Business Growth

Students should be able to:

• Discuss how and why firms grow
• Distinguish between forward, vertical and conglomerate
integration, and know reasons for mergers/ takeovers.
• Understand some of the constraints on business growth
including size of market, access to finance, owner
objectives and regulation
Key Motivations for Business Growth

Economies of Scale Build and Sustain Improve

(Lower Long Run Your Market Power Shareholder Returns
Unit Costs) from higher
Operating Profits

Reduce the Risk of a Pursuit of Synergy Effects –

Hostile Takeover Managerial i.e. from having
Objectives Bigger Sales
Key Motivations for Business Growth
• Profit motive:
• Businesses grow to provide better returns for shareholders
• Stock valuation is influenced by expectations of future sales and profits
• Cost motive:
• Economies of scale increase the productive capacity of the business leading to
lower average costs. They help to raise profit margins at a given market price
• Market power motive:
• Firms may wish to increase market dominance giving them pricing power
• This power can be used as a barrier to entry in the long run
• Larger businesses can build and take advantage of monopsony power
• Risk motive:
• Diversification across products & markets helps to reduce investor risk
• Managerial motives:
• Managers whose objectives differ might accelerate business expansion ahead
of short run profit maximisation
Organic and External Business Growth
• Organic:
• Growth from “within the business” e.g. new products; expansion
into new markets
• External:
• Growth from takeovers & mergers
• Mergers and Takeovers:
• Takeover: Where one business acquires a controlling interest in
another business = a change of ownership
• Merger: a combination of two previously separate businesses into a
new business under common ownersip
• Diversification: expanding into new markets with new
products – the riskiest growth strategy
Key Drivers of Mergers & Takeovers

1. Rapid technological change / creative destruction in industries

and markets (destroying old economic structure and creating
new one)
2. Need for economies of scale to remain cost and price
competitive in world markets
3. Need to be able to supply customers globally
4. Low demand growth in mature economies – need to have a
presence in faster-growing countries
5. Access to more distribution networks
6. Investment in faster-growing emerging markets where per
capita incomes are rising quickly
7. By-pass non-tariff barriers such as import quotas
Motives for Acquisitions

Strategic Financial Managerial

motives motives motives
• Improve & • Make best use • Self-interest of
develop the of financial managers
business resources for • Not necessarily
• Closely linked to shareholders in the best
competitive • Improve interest of
advantage financial shareholders
• E.g. economies performance • E.g. want to
of scale • E.g. higher lead a bigger
profits business

It is important to realise that many of the mergers and takeovers that hit the news
headlines are driven by managerial motives. Few minority shareholders have any
influence
Managerial Motives for Acquisitions
Personal ambition & financial reward
• Director rewards may be linked to growth
• Big takeovers attract media – boosts ego / reputation?
• Takeovers can act as “vanity projects” for senior executives –
show off someone’s talent but eventually fail to achieve their
goal

Bandwagon effect / peer pressure

• Pressure to do takeovers (if competitors are too)
• Concern that firm may be being left behind
• Over-confidence of senior management
• Pressure from advisers & the media (e.g. investment bankers
who stand to make millions from deals)
Motives for Acquisitions - Examples
Takeover / merger Main motives for the transaction

Establish global market leadership in confectionery & access

Kraft / Cadbury
emerging markets (stronger growth potential), strategic fit
Acquire valuable smartphone patents & manufacturing
Google / Motorola
expertise
Tata / Jaguar Land Economies of scale & acquire expertise, brands, capacity and
Rover distribution
Management vanity; continue reputation for big deals; over-
RBS / ABN-Amro confidence at the top of a speculative bubble just before
financial crisis, cheap money
Santander / Abbey (UK Market entry (UK) & establish base for further acquisitions to
bank) build market share in reformed financial system
WM Morrison &
Increase market share & exploit economies of scale to
Safeway – UK
improve competitiveness
supermarkets
MERGER TO International Airlines Group although both
companies continue to operate under their own brands;
British Airways / Iberia
economies of scale & survival: positioning for further
takeovers
How businesses grow
• Organic growth is where a business grows internally by reinvesting profits
or borrowing from banks.
❑ Reasons for internal growth include: increase market share; development
of new innovative products, new markets to sell existing products, existing
customers to buy more products through advertising or investing in new
capital or technologies to expand production.
✓ Low risk
✓ Easiest form of growth to manage
No new ideas or people
Might get too specialised in areas becoming out of date

• Vertical integration is where two businesses at different stages of

production, but in the same industry, join together.

• Forward vertical integration is where one firm integrates with a firm in a

stage of production closer to the customer.
How businesses grow
• Backward vertical integration is where a firm integrates with
another in the stage of production further away from the
customer, such as a car manufacturer buying a tyre
manufacturer.

• Horizontal integration is where two businesses at the same

stage of production in the same industry join together, such as a
merger between two banks or two chocolate manufacturers.

• Conglomerate integration is where two businesses in different

industries merge. For example, Tata’s (Indian) acquisitions in
different sectors including Jaguar Land Rover, Corus (steel
making), airlines, chemicals, home appliances, healthcare, IT
services
What is Organic Business Growth?

