11. Methods of development

Question 1

In what ways may an organisation’s growth be expressed?

Answer 1

• Sales revenue (a growth in the number of markets served)
• Profitability (in absolute terms, and as a return on capital)
• Number of goods/services sold
• Number of outlets/sites
• Number of employees
• Number of countries

Question 2

In what ways may an organisation grow?

Answer 2

• Develop the business from scratch
• Acquire or merge with an already existing business
• Co-operate in some way with another firm

Question 3

What are the main issues involved in choosing a method of growth?

Answer 3

• A firm may not be able to go it alone, or it may have plenty of resources to invest.
• Two different businesses might have complementary skills.
• Does a firm need to move fast?
• A firm might wish to retain control of a product or process.
• Is there a potential acquisition target or joint venture partner with compatible people and organisation culture?
• Risk: a firm may either increase or reduce the level of risk to which it is subject.

Question 4

Define organic growth.

Answer 4

Involves the expansion of a firm’s size, profits, and activities through the use of its own resources and capabilities without taking over other firms.

Question 5

What are the benefits of organic growth?

Answer 5

• The process of developing a new product gives the firm the best understanding of the market and the product.
• It might be the only sensible way to pursue genuine technological innovations.
• There is no suitable target for acquisition.
• It can be planned and financed easily from the company’s current resources and the costs are spread over time.
• The same style of management and corporate culture can be maintained so there is less disruption.
• Hidden or unforeseen losses, common in acquisitions, are less likely with organic growth.
• It provides career development opportunities for managers otherwise plateaued in their present roles.
• It could be cheaper because assets are being acquired without additional payments for goodwill
• It is less risky. In acquisitions the purchaser may also take on liability for the effects of decisions made by the previous owners

Question 6

What are the drawbacks of organic growth?

Answer 6

• It may intensify competition in a given market compared to buying an existing player.
• It is too slow if the market is developing very quickly.
• The firm does not gain access to the knowledge and systems of an established operator so it can be more risky.
• It will initially lack economies of scale/experience effects.
• There may be prohibitive barriers to entry in new markets.

Question 7

What are some reasons for international expansion?

Answer 7

1. Chance
2. Life Cycle
3. Competition
4. Reduce dependence
5. Economies of scale
6. Variable quantity
7. Finance
8. Familial
9. Aid agencies

Question 8

What are some reasons supporting international expansion?

Answer 8

– Profit margins may be higher abroad.
– Increase in sales volume from foreign sales may allow large reductions in unit costs.
– The product life cycle may be extended if the product is at an earlier stage in the life cycle in other countries.
– Seasonal fluctuations may be levelled out
– It offers an opportunity of disposing of excess production in times of low domestic demand.
– International activities spread the risk which exists in any single market
– Obsolescent products can be sold off to international customers without damage to the domestic market.
– The firm’s prestige may be enhanced by portraying a global image.

Question 9

What are some reasons to avoid international expansion?

Answer 9

– Profits may be unduly affected by factors outside the firm’s control
– The adaptations to the product (or other marketing mix elements) needed for international success will diminish the effects of economies of scale.
– Extending the product life cycle is not always cost effective
– Opportunity costs of investing abroad – funds and resources may be better utilised at home.
– In the case of marginal cost pricing, anti-dumping duties are more quickly imposed now than in the past.

Question 10

What are some strategic issues for management to consider regarding international expansion?

Answer 10

• Is the venture likely to yield an acceptable financial return?
• Does it fit with the company’s overall mission and objectives?
• Does the organisation have (or can it raise) the resources necessary to exploit effectively international opportunities?
• What is the impact on the firm’s risk profile?
• What method of entry is most suitable?

Question 11

What are some tactical issues for management to consider regarding international expansion?

Answer 11

• How can the company get to understand customers‘ needs and preferences in foreign markets?
• Does the company know how to conduct business abroad, and deal effectively with potential partners there?
• Are there foreign regulations and associated hidden costs?
• Does the company have the necessary management skills and experience?

Question 12

What are the classic reasons for mergers/acquisitions as part of strategy?

Answer 12

Marketing advantages:

• New product range
• Market presence
• Rationalise distribution and advertising
• Eliminate competition

Production advantages:

• Economies of scale
• Technology and skills
• Greater production capacity
• Safeguard future supplies
• Bulk purchase opportunities

Finance and management:

• Management team
• Cash resources
• Gain assets
• Tax advantages (eg, losses bought)

Risk spreading:

• Diversification

Retain independence:

• Avoid being taken over by acquiring predator by becoming too big to buy

Overcome barriers to entry:

• Acquired firm may have licences or patents

Outplay rivals:

• Stop rival getting the target

Question 13

Give some reasons why firms diversify?

