A2 Micro: Business Growth

This revision note looks at the growth of businesses - we will be adding fresh links at the foot of this blog to recent blog entries on business growth articles and news stories

Why do firms seek to grow?

1. The profit motive: Businesses grow to achieve higher profits. The stimulus to achieve growth is often provided by the expectations placed on a business by the capital markets. The stock market valuation of a firm is influenced by expectations of future sales and profit streams so if a company achieves disappointing growth figures, this might be reflected in a fall in the share price. This opens up the risk of a hostile take-over and makes it more expensive for a quoted company to raise fresh capital by issuing new shares
2. The cost motive: Economies of scale have the effect of increasing the productive capacity of the business and they help to raise profit margins.
3. The market power motive: Firms may wish to grow to increase their market dominance giving them increased pricing power in markets.
4. The risk motive: Growth might be motivated by a desire to diversify production so that falling sales in one market might be compensated by stronger demand in another market.
5. Managerial motives: Behavioural theories of the firm predict that business expansion might be accelerated by the decisions of managers whose aims and objectives might be different from those who are the major shareholders.

How do firms grow?

Organic growth
Organic growth is also known as internal growth and happens when a business expands its own operations rather than relying on takeovers and mergers. Organic growth might come about from:
• Expansion of existing production capacity through investment in new capital & technology
• Developing & launch of new products
• Growing a customer base through marketing

External growth
The fastest route for growth is through external growth – through mergers or contested take-overs. There are various forms of integration – explained below with some recent examples:
Horizontal integration: Horizontal integration occurs when two businesses in the same industry at the same stage of production become one – for example a merger between two car manufacturers or drinks suppliers. Recent examples of horizontal integration include:
• Nike and Umbro
• NTL and Telewest (new business eventually renamed as Virgin Media)
• Lloyds TSB (now Lloyds Banking Group) taking over HBOS

The advantages of horizontal integration include the following:

1. It 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. Creates a wider range of products - (diversification). Opportunities for economies of scope
5. Reduces competition by removing rivals – increases market share and pricing power

Vertical integration:

Vertical Integration involves acquiring a business in the same industry but at different stages of the supply chain. Examples of vertical integration might include the following:
• 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
• Sportswear manufacturers and retailers
• Drinks manufacturers integrating with bottling plants

The main advantages of vertical integration are:
1. Greater control of the supply chain – this helps to reduce costs and improve quality of inputs.
2. Improved access to important raw materials used in manufacturing.
3. Better control over retail distribution channels e.g. pub companies who can ensure that their beers and wines are sold in tenanted pubs and clubs.

Lateral Integration

This involves companies joining together that produce similar but related products. Examples include:
• Microsoft and Skype
• Google and You Tube
• Gillette and Proctor & Gamble