• Organic growth is also known as internal growth.

• It happens when a business expands its own operations rather
than relying on takeovers and mergers. Organic growth can
come about from:
1. Increasing existing production capacity through investment in
new capital & technology
2. Development & launch of new products
3. Finding new markets for example by exporting into emerging
countries such as India and South Africa
4. Growing a customer base through marketing
Examples of Organic Business Growth

Under Armour Whitbread Coca Cola Lego

acquired
Costa for
$5,1
billion
CASH
Sept 2018
The Lego business has
never made an
(Clothing, sports equipment) Whitbread owns Costa acquisition. It focuses
- generates turnover of Coffee and Premier Inn on using new product
around $2bn per year and is - two brands that have development and
consistently growing at over performed innovation as the driver
20% per year. It is doing this exceptionally well of revenues and profits.
by expanding the product despite the economic Since 2007, Lego has
range, extending into retail downturn. The tripled its revenues
operations and pushing into company is Britain’s globally – Star wars,
emerging markets biggest coffee shop Harry Potter lego sets,
chain. Lego movies
Different Types of Business Integration

Backward vertical Forward vertical Horizontal

The oil and gas industry is Brewers own chains of pubs Two airlines merging is
deeply vertically integrated horizontal integration

Conglomerate
Minnesota Mining and
Manufacturing Company
What is Horizontal Integration?

• Horizontal Integration:
• Two businesses in the same industry at the same stage of production
becoming one

• Some recent examples:

• Tata buying Jaguar Land Rover from Ford
• Volkswagen buying Porsche
• Asda buying Netto (food supermarkets)
• Virgin Money buying Northern Rock (banks)
Recent Examples of Horizontal Integration

• Jan 2016: UK DIY chain Homebase sold to Australian retail giant

Wesfarmers for £340m
• Dec 2015: Domino's buys largest German pizza chain for $86m
• Dec 2015: US chemical giants DuPont and Dow Chemical Co
agree to merge in deal worth £86bn + plans to split into three.
• Nov 2015: Pfizer's (US Pharmaceutical) $150bn purchase of of
Dublin-based Allergan (the manufacturer of Botox products)
• Nov 2015: Marriott agrees a $12bn merger with Sheraton hotels
owner to create one of world’s biggest hotel chains
• Nov 2015: AB InBev's £71bn bid for SABMiller – one of the world’s
biggest brewing mergers in recent years
• Nov 2015: AstraZeneca in $2.7bn deal for biotech firm ZS Pharma
• 2015: Horizontal mergers in the betting industry: Ladbrokes and
Gala Coral, Betfair and Paddy Power and GVC and Bwin.party
Horizontal Integration - Advantages
1. Exploit internal economies of scale – more of the same (lower
LRAC)
2. Cost savings from the rationalization of the business – this
often this involves sizeable job losses
3. Potential to secure revenue synergies (the combined company is
able to generate more sales than the two companies would be able to
separately.)
4. Wider range of products – spreading risk (i.e. diversification) –
this creates opportunities for economies of scope - more of
something similar
5. Reduces competition by removing key rivals – this increases
market share and long-run pricing power
6. Buying a existing and well-known brand can be cheaper than
organically growing a brand (increased market share)– this can
then make the entry barriers higher for potential rivals (less
risk of being bought out)
Horizontal Integration -Disadvantages

1. Diseconomies of scale/different cultures in

businesses
2. Share price might get too high to be bought
3. Some workers (or assets/capital equipment)
might lose their jobs if duplicated roles (i.e.
both companies had HR managers and only
one is needed)
4. Some workers might have to travel or move
abroad
What is Vertical Integration?

• Vertical integration
• Acquiring a business in the same industry but at a different stage of the
supply chain
• The merger of two firms at a different stage of the same industry
or process of production or same final product
1. Forward vertical: An integration of a business that is closer to final
consumers e.g. a manufacturer buying a retailer
2. Backward vertical: Closer to the raw materials in the supply chain e.g.
a manufacturer buying a raw material or component supplier
Vertical Integration - Examples
• Brewers owning/operating pubs (forward vertical) or buying hop
farms (backward vertical)

• Drinks manufacturers such as Coca Cola integrating with bottling

plants (forward)

• Pig processing business buying a pig farm (backward)

• Technology companies growing vertically through hardware,
software and services
• PayPal, acquired by eBay for $1.5bn in 2002 (forward)

• Google buying Motorola, a phone maker (backward)

• Nov 2015: Ikea Buys Romanian, Baltic Forests to Control Its Raw Materials
Vertical Integration - Advantages

1. Control of the supply chain – this helps to reduce unit costs and
improve the quality of inputs into the production process
2. Improved access to key raw materials perhaps at the expense
of rival businesses
3. Better control over retail distribution channels + adding new
channels to your sales platforms
4. Removing suppliers and market intelligence from competitors
which then helps to make a market less contestable (increases
market power)
Vertical Integration - Disadvantages
1. Firm might not need to buy all supplies