Answer 13

• Objectives can no longer be met without diversification.
• The firm has more cash than it needs for expansion.
• Firms may diversify even if their objectives are being or could be met within their industry, if diversification promises to be more profitable than expansion.

Question 14

What are Porter’s attractiveness tests?

Answer 14

(a) The ‘cost of entry’ test
(b) The ‘better off’ test

Question 15

What should the acquirer evaluate before proceeding with an acquisition?

Answer 15

• The prospects of technological change in the industry
• The size and strength of competitors
• The reaction of competitors to an acquisition
• The likelihood of government intervention and legislation
• The state of the industry and its long-term prospects
• The amount of synergy obtainable from the merger or acquisition

Question 16

Define synergy

Answer 16

The benefits gained from two or more businesses combining that would not have been available to each independently.

Sometimes expressed as the 2 + 2 = 5 effect.

Synergy arises because of complementary resources which are compatible with the products or markets being developed and is often realised by transferring skills or sharing activities.

Question 17

What are four sources from which synergies arise?

Answer 17

Marketing and sales synergies:

(1) Benefits of conferring one firm’s brands on products of another.
(2) Use of common sales team and advertising.
(3) Ability to offer wider product range to the client.

Operating synergies:

(1) Economies of scale – in purchasing of inputs, capital equipment etc.
(2) Economies of scope – including use of distribution channels and warehousing.
(3) Rationalisation of common capacity (eg, logistics, stores, factories).
(4) Capacity smoothing (eg, one firm’s peak demand coincides with the other’s slack time).

Financial synergies:

(1) Risk spreading allows cheaper capital to be obtained.
(2) Reduction in market competition if firms in similar industry.
(3) Shared benefits from same R&D.
(4) Possibly more stable cash flows.
(5) Sale of surplus assets.

Management synergies:

(1) Highly paid managers used to fix ailing firm rather than administer successful one.
(2) Transfer of learning across businesses.
(3) Increased opportunity for managerial specialisation in a larger firm.

Question 18

What are the two types of acquisition approaches?

Answer 18

1. Agreed bids
2. Hostile (contested) bids

Question 19

What are some reasons for the poor performance of acquisitions?

Answer 19

• Acquirers conduct financial audits but, according to research by London Business School, only 37% conducted anything approaching a management audit.

• Some major problems of implementation relate to human resources and personnel issues such as morale, performance assessment and culture. If key managers or personnel leave, the business will suffer.

• A further explanation may be that excessive prices are paid for acquisitions, resulting in shareholders in the target company being rewarded for expected synergy gains.

• Lack of actual strategic fit between the businesses.

• Failure of new management to retain key staff and clients.

• Failures by management to exert corporate governance and control over larger business.

Question 20

What are some reasons acquisitions still occur?

Answer 20

• Many acquisitions and mergers are successful.

• Evidence of a loss of value resulting from a merger doesn’t consider whether a worse outcome might have occurred if the firms had not combined.

• Vested interests of corporate financial advisors in pressing for the acquisition, ie, commissions and fees.

• Weak corporate governance allows domineering CEOs or boards to pursue personal agendas with shareholder funds (eg, ‘empire building’).

• Short-term need for boards to give impression of strategic action to convince investors that business is growing.

Question 21

What factors should be considered when choosing business partners for joint ventures, alliances and franchising?

Answer 21

Drivers: What benefits are offered by collaboration?

Partners: Which partners should be chosen?

Facilitators: Does the external environment favour a partnership?

Components: Activities and processes in the network.

Effectiveness: Does the previous history of alliances generate good results? Is the alliance just a temporary blip?

Market-orientation: Alliance partners are harder to control and may not have the same commitment to the end-user.

Question 22

Define consortia and a joint venture.

Answer 22

Consortia: Organisations that co-operate on specific business prospects.

Joint venture: Is a contractual arrangement whereby two or more parties undertake an economic activity which is subject to joint control.

Question 23

What are advantages of joint-ventures?

