Organic growth – This occurs when businesses expand internally rather than taking over or merging with other businesses. Organic growth can exist through a number of different ways such as increased output, expanding into international markets, launching new products etc.
Stages of production – Primary sector the extraction of raw materials e.g. mining) à secondary sector (manufacturing things e.g. cars) à tertiary sector (the provision of services e.g. retailers).
How businesses grow:
- Forward and backward vertical integration -This occurs when a business merges or takes over another business that is in a different stage of production from them. Vertical forward integration would be the merging or taking over of a firm that is a stage ahead of the business in the production process e.g. a fishing business merging with a fish a chip chain. In contrast to this, a business may decide to take part in backwards vertical integration. This is when a business takes over or merges with another business that is a step behind them in the production process e.g. a book shop merging/taking over a publishing company or a coffee shop merging/taking over a coffee bean supplier.
- Horizontal integration – A business may decide to takeover/merge with a business that is in the same industry and at the same stage in the production process as them e.g. a supermarket merging/taking over another supermarket.
- Conglomerate integration – Business’s may also decide to expand through merging or taking over a business in another industry to what they’re in. This can give businesses the chance to expand into different markets which they may have struggled to compete in through organic growth.
Advantages and disadvantages of:
- Reduced risk – The main advantage of growing organically is the reduced risk of enduring any of the detrimental effects that may occur during mergers and takeovers e.g. a clash of business cultures. This is one of the many reasons why takeovers and mergers often fail.
- Helps to avoid diseconomies of scale – By growing organically it allows the business to grow at a more sustainable pace. As a result of this, there is less chance of the business experiencing increased costs as a result of diseconomies of scale.
- Slow growth – The reduction in the rate of growth can also be a disadvantage. By growing organically it will take longer for the business to increase its market share, by which point their competitor that has grown through a merger/takeover may be dominating the market.
- Guarantees source of raw materials or outlet for product – By acquiring or merging with a business in a different stage of production to yours it gives an outlet for the business’s products. For example, if a fishing business would have a guaranteed demand for their fish if they were to merge with a fish and chip chain. This is because the fish and chip chain is ahead of them in the stages of production.
- Greater control over supply chain – If a business were to merge or takeover a firm a stage behind them in the production process they are able to control the supply of their products. As a result of this, they may be able to change the supplier’s business model in order to make them more efficient. By doing so they’re able to reduce their costs of production, allowing them to offer their goods/services at lower prices, thus increasing their competiveness within the market.
- Better access to raw materials – A manufacturer can merge/takeover their supplier of raw materials through vertical backwards integration. This will allow them to control the supply of raw materials that they have access to. Therefore, during times of increased demand the manufacturer is able to increase their supply of raw materials e.g. through shifting more resources towards the primary sector business.
- Reducing competition – One of the big benefits of merging/taking over a business in the same industry and at the same stage in the production process is that it reduces competition. The business that is being taken over/merged with was once a competitor that had a certain share of the total sales revenue in the market. This means that the acquisition of that business will force the customers that it once had, to shop elsewhere, some of whom will shop at the business that took it over/merged with it.
- Reduction in costs – By merging/taking over another business in the same industry at the same stage of production, costs can be reduced. This is mainly done through the integration of the departments in the different businesses. For example, rather than having two different human resources departments for both businesses, they can be merged into one. As a result of this, the business can reduce the number of staff they employ and therefore reduce the amount of money that they spend on staff wages.
- Reduces risk – The main reason why businesses merge with other businesses in unrelated industries is to reduce risk through diversification. Through conglomerate integration the business no longer has to rely on the performance of one market alone. For example, a supermarket chain relies on high levels of consumer spending for their business to thrive. This means that during times of poor economic growth they can struggle to make a profit. That problem can be reduced by having another business operating in a different market such as the technological industry. For example, although the retail industry may have had a bad year, the technology industry may have thrived, thus offsetting the poorly performing supermarket chain.
- Lack of knowledge – Entering a new market can be extremely risky if the business owner does not have experience or expert knowledge of the market. As a result of this, they may make poor decisions and are unable to attract new customers.
Mergers/takeovers advantages and disadvantages:
- Different business cultures – One of the main downsides to any type of integration is the difference in business cultures that may exist amongst the two businesses. This can lead to more disputes amongst employers and overall inefficiencies. The incompatibility between the two businesses can lead to increases in costs of production which may force the price of their goods/services upwards.
- Diseconomies of scale – Another big downside to mergers or takeovers is the diseconomies of scale that may occur. When a business becomes too big they will experience a range of problems such as poor communication and a lack of coordination. Again, this can lead to inefficiency within the business, causing costs to increase.
- Economies of scale – By merging/taking over another business, it will allow for increased outputs as the output of the original business and the one they’re merging with will now be combined. This help them experience the benefits that are derived from increased output such as, lower borrowing costs and being able to spread marketing costs over a larger output.
Constraints on business growth:
- Size of the market – Businesses may operate in small or niche markets, meaning that the demand for their goods/services will be limited. As a result of this, there is little room for the business to expand and therefore there is less chance of them experiencing economies of scale.
- Access to finance – The smaller the business is, the harder it is for them to access finance. This is due to the fact that start-up or small businesses are much more of a risk than established businesses. This is for a number of reasons such as the ability for larger businesses to diversify their product range and operate in a number of different markets. Furthermore, the interest rates are likely to be higher for smaller business as they have less bargaining power, due to the fact that they’re of higher risk and they’re likely to be borrowing smaller amounts of money. Overall, the inability for smaller firms to access finance can halt investment in the business and therefore damages their ability to grow.
- Owner objectives – The business owner may not have the objective of growth. For example, instead they may aim for corporate social responsibility. By doing so they may increase their costs of production, thus reducing their profit margins and therefore potentially they’re overall profit. This may also constrain their business from growing.
- Regulation – One of the main types of regulation that can constrain a business’s growth is that of monopoly power. The attempt of some businesses to expand can be blocked by the competition and markets authority if they deem that a merger or takeover would give the business too much power. This conclusion is reached through the determination of whether or not the merger/takeover would result in a detrimental outcome for consumers in terms of abusive price setting powers. For example, if there was only one dominant business within a market then they are likely to be able to set prices at extortionate rates as consumers have little other option but to buy their goods/services from them as there is no or inadequate alternatives.