Growth of Firms

Firms can grow internally by:

• By investing in more capital goods by borrowing more money, raising more funds from owners or by keeping some of the profit back in business.

Firms can grow externally by:

• Through INTEGRATIONINTEGRATION-when one firm combines with another business.

• This can happen in any two ways:• By a merger-a friendly deal where two

businesses join together (each business owns a share of the other business for mutual benefit or,

• By a takeover-a forced and sometimes hostile deal where one firm buys a share of the other business.

Integration can take place in two

directions-• HORIZONTAL integration. This occurs when firms in the same industry and at the same stage of the production process combine to form a larger business.

• For example: a merger between two banks - Westpac and Trustbank =WestpacTrust

Advantages• It reduces competition, thus increases market share• Increase in market power• It has greater control on prices to make more profit• Gain new ideas from the other business• As its scale of operations is greater, it may

experience economies of scale (decrease in average costs=efficient use of resources=more profit

• The new business may not need all of the workers. They could remove some workers to become efficient and make more profit

Disadvantages

For Firms• The businesses may have different

objectives and targets• It costs a lot of money to merge with or

takeover another business• Communication problemsFor Consumers• They may have to pay higher prices due to

lack of competition• Less choice

VERTICAL integration

• This occurs when a firm expands by combining with an existing business in the same industry but at a different stage of the production process.

• This can be Backward or Forward

1st Type

• Forward Vertical Integration - where a firm buys into another in a later stage of production.

• For example, a group of farmers buys the local milk processing plant.

2nd Type

• Backward Vertical Integration - where a firm buys into another firm in an earlier stage of production. For example, when KFC (takeaways) buys the country’s biggest poultry processing plant.

Why vertical integration?

• Forward integration involves integrating with customer firms to ensure retail outlets for products.

• Backward integration involves integrating with a “input” supplier to reduce supply costs (or guarantee their quality).

Frank Allen Tyres

Dunlop

Rubber plantation

Advantages of vertical integration:

• It has the advantage of cutting costs by reducing the profits, or reducing costs made at different stages of production.

• It also controls the quality and delivery of materials right through the production process.

• • Increase entry barriers to potential competitors

• Increased control of the market.

• Better able to deal with any periods of shortage.

Disadvantages of vertical integration

• Increase in costs e.g. May need to appoint staff to run the business

• Inexperience in the field could prove costly

• Possible diseconomies of scale that may arise in terms of administration

• Decreased ability to increase product variety

Diversification Firms can also expand by Firms can also expand by

diversification. diversification. This involves take over This involves take over or merger with another firm in an or merger with another firm in an unrelated industry.unrelated industry.

When a firm increases the range of When a firm increases the range of businesses it is involved in, it may businesses it is involved in, it may develop into an industrial combine, or develop into an industrial combine, or conglomerateconglomerate..

For example: MitsubishiFor example: Mitsubishi

Why Diversify?Advantages

Firms diversify for a number of reasons:Firms diversify for a number of reasons: to spread their risks. When sales in one to spread their risks. When sales in one

industry are depressed, other industries industry are depressed, other industries provide more buoyant salesprovide more buoyant sales

to obtain other revenue sources, (so that it to obtain other revenue sources, (so that it is not dependent on one market).is not dependent on one market).

To increase the range of products they To increase the range of products they make or sell.make or sell.

To develop into a conglomerate.To develop into a conglomerate. Take advantage of existing expertise, Take advantage of existing expertise,

knowledge and resources in a company.knowledge and resources in a company.

Example

• A market gardener whose property is next to a McDonalds car park. The market gardener turns part of his property into a mini-golf course to make additional income from the crowds who stop for takeaways.

Disadvantages

• May result in the slowing growth of its core business.

• Adding management costs.• Losses may incurred during the

market consolidation process.• Complex dealings with the legal

requirements of different countries.