Answer 23

• They permit coverage of a larger number of countries since each one requires less investment.
• They can reduce the risk of government intervention.
• They can provide close control over operations.
• A joint venture with an indigenous firm provides local knowledge.
• They can also be a learning exercise.
• They provide funds for expensive technology and research projects.
• They are often an alternative to seeking to buy or build a wholly owned manufacturing operation abroad.
• Core competences, which are not available in one entity can be accessed from another venturer.

Question 24

What are the major disadvantages of joint ventures?

Answer 24

• Major conflicts of interest over profit shares, amounts invested, the management of the joint venture, and the marketing strategy.
• Problems in each party protecting intellectual property such as proprietary product designs, process methods.
• Danger that a partner may seek to leave joint venture if its priorities change (eg, shortage of funds) or it is acquired by another firm.
• Lack of management interest: the JV will be seen as a secondment outside of the main career hierarchy of the parent firms.
• Exit routes may be unclear, including sharing of the assets generated in the venture.
• Contractual rights may be difficult to enforce across geographical borders or regulatory boundaries.

Question 25

Why do some firms enter long-term strategic alliances with others?

Answer 25

• They share development costs of a particular technology.
• The regulatory environment prohibits take-overs
• Complementary markets or technology.

Question 26

What are some limitations of alliances?

Answer 26

• Core competence: each organisation should be able to focus on its core competence. Alliances may not enable it to create new competences.
• Strategic priorities: if a key aspect of strategic delivery is handed over to a partner, the firm loses flexibility. A core competence may not be enough to provide a comprehensive customer benefit.

Question 27

What are the four common types of information systems based alliances?

Answer 27

• Single industry partnerships: for example, UK insurance brokers can use a common system called IVANS to research the products offered by all of the major insurance companies.

• Multi-industry joint marketing partnerships: A well-known example is holiday bookings, where a flight reservation over the internet is likely to lead to a seamless offer of hotel reservations
and car hire.

• Supply chain partnerships: greater and closer co-operation along the supply chain has led to the need for better and faster information flows.

• IT supplier partnerships: a slightly different kind of partnership is not uncommon in the IT industry itself, where physical products have their own major software content. The development of these products requires close co-operation between the hardware and software companies concerned.

Question 28

What are licensing agreements?

Answer 28

A licence grants a third-party organisation the rights to exploit an asset belonging to the licensor.

Licences can be granted over:

• The use of brands and recipes
• A patent or technology
• A particular asset

Question 29

What is franchising?

Answer 29

Franchising is a method of expanding the business on less capital than would otherwise be possible.

Franchisers include IKEA, McDonald’s, Starbucks and Pizza Hut.

Question 30

What is the mechanism for franchising?

Answer 30

• The franchiser grants a licence to the franchisee allowing the franchisee to use the franchiser’s name, goodwill, systems.

• The franchisee pays the franchiser for these rights and also for subsequent support services which the franchiser may supply.

• The franchisee is responsible for the day-to-day running of the franchise.

• Capital for setting up the franchise is normally supplied by both parties.

• The franchiser will typically provide support services

Question 31

What are some advantages of franchising to the franchiser?

Answer 31

• Rapid expansion and increasing market share with relatively little equity capital, since franchisees will put in some capital.

• The franchisee provides local knowledge and unit supervision.

• The franchiser has limited capital in any one unit and therefore has low financial risk.

• Economies of scale are quickly available to the franchiser as the network increases.

• Franchisee has strong incentives.

Question 32

What are some advantages of franchising to the franchisee?

Answer 32

The advantages for the franchisee are mainly in the set-up stages, where many new businesses often fail.

The franchisee will adopt a brand name, trading format and product specification that have been tested and practised. The learning curve and attendant risks are minimised.

The franchisee usually undertakes training, organised by the franchiser, which should provide a running start, thus further reducing risk.

Question 33

What are some disadvantages of franchising to the franchiser?

Answer 33

• A franchisee is largely independent and makes personal decisions about how to run his operation. In addition, the quality of product, customer satisfaction and goodwill is under his control.

• There can be a clash between local needs or opportunities and the strategy of the franchiser.

• The franchiser may seek to update/amend the products/services on offer, while some franchisees may be slow to accept change or may find it necessary to write off existing inventory holdings.

• The most successful franchisees may break away and set up as independents, thereby becoming
competitors.

Question 34

What are situations where agents can be used?

Answer 34

These can be used as the distribution channel where local knowledge and contacts are important, eg, exporting.

Also includes:

• Sales of cosmetics
• Holidays
• Financial services, eg, insurance

The main problem for the company is that it is cut off from direct contact with the customer.