3.1.2 Business growth

Business growth 

There are two types of growth. 

Organic (aka internal) 

e.g. UnderArmour/LEGO 

Organic growth is the internal expansion of a company - no other companies are involved.  This is the most common type of growth, as most firms are small or medium-sized, so don't have the resources necessary for external growth. 

Can be done in various ways: 

through advertising and reaching out to more consumers, hence building customer base

by expanding into new markets/introducing new products

expanding existing production through investment in capital such as building factories, acquiring new machines, etc. 

Advantages: 

Cheaper, more cost-effective. 

Easier and less complicated. 

Less risky. 

Disadvantages:

Growth usually takes a long time. 

It is hard to expand internationally without making acquisitions as different countries have different legal rules, etc. This could also hold true for expanding into different markets. 

Inorganic (aka external) 

e.g. Google acquiring Motorola/Amazon buying Twitch 

This is growth involving other companies. Can be done one of two ways: 

1. Merger

Combining two previously separate businesses into one business, with the consent of both boards of directors. 

2. Takeover 

When one business literally buys or takes over another. hostile, as goes against the wishes of one set of board of directors. 

Advantages: 

Faster growth. 

Easier diversification into new markets if a company acquires another already in that market. The knowledge is then already there for them. 

Easier to expand internationally by acquiring a company in that country - increase presence in faster-growing countries. 

Disadvantages:

Risky 

Initially expensive to acquire other companies. 

May also be complicated.

There are different ways in which two companies can merge/be acquired. 

Vertical integration 

Merger or takeover between firms at different production stages in the same industry. 

Production stages:

Primary - usually produce commodities
hard primary industries include raw material extraction
soft primary industries include agriculture, fishing, forestry, etc. 

Secondary - manufacturing 

Tertiary - services such as marketing, consultancy, etc. 

Forward (towards customer)

A company takes over another company that it supplies (further up the production chain towards the consumer)

e.g. Fuller's brewery acquiring a pub. 


Advantages: 

To increase profits by:

Removing a layer of intermediary profit, resulting in lower costs. Larger firms get economies of scale - banks might give them lower interest rates as they are now more stable and less risky. Loan cost per £ is smaller.

Reduces the number of outlets available to competitors and therefore reduces competition, leading to a more inelastic PED and greater price setting power, therefore greater revenue.

Backward (away from customer)

A company takes over another company that supplies it (down the production chain away from the consumer) 

e.g. Fuller's brewery buying a hops farm. 

Generally:

Forward = raw materials -> production/manufacturing -> retail to consumers

And backwards = retail -> production/manufacturing -> raw materials 

Advantages: 

There is more control over supply (e.g. with the hops farm), reducing risk. Less subject to market forces (e.g. changes in the price of oil wouldn't matter as much if you had your own supply of oil) 

Cost control, control over prices, and a greater level of market control/power. Firm doesn't have to pay inflated prices to competitors but instead is able to decide what competitors will have to pay. 

Disadvantages (for both forwards and backwards):

Upfront costs - you have to pay a premium. There is a chance a firm isn't worth what you thought it would be. 

Different skillset- the merger/takeover may not work. The further from the core competencies of the original company, the greater the risk and the company would be less familiar with the new acquisition's market. 

If integration turns out to be difficult, costs may actually increase. 

Horizontal integration 

Merger/takeover between two firms at the same stage of production in the same industry combine to form a single company. 

e.g. Facebook and Instagram, Sasda 

NB: in the real-world companies don't overlap perfectly so there is very little perfect horizontal integration 

Advantages: 

Not as risky, as the original company is not moving away from its core competencies, so is familiar with the industry and stage of production. 

Economies of scale reduces LRAC. 

Reducing competition leads to PED becoming more inelastic. This allows the firm to profit maximise at a higher price, and increase revenue.
Less competition also increases market share and power. 

Conglomerate integration  

Two firms in completely different industries combine.

e.g P&G, Unilever

Advantages: 

Diversification reduces risk as if one venture fails, another might succeed.

Non-technical economies of scale
e.g managerial, two management teams aren't needed so one can be cut out, reducing costs. same goes with accounting, marketing, etc. divisions. (economies of linked processes) 

Constraints on business growth

See linked 'Why do some firms remain small?' 

Small 'niche' markets means demand is limited, so revenue is limited

Owners objectives may be to have a comfortable life/reach a comfortable work/life balance rather than aim to profit maximise in the LR. May not want to undertake extra work and risks, rather have free time than extra profit.

May be harder to access finance for some firms as they don't have the collateral/banks deem them too 'risky', thinks they are likely to go out of business.

Firms may not have the expertise or skills to expand. Either:
- Lack entrepreneurial skill
- Lack the resources to deal with regulation and bureaucracy involved as they become larger

Regulation may prevent firms from staging mergers/takeovers. If the CMA (or FTC in the US) deem the takeover to be anti-competitive and potentially harmful to the consumer they may block it. this prevents firms from becoming 'too big' and gaining too much market share - essentially aims to prevent monopolies from occurring and reductions in consumer choice.