Success criteria:

.

Learning Intentions:

You should be able to:

Describe using examples of methods of growth.

Describe using examples methods of contraction.

To introduce pupils to methods of growth and contraction

The Growth of Firms

Key definitions

• Organic growth: growth from “within the business” e.g. new products; expansion into new markets

• External growth: use of takeovers & mergers

Types of Integration

• Horizontal Integration: two businesses in the same industry at the same stage of production becoming one

Horizontal Integration

• Tata buying Jaguar Land Rover from Ford• Volkswagen buying Porsche• Asda buying Netto (food supermarkets)• Amazon buying LoveFilm• Virgin Money buying Northern Rock• Verizon’s $130bn purchase of Vodafone’s interest in

its US mobile joint venture• Suntory of Japan paid £1.35bn to buy

GlaxoSmithKline’s drinks brands Lucozade & Ribena

Microsoft - Nokia

Advantages of Horizontal Integration

• Internal economies of scale • Cost savings from rationalisation• Wider range of products - (diversification) -

Opportunities for economies of scope• Reduces competition by removing rivals – increases

market share and pricing power• Can make the entry barriers higher for new rivals

Types of Integration

• Vertical integration: acquiring a business in the same industry but at different stages of the supply chain

– Forward vertical: Closer to the consumers e.g. a manufacturer buying a retailer

– Backward vertical: Closer to the raw materials in the supply chain e.g. a manufacturer buying a raw material supplier

Authors/Agents

Wholesalers

Retailers

Consumers

Publishers/Distributors

BookstoresChains

IndependentBookstores

SupermarketsInternetRetailers

Book Clubs

Vertical Markets: The Book Industry Supply Chain

Amazon – Huge Market Power Volume Value

% %

Chain bookshops* 29 36

Independent bookshops 4 5

Bargain bookshops 9 4

Supermarkets 13 10

Other shops 12 8

Book clubs 6 6

Internet-only retailers# 27 31

* Waterstone’s, WHSmith, Blackwell# Internet only – e.g. Amazon, Play.com

Internet Only Book Sales in UK (2011)

Market share

Amazon 70%The Book Depository 4-5%Play.com 3-4%Others (including publishers’ direct)

22%

Hotel ChocolatA vertically integrated business that owns and operates cocoa plantations in St Lucia (the Rabot Estate pictured above) and which roasts and manufactures chocolate in Cambridgeshire + owns many retail units across the UK

Other examples of vertical integration

• Film distributors owning cinemas + digital streaming platforms• Brewers owning/operating pubs (forward vertical) or buying

hop farms (backward vertical)• Record labels and radio / online music stations• Drinks manufacturers integrating with bottling plants• Pig processing business buying a pig farm• Technology companies growing vertically through hardware,

software and services– PayPal, acquired by eBay for $1.5bn in 2002– Google buying Motorola, a phone maker

Recent Deals

Advantages of Vertical Integration

• Control of the supply chain – this helps to reduce costs and improve the quality of inputs into the production process

• Improved access to key raw materials perhaps at the expense of rival businesses

• Better control over retail distribution channels• Removing suppliers and information from

competitors which helps to make a market less contestable

Types of Integration

• Horizontal integration: companies joining together that produce similar but related products

• Conglomerate: Disparate businesses

What type of integration here?

A B

What type of integration here?

A B

Mergers and Takeovers

• Takeover: Where one business acquires a controlling interest in another business = a change of ownership

• Merger: a combination of two previously separate businesses into a new business

• Diversification: expanding into new markets with new products – the riskiest growth strategy

Examples of successful deals

Successful takeovers and mergers

L’Oreal & The Body Shop (more shops, higher profits)

Google & YouTube (rapid growth & advertising revenue)

Tata & Jaguar Land Rover (£1bn profits in 2011)

Santander & Abbey, Alliance & Leicester, Bradford & Bingley (higher profits & market leadership in UK)

Taylor Woodrow & George Wimpey (economies of scale for two leading house builders merged together)

Kraft / Cadbury – market leadership

Some examples of motivesTakeover / merger Main motives for the transaction

Kraft / Cadbury Establish global market leadership in confectionery & access emerging markets

Google / Motorola

Acquire valuable smartphone patents & manufacturing expertise

Tata / JLR Economies of scale & acquire expertise, brands, capacity and distribution

RBS / ABN-Amro Management vanity; continue reputation for big deals; over-confidence

Santander / Abbey

Market entry (UK) & establish base for further acquisitions to build market share

