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August 10, 2014

Why do a company grow?

How is growth measured?·     

  • Sales turnover
·      
  • Numbers employed
·      
  • Market share
·      
  • Stock market value (market capitalization – value of shares)
·      
  • Value of its assets


Not all the five measures above give the firm the same size – they vary between firms. 


How do firms grow?

Internal growth: 
This occurs through a firm expanding in its current market or finding new markets. 


External growth: 
·      

  • Horizontal integration:
-       

-Integration between firms at the same stage of production or distribution. 


-e.g. Bank Santander and Alliance & Leicester in July 2008 or the merger between ITV companies Carlton and Granada in 2003 (leading to ITV becoming the biggest terrestrial commercial broadcaster in the UK). 


-e.g. BA and Iberia merger will see them become the fourth largest firm in the airline industry. This should save the firms £350m per year, and increase the destinations they provide. Will still operate as two airlines. 


-.g. Asda purchased Netto in May 2010 – increased Asda’s market share by around 0.8% BUT Asda is being forced to sell 47 out of the 194 Netto outlets to ensure competition. 
·      

Vertical integration:
-       

-Mergers between firms at different stages of production or distribution.


- If the firm taken over is at the next stage (e.g. secondary taking over tertiary) of production then the integration is known as forward-vertical.


-e.g. Apeejay Surrendra Group (who grow a lot of tea in their Indian plantations) bought Typhoo Tea (who blend and package tea) for £80m in 2005. 


-If the firm taken over is at the previous stage of production then it is known as backward-vertical. 


-e.g. Sony taking over MGM in 2004 and gaining access to the 4,000 films in its library – they can use this for video on demand and new cable channels. 


-An example of forward and backward integration is with BP, who refine crude oil into petrol as well as engaging in oil exploration and distribution of petrol at its filling stations

– it is fully integrated. 
·      

Conglomerate:
-       

-  Integration between firms that are in different, unrelated industries

– these firms are said to be diversified. 


-These were more common in the 1960s and 70s. 


- e.g. Unilever, which has, over the years, bought 900 brands in food production, beauty products and household goods. 


-Today, many conglomerates are demerging, such as Lonrho in 1996 and Hanson Trust in 1996. 


Why do some firms grow? ·      

  • Increase market share: become the dominant firm in an industry
·     
  •  Increase sales: through larger brand recognition and more sales outlets
·      
  • Exploit economies of scale: firm is able to exploit their increased size and lower LRAC (long-run average cost) – by driving down LRAC and approaching the minimum point on the LRAC curve, the firm is moving closer to productive efficiency. 
·      
  • Risk-bearing economies: if product diversity is increased it can mean that a firm is better able to withstand downturns in the economic cycle or changes in the demand for specific products.  
·      
  • Benefit from greater profits: a firm aims to maximise profits and may be able to achieve this through expansion.
·      
  • Gain market power: so as to prevent potential takeovers by larger predator firms and be better able to exploit the market.
External growth can be attractive to firms because it speeds up the process by which firms can achieve the benefits listed above. 
Integration can sometimes receive government encouragement as domestic firms may need to be large to compete internationally. However, internal growth is generally considered to be preferable to external growth, especially when it involves product innovation.


Disadvantages:
·      

  • Diseconomies of scale, e.g. in the supermarket industry when Morrisons took over Safeway there was not perfect synergy as management and financial cultures differed between the two firms. 
·      
  • Inability to pay customers personal attention.
·      
  • Companies may expand too fast (e.g. Sock Shopin the 1980s) – insufficient working capital to cope with the extra commitments of a larger firm such as higher interest payments and more creditors – increase a firm’s financial commitments and they can simply run out of cash – this problem is called overtrading – cash and profit are not the same thing, and many profitable firms have gone out of business by running out of cash. 
·      
  • External growth:
-       
  • Can confer a degree of monopoly power – exploitation of the consumer.
-       
  • Post-merger rationalisation – direct loss of jobs e.g. Leeds-Halifax merger of 1995 resulted in the closure of some branches, particularly where the two societies had branches in close proximity. Similar job losses are likely following the emergency banking mergers of 2008 – in 2009 Lloyds announced the closure of its Cheltenham and Gloucester Building Society branches.
-       Research showed that 2/3 mergers in the US resulted in reduced shareholder value. 


Why do some firms remain small?

What are small firms?


According to the 1971 Bolton Report, small firms are firms:
-       

-With relatively small market share
      

-With owners who manage the firm in a personalised way, and
      

-Who aren’t part of any larger enterprise/don’t have a formalised management structure.


Small firms are usually sole traders, partnerships and private limited companies.


Barriers to entry:
·      

  • Legal barriers: can prevent firms from growing/entering an industry, e.g. need to have a permit to operate, need to have a license from the government (such as with commercial radio stations). 
·      
  • Overt barriers: imposed by businesses currently operational in the industry e.g. through branding and increasing brand loyalty, lowering prices to just above average cost, lowering prices below average cost (predatory pricing – firms can be fined for this.
  • Sunk costs: costs which firms will not be able to recover on exit e.g. advertising and research & development. 

  • Niche-market businesses: 
·      

- Specialist or niche markets exist that large companies do not wish to supply.
·      

-These markets don’t support expansion – there is little scope for growth.
·      

-e.g. corner shops with their irregular opening hours, manufacturers of cricket bats etc. 


  • Lack of expertise:
·      The owner of the firm may lack the knowledge or expertise to expand.
·      This may mean they lack access to the necessary funds to expand.

  • Low optimum efficiency:
·      

-The minimum efficient scale of production is low in many industries – no significant economies of scale for such firms. 


-Once a firm has reached optimum efficiency any further increase could result in inefficiencies and increased costs.
·      

-e.g. expansion of an independent restaurant may require the miring of a manager and the training of a chef

– the loss of personal managerial control may lead to increased costs and eventually losses. 


  • Avoid attention from potential buyers:
·      If a firm grows too large then its increased profits may result in unwanted offers from larger firms to take them over.
·      This means that some firms prefer to remain small. 

  • Lack of motivation:
·      Some sole traders aren’t willing to take on the opportunity cost in terms of lost leisure from expansion.

  • Other reasons: 
·      

-Value is placed on personal attention in some areas, e.g. management consultants.

 -Contracting out – many small firms supply larger companies. 
·    

- Co-operatives – independent businesses may join together to gain the advantages of bulk-buying while still retaining their independence (e.g. UK grocery chains such as Spar). 
·    

-Monopoly power – large firms may allow smaller firms to exist to disguise restrictive practices. 
·      

-Family businesses – wish to remain in control of their businesses, and don’t want to take the risk of expansion. 


Why do some firms break up? ·      

  • Since the 1990s there has been a trend towards the break-up of larger companies.
·  
  • This is due to diseconomies of scale, it emerged that difficulties inherent in managing large firms (particularly conglomerates) were being recognized, businesses wanted to improve focus.
  • Demergers  create a number of smaller firms, all able to concentrate on their specialist area and maximise their own economies of scale. 
·      
  • e.g. British Gas– demerged and formed BG (produces gas), Centrica (focused on selling gas), and Lattice Group (focused on the transportation of gas – this has since merged with National Grid). 
·
  • e.g. Cadbury-Schweppes – in 2007 Cadbury decided to demerge with Schweppes and Dr Pepper to ‘separate the Beverage and Confectionery businesses’ so that Cadbury could become the ‘biggest’ and ‘best’ confectionery company. 

            


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