The growth of firms.

I have decided to not run in a chronological order as such, with these notes being a little everywhere. But i felt like catching up on growth today.

So.. growth..

Growth is absolutely vital for firms, not only to allow them to work towards the MES (minimum efficient scale) but to allow them to increase market share and allow them to gain a dominant position in the market. 

Firms seek to grow to raise returns for shareholders, known as dividends. Tutor2u claims that 'the the 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 may be reflected in a fall in the share price' And so, increases the risk of a take over and makes it more expensive to raise fresh capital by attempting to sell more shares.

Firms may also want to grow for reasons driven by managers, such as expansion or increasing sales revenue, rather than reasons driven by shareholders. 

Lastly, firms may intend to grow to enable a diversification of their products, so that if sales fall in one market segment, stronger demand in another may act as compensation, to protect a company from failure or a saturated product. 

Growth can be organic (internal), or inorganic (external)

The former refers to growth stimulated by retained and internal profits or loans, which can be used to finance expansion over a period of time. 

Organic growth can be stimulated by: 

• Extending an organisations geographical reach, e.g exporting
• Expanding into new products in order to increase the size of its available market 
• Using marketing to expand the customer base
• Expansion of production capacity through investment and machinery

An example of organic growth is Poundland, (taken from Tutor2u's growth of firms site)

"Poundland was formed in 2000 and has grown strongly due to a focus on a constantly rotating product range sold at a single price point. Ten years after starting-up, Poundland was sold to a US venture capital firm for £200 million, when its revenues had grown from nothing to over £400m per year. The organic strategies was to open new stores in suitable locations and repeat the formula of offering heavily discounted products to a mainly female customer base. Poundland’s profits grow 26.5% in the year to April 2012. It will open 60 new stores in 2012" 

Organic growth can be impeded by a lack of retained profits, and is typically a slow process, as the market may be saturated or highly competitive. 

The other type of growth is inorganic/external growth.

This can be a much more rapid process in comparison to organic growth where companies can carry out mergers, intergrations or acquisitions. Mergers can be amicable or hostile, where a takeover may have to be accepted as a deal by its current owners. 

There are four types of merger:

1. Horizontal - Refers to integration between firms at the same stage of production. In example, the merger between ITV companies Carlton and Granada in 2003. The decision to merge was justified by the 'changing nature of television' and the emergence of digital broadcasting, and threats from both cable and satellite channels. Other horizontal merger examples - When Morrison's bought safeway in 2003. Banco Santander purchasing Abbey National in 2004. More recent mergers (Virgin Active buying Esporta gyms in 2011). Advantages of horizontal integration: synergy (2+2-5..) Making the most of the benefits from both companies to produce a supposedly better firm. There is also room for rationalization - such as streamlining the company to make it more competitive. Secondly, monopoly power could possibly be attained. Thirdly, as the merger has increased the size of the business, there is opportunity for internal economies of scale to be had. 
2. Vertical - refers to integration between firms at different stages of production. Vertical backwards integration occurs when the firm takes over a firm in the previous process, i.e a firm in the tertiary sector takes over a firm in the secondary (manufacturing sector). An example of this is Sony, who own MGM with 4,000 films to their name. Sony can make use of the films for video on demand. Vertical forward integration refers to a firm taking over a firm in the next process, e.g a farm taking over a farm shop. It is argued that some businesses can integrate both backwards and forwards, an example is BP - involved in crude oil refinement, the distribution of oil and 'oil exploration' Advantages: Control of the supply chain, or a way into a market i.e a brewery could sell the beer in a newly bought pub - more control over retail channels. 
3. Conglomerate - considers a situation where the firms don't appear to have a blatant relationship, and may be in unrelated industries. In essence, they are diversified. A modern day example is the Indian 'giant' Tata Group which is involved in different market sectors such as tea, construction and cars, it operates in more than 80 countries. 
4. Lateral - Integration between firms which are in different but related industries. Proctor and Gamble and Gillette both sold household goods, and merged laterally in 2004. In 2008 there was a merger between Mars and Wrigley. Google and Youtube. An advantage of lateral integration is the advantage of economies of scope. 

Firms can also co-operate in joint ventures. This gives firms the opportunity to benefit from the strengths of mergers, whilst being able to maintain their legal entity and pursue common projects. Examples of joint ventures are Google and NASA, and Hugo Boss and Proctor & Gamble. 

Why don't mergers always work?

Integration is not always successful. Diseconomies of scale (Control, co-ordination etc) can occur and influence post merger profitability. There was a lack of synergy between Morrison's and Safeway (financial and managerial culture differences). 

Nutter's book claims that the most famous 'demerger' was Daimler-Chrysler. The former bought the latter for approx 36 billion dollars but the managerial culture clash resulted in a failure of this 'marriage'. Nine years later, Daimler sold Chrysler to Cerebus. 

"We overestimated the potential of synergies" - Dieter Zetsche, senior Daimler exec. 

Integration is not always favoured by the economy. It can produce monopoly power, whereby the consumer can be exploited with inefficiency occuring statically, productively and allocatively. Streamlining after the merger can also result in a loss of jobs. And lastly, research conducted by Geoffrey Mees found that two-thirds of all mergers in the US reduced shareholder value. 

Governements however, can favour mergers as they are able to export and compete in international trade, which as we learnt in AS economics can benefit the domestic economy in terms of an increase in national income. 

Note, i am using notes from Tutor2u, The AQA Economics A2 Textbook by Lawrence and Stoddard and Business Economics Microeconomics for AS by Nutter. Some of the notes are not my own.