Growth
There are
many different methods for firms to grow; organically, through mergers or
acquisitions or through joint ventures.
External Growth
Joint Venture
A joint
venture is where 2 or more firms work together in an industry to make a profit.
This may allow a company access into a certain market and give another company
valuable knowledge and resources. One example of a joint venture is when Tesco
bought a 50% stake in Hymall supermarkets, a Chinese firm. The deal gives Tesco
access to the lucrative Chinese market which is fast expanding ahead of other
competition like Carrefour and WalMart. It is easier for Tesco’ to pursue a
venture like this rather than try to set itself up in China on its own. This is
because it has no market presence there and would have to spend a lot of money
building the brand there as well as developing a supply chain. It may have been
cheaper for them to purchase Hymall than to do this. Hymall also has the support
of the Chinese government as it was initially a Chinese firm and is still 50%
controlled by China. The advantages to the venture for Hymall, is that they can
use the knowledge that Tesco has from the venture to expand further. It may
also allow them to expand abroad and they would presumably make a large profit
as Tesco would put a lot of resources into making the venture a success (due to
the potential profits). Tesco also has a lot of money capital that Hymall may
not have.
Mergers
Mergers can
be between 2 companies that jointly agree to join or if 1 firm attempts to
purchase another firm hostilely.
Vertical Forward
A forward
vertical merger is when a firm that is lower in the production process
purchases a firm that is further on in the process. This ensures that the
supplier firm has an outlet to sell its product or service. One example is oil
companies purchasing petrol stations, so they aren’t relying on someone else
purchasing oil and then selling it on. They can also make more profit from this
that if they went through a middle man.
Vertical Backward
A backward
vertical merger is when a firm acquires another firm that is lower on in the
production process. This is usually done to secure supplies or reduce costs. An
example of this is a fast food retailer purchasing one of its supplier firms
that make the food. This ensures that the fast food retailer has supplies (as
it owns it) and it also won’t have to pay that company a profit and hence can
make things more cheaply. It may also increase the barriers to entry for new
firms.
Horizontal
Horizontal
integration is when 2 firms that are in the same stage of the production
process merge to form 1 firm. An example of this is Lloyds (bank) and TSB
(bank) which merged to form Lloyds TSB. Usually, the new merged firm benefits
from economies of scales and can employ cost-cutting to maximise profits.
Demerger
Occasionally
a firm may decide to demerge and split into different firms. This can be done
if it is forced to due to anti-competition laws, or because one firm isn’t
making much profit and it would make more sense to split the firm into 2 so
they can be managed more efficiently.
Examples of demergers include News Corporation spinning off its TV
business from its newspaper division. This is because the TV business is much
more lucrative than the newspaper division and as 1 firm the share price is a
lot lower than if the TV business were separate. It also ring fences the
TV-side from any legal proceedings against the newspaper-division due to
hacking allegations. Another example is that of Fosters spinning off its wine
division in order to focus on its more profitable beer division. It will make
money by selling the wine division and it can use this to invest in the beer
division to make a further profit.
A final
example is that of Direct Line Group which owns Direct Line, Green Flag and
Churchill. DLG is currently a subsidiary of RBS but is in the process of being
sold off to comply with EU competition laws.
Internal
divestment can occur if the company removes certain products from the market or
withdraws from a market or sector.
The selling
off of divisions can be profitable; this could then be delivered to
shareholders or re-invested into the core business to expand growth.
Conglomerates
Growth can
also be achieved by buying firms in different sectors. This might be achieved
if another sector is doing well and a firm wants to profit from this or perhaps
to hedge the firms bets or because a director spots a firm that it can buy
cheap. An example of a conglomerate is Unilever which has a diverse portfolio
of products (which it has acquired) from washing-up liquid to ice cream
producers. Virgin is another example they have their train business and an
aviation industry, this is an example of a firm hedging its bets, if people are
flying less they may instead be using trains, therefore Virgin profits.
Internal Growth - Organic Growth
Organic
growth (internal growth) is based on investing in what the firm currently does.
This can be done by expanding the product range; a firm can expand its range by
selling products closely related to its main seller. For example a firm that
makes and sells motorbikes might expand its range to include helmets and
clothing, and may also offer custom design. It can also pursue growth by
targeting new markets; this can be achieved by targeting different customers or
entering a new country (or even opening more stores in a different town or
city). This links in with expanding the distribution network; make the product
or service available in more locations. Hence internal growth can be pursued by
a firm increasing its output by increased investment or by expanding the labour
force.
Organic
growth is usually financed with retained earnings, borrowings or a rights
issue. Firms usually offer like for like data on their annual report which
shows how much organic growth has been pursued.
Reasons for
Growth
Profit maximising firms are motivated to grow in size to
exploit economies of scale more fully. Horizontal mergers usually provide a lot
of savings and the new firm can exploit a lot of economies of scale. A larger
firm means it has a greater market share and therefore may be able to exploit
its market more with less competition.
Large companies can reduce risk; conglomerates have
businesses in a lot of different sectors, therefore in one sector becomes less
profitable the firm will still be able to remain in business due to its
operations in other sectors. Conglomerates are likely to diversify to buy firms
which don’t have a cyclical demand pattern (or one that isn’t too large).
Benefits of
Mergers
Avoiding duplication can result in a lot of cost cutting, for example 2 firms may be both employing a large administration force, and if they were to merge they could share the administration force and hence cut jobs and reduce costs; this is known as rationalisation. Although this would result in fewer jobs it may also enable the firm to reduce prices hence benefiting consumers (alternatively the firm may just make larger profits benefiting shareholders).
There are also a variety of economies of scale that can
result from a merger (particularly a horizontal merger).
Costs of
Mergers
Higher prices may arise if the merged firm faces less competition in the market. This will be at the detriment to consumers. Mergers will also lead to less choice for consumers.
Jobs losses can also arise if the merged firm looks to avoid duplication or if it is taken over by an asset stripping company that removes under-performing sectors of the firm.
The new firm may experience diseconomies of scale, the larger firm may not be able to motivate workers who may feel they are just a cog in a corporate machine and hence productivity may fall.
Globalisation
Globalisation has resulted in firms increasing in sizes since
the 1980s with the advent of better transport and communication. In some
markets this has led to the growth of giant firms with operations in a host of
countries. These firms that conduct business in a variety of different
countries are known as multinational corporations.
Page last updated on 20/10/13
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