better with overcapacity.
Take over
When one business buys another.
Take over among plc can occur because their shares are traded openly for anyone to buy.
A business can acquire another by buying 51 per cent of their shares (not always the case).
Once a company has been bought it loses its identity and becomes part of the predator company.
However, ltd can’t be taken over unless the majority shareholders invite others to buy their shares.
Takeovers of plc result in a sudden increase in share price.
Sometimes more than one company might attempt to take over the same company - could lead to sharp increase in share price.
Reasons for mergers and takeovers
A main motive synergies- result from economies of scale, reduction of risk through diversification, management.
Quicker way to expand a business - instead of buying new resources and training staff just acquire or merge with a business specializing in that field.
Helps to consolidate position (more powerful) in the market. Can also avoid being taken over by expanding.
Integrating with businesses overseas allow for an entry into foreign markets and globalisation. Avoids paying tariffs on goods sold abroad.
Gain economies of scale.
Horizontal integration
When two firms in the exact same line of business and stage of production join together.
Benefits: Common knowledge of markets Lower chance of failure Similar skilled employees Less disruption Larger base of customers Reduced competition Reducing production costs
Limitations:
Reduced flexibility- size makes it harder to manage
Laid off employees- to avoid duplication of work
Conflict culture and leadership skills
Vertical integration
When firms in different stages of production join together.
Forward vertical integration- when a business joins with a business in the next stage of production.
Backward vertical integration- where a business joins with another in the previous stage of production.
Guarantees and controls the supply of components and raw materials.
To remove profit margin that the supplier would demand.
To remove the profit margin expected by the firm in the next stage of production.
Conglomerates
A very large business organisation that owns a number of other businesses.
Although each business operates as a separate entity they are still under the control of the owner/conglomerate.
Pros:
They are usually acquired through mergers and takeovers.
The wide range of business interests spreads the risk of enterprise. If one company is not doing well financially group profits can help.
Can fully exploit economies of scale.
Cons:
Diversification can result in difficulties - specialization and skills in one business may not be required in another.
Overtime they can become confusing and fail to maximise its full potential.
Sometimes they may take too long to get rid of failing companies, due to fear of losing diversification.
Financial risk and rewards
Rewards:
The main reason firms join together is to improve their financial strength and make more money.
Stakeholder benefits- shareholders in the target company often get higher dividends.
Stronger balance sheet- company will have more assets which are likely to be more diverse. Cash may also rise due to the high revenues generated by the large organisation.
Lower costs- they will be larger and able to exploit economies of scale to lower costs
Lower taxes- If a business takes over another located in a ‘low tax’ area tax liabilities could be reduced.
Risks:
Mergers and takeovers can sometimes go wrong and may have a long term financial impact on a company.
Integration costs- Physically integrating the companies can be a very long, time-consuming and tiring process. Businesses often underestimate the costs required in the process. eg. severance pay for laid off workers, technical changes, systems changes etc…
Overpayment- this is one of the main reason for the failure of mergers and acquisitions. This either happens because the financial benefits are overestimated or the costs are underestimated.
Bidding wars- these can occur when more than one companies are interestested in another. The price can sometimes rise drastically.
Advantages
Rapid growth- businesses grow way faster from mergers and takeover than growing organically.
Strategic benefits- can help businesses improve strategic position - they can complement each other and fill in gaps - one’s strength can compensate for the other’s weakness
Economies of scale- can benefit from this as fast as overnight, Only one head office is needed therefore one can be closed down - reducing costs. The large size allows for cost savings, increased specialisation and raising capital.
Eliminates competition- companies can take over rivals hence reduce competition in the market - raised prices
Disadvantages
Regulatory intervention- if regulators think a merger or takeover acts against interests of customers, they have the power to order an investigation, which takes time and causes delays. Regulators have the power to reject them.
Drain on resources- they can cost a lot of money. Growing too rapidly by going on a takeover trail may stretch financial resources and damage other aspects of the business.
The alienation of customers- rapidly growing customers may lose touch with their customers. With focus primarily being on growth the needs of customers get overlooked. This could damage their image and result in a loss of customers.
Loss of managerial control- very rapid growth can lead to loss of control by senior executives. Bigger organisations require more layers of management which makes communication takes longer within the company and could negatively impact chain of command. Diseconomies of scale will occur and lead to high costs.
Joint venture
When businesses join together and combine resources to complete a specific project
Advantages
Gives business access to new markets and distribution networks
Possible specialisation/ skilled workers/
new knowledge
Shared risks/ costs
Access to better resources- advanced tech
Enables growth without needing to borrow funds or look for outside investors
Disadvantages
The objectives of a join venture are not always very clear and often not communicated to all people involved
Clash of cultures- difference in beliefs, tastes and preferences may result in poor co-operation and integration
Limited outside opportunities- job venture contracts may restrict external activities of participants companies
