Growing a Business
The growth of businesses is related to several other topics at A2 level – including:
1.
2.
3.
4.
5.
Economies of scale and scope
Development of monopoly power in markets
Different objectives of businesses e.g. growth max rather than pure profit max
The role of profit in allocating scarce resources
Competition policy and economic welfare – market power issues
Why grow?
Profits and shareholder value
Higher dividend income for shareholders in listed companies
Capital gains from rising share prices
Profits help to finance future business expansion
Stock market expects growth – under-performance damages share prices
Market share / market power
Growing monopoly power and pricing power
Opportunities for price discrimination
Economies of scale and scope
Falling long run average cost – leads to higher profit margins
Extending the value of a brand
Managerial motives
Managerial satisfaction / status from working for growing businesses
Methods of growth
Internal growth
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When the company increases in size on its own
Through
o Increased demand
o Expanding range (scope) of products
o Selling products in a number of locations
o Investment in capital and labour inputs
o Joint ventures with other businesses (see below)
External growth – the integration of two or more businesses - includes
• Merger (where 2 companies combine to become one new company)
• Takeover (where one company wants to buy another company and make it part of its existing
business)
Horizontal integration
Subsidiary companies are created. Each markets the product to different market segments or geographical areas
Examples:
Adidas - Reebok
Nike and Umbro
Body Shop and L'Oreal
NTL and Telewest
Capital Radio and GWR
Carlton and Granada to form ITV plc
AOL and Bebo
US Airways and American Airlines
General Motors acquisition of parts of Daewoo
Renault-Nissan
Tata and Jaguar
Morrisons takeover of Safeway
Corus and Indian Steel firm Tata
Virgin Active and Holmes Place
Advantages of horizontal integration
1. Increases the size of the business and allows for more internal economies of sale – lower long run
average costs – improved profits and competitiveness
2. One large firm may need fewer workers, managers and premises than two – a process known as
rationalization again designed to achieve cost savings
3. Mergers often justified by the existence of “synergies”
4. Wider range of products - (diversification). Opportunities for economies of scope
5. Reduces competition by removing rivals – increases market share and pricing power
Lateral integration
Subsidiary companies join together that produce similar but related products
Good examples
Ottakars and HMV
Sony and BMG
eBay and Skype
Google and You Tube
Gillette and Proctor & Gamble
Vertical integration
Backward vertical - owning subsidiaries that produce some of the inputs used in production
Forward vertical - subsidiaries that distribute or market products to customers
Examples
Film distributors owning cinemas
Brewers owning and operating pubs
Tour operators / Charter Airlines / Travel Agents
Crude oil exploration all the way through to refined product sale
Record labels, record stations
1. Control of the supply chain – helps to reduce costs (eliminating intermediate profit margins)
2. Access to important raw materials
3. Control over retail distribution channels
Joint ventures
Increasingly common – reflecting collaborative nature of production and research
Good examples of joint ventures
Sony Ericsson - mobile phone joint venture
Google and NASA
Hollywood studios fighting internet piracy
Boeing and Lockheed
Hugo Boss and Proctor & Gamble
MySpace and Skype
Advantages from joint ventures include
Commercial synergies from two linked businesses
Pursuit of a mutual strategic goal
Faster brand development
Transfer of technology/skills
Extension of market reach
Access to new technologies and new customers in growing markets
Access to innovative managerial practices
Access to scarce resources e.g. scarce mineral deposits
Strengthens the competitive position of the businesses at a time of rapid structural change in markets
Helps to spread the cost of research e.g. in R&D into technologies to reduce CO2 emissions
Evaluation:
Many takeovers and mergers fail to achieve their aims
Financial costs of funding expensive takeovers
Burden of loan finance / leverage
Need to raise fresh equity – negative impact on a company's share price
Many mergers fail to enhance shareholder value
Clashes of corporate cultures
Failure to find the "synergy gains“
Winners' curse - paying over the odds to take control of a business
Competition policy concerns
Risk of monopoly power from vertical and horizontal integration
Integration often leads to sizeable job losses – economic and social consequences
Test yourself:
Check your understanding by taking this multiple choice test on the VLE
http://vle.tutor2u.net/mod/quiz/view.php?id=1484