Size of Businesses (2) Flashcards
Organic Growth
Firms increasing their output through increased investment, increased labour force and etc.
External Growth ( Merger or Takeover )
Merger is the joining together of two or more firms under common ownership done through the agreement of the Shareholders
Takeover implies that one company wishes to buy another company. It can be amicable which the bid to purchasing company is accepted by the selling company. Or a hostile takeover which is the takeover of the company by attaining more than 50% of their shares.
Horizontal Integration
Merger between two firms in the same industry, at the same stage of production. For instance, the merger of two car manufacturers or two bakeries.
Advantages:
- Reductions in average costs due to economies of scales.
- Reduce competition in the market by removing rivals
- Higher total market share and sales due to combined sales of boughtover firm
- Increased ability to control prices to attempt for higher sales or prices.
Cons:
- Firms often pay too much for the firm their purchasing, the costs of purchase may exceed the profit generated in the ST.
- May be badly managed due to confilicting managing styles and personalities of key-workers or board members resulting in inefficiency or leaves by performing individuals.
Vertical Integration
Merger between two firms in the same industry but at different production stages.
Pros:
- Cost savings. Integrating a supplier or a buyer into the firm may make them more efficient.
- Vertical Integration may reduce risk. For example, as Supplier might have the technology that could offer the firm a competitive advantage.
- Better control of the industry. Takeover implies a better control of supplier prices or retail prices, firms can adjust it appropiately to their liking to generate more sales.
Cons:
- Firms may pay too much for the firm they takeover and share price of the firm falls rather than rises.
- Difficulties of the merger. Two firms may fail to integrate due to conflict between the two different managements and styles. Furthermore, they may be excessive layer of management and employees which lead to higher costs.
- Key-workers in the firm may leave taking the very much needed expertise and experience that made them successful in the first place.
- Knowledge gap. A manufacturer of Computer Chips lack the necessary knowledge to sell Computers in that market. The required marketing skills, operation costs and etc may make it perform worse before it was bought leading to less profits.
Forward Vertical Integration
A supplier merging with one of its buyers.
Eg. A Car Manufacturer purchasing a Car Dealership,
A Meat Producer purchasing a Restaurant.
Backward Vertical Integration
Buyer purchasing one of its supplier.
Eg. Coffee House purchasing a Coffee Producer
Clothes manufacturer purchasing its Fabric Producer
Conglomerate integration
Merging of two firms with no common interest, not in the same industry.
Eg. A Football Club purchasing a Tissue Manufacturer
Insurance Company purchasing a Clothing Chain.
Benefits:
- One advantage is to reduce risk. Buying another firm means that the risk is spread into different industries if one particular one isn’t doing well.
- More source of Finances and Capital which can be used to help expand other Businesses or branches. Transfer of efficient workers or relevant capital may occur.
- Asset Stripping. Some companies specialise in purchasing other companies when they see the company having valuable assets combined higher than the actual purchase price of the firm.
Costs:
- Do not have expertise to enter the market. Lack of specialist understanding reduces performances and causes inefficiency in sales or production.
- Asset Stripping doesn’t benefit workers, customers or local economies.
- May pay too much, profit generated may be less than costs.
- Resources and Managers may be spread too thinly due to wide arrange of tasks. Since they are not specialised in any, they will be very inefficient compared to sole Managers that focus on one business.
Constraints on Business Growth
- Size of the Market:
The consumers might be inadequate or too small for any possible chance of expansions by firms. For example a flower shop in rural Spain can only expands to other villages where the population is small. Or the international market for Cricket Balls which are only popular in India. - Owner Objectives:
Every owner has their own respective goals and interest, they may be content with the current level of profit and do not want to risk or work hard for the effort needed to expand a Business. - Regulation:
In some areas, regulation may be a constraint such as the EU where Mergers that would create dominant companies are examined and may be illegal.
Reasons for Business Growth for Some firms compared to Others
- Larger company may be able to exploit EOS more fully. A merger of manufacturers might result to larger potential EOS then a merger of Finance.
- Larger company has more control in its market. It can reduce competition through price and non price competitions.
- A large company may diversify by being a Conglomerate. This way when a firm in a industry is under-performing, other firms in different industries can make up for the reduced profits. Spread of risks makes the firm more financially stable and stronger.
Impact of Growth of Firms on its Businesses
Business:
- Benefit from a merger if EOS lead to greater efficiency and reduced costs.
- More capital to develop new and innovative products which can generate higher sales and market share. -
- Greater efficiency allows firms to survive greater -competitions in forms of Price Wars in their Markets.
However,
If Merger leads to DEOS then inefficiency will result in less profits.
Impact of Growth of Firms on Workers
Workers:
- May gain promotion and higher salaries in new, larger merged firms.
However,
it is at the cost of other workers who might lose their jobs due to redundancy and saving of costs.
Impact of Growth of Firms on Consumers
Consumers:
- Might receive lower prices due to efficiency Merged firms which increases Consumer Surplus
- New and Innovative products may be created which will increase the Consumer Welfare and Utility.
However,
if Merging leads to less products, it gives the consumer fewer variety of options to choose from which might reduce their welfare.
Furthermore,
if the Merger or Growth leads to higher prices, lesser Consumer Surplus is gained by the Consumer.
Demerger
Demerger occurs when a firm splits itself into two or more separate parts to create that said amount of firms.
Reasons for Demergers
Reasons:
- Lack of Synergies. One part of the firm may have no impact on the other part of the firm which may be more profitable or efficient without it. Hence, there are no synergies between the two firms which may lead to DEOS.
- Value. The individual price of the demerged firms may be possibly higher than the combined price of a single larger firm. For example, an underperforming side of the Business may drag the share price of the whole company despite other parts performing well. Splitting may in fact create ‘more value’ as theorised by Financial Markets.
- Focused Companies. In the 1970s, it was popular to diversify risk by being a Conglomerate. In recent times, Companies have moved away from that trend after findings of higher profit and growth in the concentration of one specific market. Being a Market Leader in one massive industry may be more profitable than being Number 4 or 5 in multiple others. This may be due to higher EOS and knowledge which leads to greater efficiency, lower costs and higher profits.
Impact of Demergers onto Businesses
Businesses:
- Will benefit from demergers that have increased specialisation that results to greater efficiency. This may lead to cut costs or the creation of new and innovative product which may lead to higher profits.
However, if demerger leads to DEOS, then the exact opposite will happens and profits will fall.
