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Study notes

Explaining the Internal and External Growth of Businesses

  • Levels: A Level
  • Exam boards: AQA, Edexcel, OCR, IB, Eduqas, WJEC

Businesses can grow organically (internally) or externally through a process of merger / acquisition

How do firms grow? - revision video

Organic Growth of Businesses

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:

  • Increasing existing production capacity through investment in new capital & technology
  • Development & launch of new products
  • Finding new markets for example by exporting into emerging countries
  • Growing a customer base through marketing

External Growth of a Business

There are many potential advantages:

  • Faster speed of access to new product or market areas
  • Increased market share / increased market power
  • Access internal economies of scale (perhaps by combining production capacity)
  • Secure better distribution channels / control of supplies
  • Acquire intangible assets (brands, patents, trademarks)
  • Overcome barriers to entry to target new markets
  • Defend a business against a takeover threat
  • Enter new segments of an existing market
  • To take advantage of deregulation in an industry / market

Horizontal Integration

An example would be between two car manufacturers or drinks suppliers.

Recent examples:

FedEx and TNT Express - Horizontal Integration

US giant FedEx has agreed a deal to acquire their loss-making rival TNT Express for €4.4bn. For FedEx the merger offers a chance to build a much larger European presence and compete more effectively with businesses such as UPS.

The businesses are both well known to consumers but of a different scale. TNT made revenues of $7.3bn in 2014 with around two-thirds generated in Europe; a fraction of the $47bn turnover of FedEx.

TNT delivers over a million consignments each day and it has invested heavily in expanding it's European road network which now connects over 40 countries through 19 road hubs and over 550 delivery depots.

FedEx and TNT Express expect the deal to be completed by mid 2016 providing it gets clearance from the EU competition authorities.

Google's most expensive acquisitions

Advantages of Horizontal Integration

  1. It increases the size of the business and encourages internal economies of scale – lower long run average costs – improved profits and competitiveness
  2. One larger merged firm may need fewer workers, managers and premises than two – a process known as rationalization designed to achieve cost savings
  3. Mergers often justified by the existence of “synergies"
  4. Creates a wider range of products - (i.e. diversification). Opportunities for economies of scope
  5. Reduces competition by removing industry 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.

The supply chain is the process by which production and distribution gets products to the customer.

  1. Forward vertical: Closer to the final consumers of the product e.g. a manufacturer buying a retailer
  2. Backward vertical: Closer to raw materials in the supply chain e.g. a steel firm buying a coal mine

Examples of vertical integration:

  • Film distributors owning cinemas and digital streaming platforms
  • Brewers operating pubs (forward vertical) or buying hop farms (backward vertical)
  • Crude oil exploration all the way through to refined product sale
  • Record labels and music stations
  • Drinks manufacturers buying bottling plants
  • Google - a software business - buying Motorola, a phone maker
  • Technology companies growing vertically through hardware, software and services

Advantages of Vertical Integration

The main advantages of vertical integration are:

  1. Control of the supply chain – this helps to reduce costs and improve the quality of inputs into the production process
  2. Improved access to key raw materials perhaps at the expense of rivals who must then pay more
  3. Better control over retail distribution channels e.g. pub companies who ensure that their beers and wines are sold in tenanted pubs and clubs
  4. Removing suppliers, and crucial information from competitors which helps to make a market less contestable

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