2. Might not have specialist knowledge of production

and might not be able to adopt to changes in
consumer demand or limited choice for consumers

3. Different cultures in businesses and

diseconomies of scale.
Conglomerate Integration
• A conglomerate has a large Market value in billion U.S. dollars
0 50 100 150 200 250 300
number of diversified businesses.
•
General Electric (U.S.) 253.5
The world’ s biggest United Technologies (U.S.) 107.1
conglomerates include businesses 3M (U.S.) 105.1
such as General Electric and 3M Siemens (Germany) 97.7
(formerly known as the Minnesota Honeywell International (U.S.) 81.6
Mining and Manufacturing Danaher (U.S.) 60.1
Company –US multinational Hutchison Whampoa (Hong… 59.8
operating in the fields of industry, ABB (Switzerland) 50.3
health care, and consumer goods) CK Hutchison (Hong Kong) 47.6
and Siemens from Germany Jardine Matheson (Hong Kong) 43.2
• Another is Samsung – the Philips (Netherlands) 27.7
electronics giant also makes Itaúsa (Brazil) 21.2
military hardware, apartments, Swire Pacific (Hong Kong) 20
ships and Samsung also operates a Ingersoll-Rand (Ireland) 17.9
Korean amusement park! Sime Darby (Malaysia) 16
World's largest conglomerates as of April 6, 2015, based on
market value (in billion U.S. dollars)
 Advantages and disadvantages of
Conglomerate integration
• Advantages: (1) reducing risk by operating in
different markets; (2) benefiting from
knowledge from the other market; (3) more
recognised brand; (4) opportunity for asset
stripping (sell different parts separately)

• Disadvantages: (1) requirement for different

skills/ lack of expertise in new areas; (2) not
necessarily benefiting from economies of
scale/cultural difference.
Why do many mergers/takeovers fail?
1. Huge financial costs of funding takeovers - deals relied on
loan finance - this leaves a big debt overhang after the deal
2. Integrating systems – companies might have very
different technology systems that are expensive or
impossible to marry e.g. eBay & Skype
https://www.pcworld.com/article/171267/skype_ebay_divorce_
what_went_wrong.html
3. Share price: The need to raise fresh equity through a rights
issue to fund a deal which can have a negative impact on a
company's share price
4. Many mergers fail to enhance shareholder value because of
clashes of corporate cultures, priorities and key
personalities
Why do many mergers/takeovers fail?

5. The enlarged business may suffer a loss of customers and also

some of their most skilled workers post acquisition (a loss of
human capital)

6. Paying too much: the ‘winners curse’ - i.e. companies paying

over the odds to take control of a business – this is particularly
the case with takeovers driven by management ego

7. Bad timing – mergers and takeovers that take place towards the
end of a sustained boom can often turn out to be damaging for
both businesses
 Mergers/takeovers
• Mergers
• 2 or more companies agreeing to become one united company i.e. in
1998, American automaker Chrysler Corp. merged with German
automaker Daimler Benz to form DaimlerChrysler (Daimler AG).
• In December 1998, the American oil and gas company Exxon and the
American oil and gas company Mobil merged after signing an
agreement to form ExxonMobil.
• British Royal Dutch Petroleum Corporation and Dutch Shell Transport
& Trading merged in 2005 after a close a cooperation in years before.
They formed Royal Dutch Shell Plc
• Takeovers or Acquisitions
• Purchase of a controlling share (>50%) in another business
i.e. in 2014 Facebook bought WhatsApp for $19bn
(£11.4bn)
Key Constraints on Business Growth
Growing businesses
winning significant In contestable
market share may markets there is
About 300 mergers are
come to attention of typically notified to the always the threat of
the competition Commission each year entry from rival
authorities e.g. firms; technological
Amazon and Google Regulation Competition change in reducing
https://www.busines entry barriers
sinsider.com/amazo
n-not-paying-taxes-
trump-bezos-2018-4

Businesses achieving
success in niche
Many small-medium Size of the
sized businesses run Finance markets may find
up against finance
Market limits to scalability.
constraints including Others successfully
access to loans and leverage brand to
risks of raising enter new markets
equity in capital
markets
Impact of growth of firms
On businesses:

Positive:
– allows firms to increase market share, benefit from
economies of scale and gain higher profits. This means
productive efficiency will increase if cost of production falls
after the merger because of economies of scale. Allocative
efficiency will increase if merged company provides a wider
range of goods and better quality.

Negative:
-However, the firm might suffer from diseconomies of scale
due to inability to control - lead to inefficiencies and losses.
Impact of growth of firms
On workers:

Positive:
– increased job security as a large firm might offer greater
security than a small firm, possibility of higher wages if the
firm is more profitable, promotion.

Negative:
-Increased mechanisation might result in few new jobs and
little job security.
Impact of growth of firms
On consumers :

Positive:
– lower prices if the firm benefits from economies of scale
– new innovative products

Negative:
-exploitation of consumers if the firm gains monopoly power
which means less competition

• 10 Companies that secretly control the world:

https://www.youtube.com/watch?v=FbyNp-5U6pg