WM Morrison & Safeway

Increase market share & exploit economies of scale to improve competitiveness

British Airways / Iberia

Consolidation; economies of scale & survival: positioning for further takeovers

Example of the Winner’s Curse - RBS

• In 2007, RBS was part of a consortium that bid £49bn as it competed to buy ABN-Amro

• RBS clearly overpaid for the takeover

• The subsequent effect on RBS's capital reserves led to the forced nationalisation of RBS in 2008 to avoid a collapse of the UK banking system

Some truly awful deals (1)

£175m

SOLD£25m

Some truly awful deals (2)

£10bn

Written Off + New Liabilities

£15bn+

Examples of deals that failedFailed takeovers and mergers

News Corp & Myspace (bought for £580m; sold for $25m)

ITV & FriendsReunited (bought for £175m; sold 3 years later for £25m)

Cisco & Flip (bought for $590m; closed down in a year)

RBS & ABN-Amro (bought for £10bn; results in losses of at least £15bn & nationalisation)

Terra Firma & EMI (bought for £4.2bn; sold 3 years later for loss of £1.75bn) – one of biggest private equity failures

De-mergers

• When a firm decides to split into separate firms• Some of the key motivations for de-merger include:

– Focusing on core businesses to streamline costs and improve profit margins

– Reduce the risk of diseconomies of scale and diseconomies of scope by reducing the range of functions in a business, lower management costs

– Raise money from asset sales and return to shareholders– A defensive tactic to avoid the attention of the competition authorities

who might be investigating possible monopoly power in an industry / market

Examples of de-mergers

• The US pharmaceutical company Pfizer sold their infant nutrition business to Nestle

• Demerger of Cadbury's US drinks business creating a business called Dr Pepper Snapple Group

• Severn Trent Water demerged its waste management business Biffa

• Demerger of British Gas into a gas pipeline business Transco + an oil and gas exploration company

• Talk Talk demerged from Carphone Warehouse in 2010

Examples of de-mergers

• Fosters Group de-merging its two main operating divisions – one focusing on beer, the other on wine

• Punch and Spirit pub groups created out of demerger of Punch Taverns in 2011

• US food giant Sara Lee sold off coffee business Douwe Egberts• Quantas demerged their airline business and run stand-alone

domestic and international airline businesses with each having their own profit and loss account

• News International demerged their Film and TV and Publishing businesses

News InternationalFi

lm a

nd T

V

• Fox News• 20th Century Fox• Sky• Fox Television

Publ

ishi

ng

• Dow Jones• Wall Street Journal• New York Post• The Times• The Sun• Harper Collins

Growth

How to answer questions from examination questions – PROPERLY!

2008 Past Paper

Describe how both horizontal and Vertical integration could allow an organisation to become even larger andmore profitable?

5 marks10 minutes

Tips for success!

Always read the question carefully

Refer to the question at all times

Look at the mark allocation – in general 1 mark = 1 good point

Give real-life example

Use bullet points – but give an introductory paragraph at the start

Use paragraph – but do NOT waffle – an examiner can see through it

Key words

Describe: Write down in detail the main topics that the topic is requiring. In this example, the question is asking you about – HORIZONTAL and VERTICAL INTEGRATION and how an organisation can become larger and more profitable.

Solution – by bullet pointsHorizontal and vertical integration can benefit an

organisation become even larger and profitable due to the

following:Horizontal integration • Can use economies of scale and reduce unit cost of

products.• Can dominate the market as a larger single organisation.• May allow for higher prices to be charged as competition is

reduced.• Reduction in costs – max 1.Vertical integration• Profits are increased by cutting out the ‘middle men’.• Stock can be cheaper due to backward integration.• Guaranteed source of supplies and prices of stock.• Reduction in costs – max 1.Maximum of 4 for only horizontal or vertical.

Solution – by paragraph An organisation can become even more profitable and larger through

horizontal integration as this is when 2 companies that are at a similar stage in production join together and can experience the (benefits of economies of scale and reduce the unit cost of production). By the 2 companies joining they can also (dominate the market as they could become a very large organisation). Both companies (may also be able to reduce costs as they will have a duplication of resources available and can cut down on this and become a more efficient operation). In addition, this may allow each of the companies to (charge higher prices as the competition is reduced). (A real-life example of this could be ASDA and Walmart). Likewise with vertical integration, which is when 2 companies who are at different stages of production in the same industry join together (may experience higher profits as less “middle men” are required), (stock prices can be cheaper due to backward integration – eg Jam factory taking over farm), (a guaranteed source of supplies is always available at a good price) and (overall they can experience a general reduction in costs). Any of the above combinations will increase the size and profitability of an organisation.