Unit 3: Business Economics & Economic efficiency Motivations for growth

Unit 3: Business Economics & Economic efficiency Firms & their motivations: Objectives, structure, costs, revenues, profit Market Structure: Perfect competition, Monopoly Monopolistic competition, Oligopoly Pricing Strategies and Contestable Markets Government intervention to promote competition

Company Growth: Specification requirements Students should understand how firms begin and the constraints on their development Students should understand the reasons why firms seek an expansion in market shares and may derive monopoly power. They should also be able to distinguish between different methods of the growth of firms e.g. the distinction between internal and external growth, and different types of integration.

The Growth of Businesses Motivations for growth

Why and How do firms grow? Explain internal and external growth Explain two growth drivers for M&A transactions Distinguish between forward, vertical and conglomerate integration Explain why firms demerge

Company growth A firm exists to bring together factors of production in order to produce goods or services Firms range in organisational complexity from sole proprietors to PLCs Firms may undergo organic growth, building upon their own resources and past profits If limited by the size of their markets, firms may diversify into new markets or products Firms may also grow through h o r i z o n t a l, VERTICAL or conglomerate mergers and acquisitions Globalisation has enabled the growth of GIANT firms operating on a global scale

Why is one of the main business objectives growth? Market power What do businesses gain from growth? Profits Reduced Costs (EoS) Risk aversion Dividends to shareholders Managerial motives

The motivations for growth The profit motive: May be driven by stock market expectations Shareholders looking for capital gains from rising share prices and regular income from share dividends The cost motive: Increasing returns (economies of scale) which leads to a fall in long run average cost Lower costs important in establishing and maintaining a competitive advantage The market power motive: Market dominance gives a business increased pricing power in specific markets Monopolies for example can engage in price discrimination.

The motivations for growth The risk motive: The expansion of a business might be motivated by a desire to diversify production and sales Diversification of products and also out-sourcing of different stages of production Managerial motives: Decisions and strategies of managers employed by a firm might be different from those with an equity stake in the business Behavioural theories of the firm suggest that pure profit maximisation is difficult to achieve and rarely seen

Growth – the profit motive Monopoly Profit MC Price & Cost AC P1 AC AR MR Q1 Output

Growth of Firms – Scale Economies Cost per unit AC1 AC2 AC3 LRAC Q1 Q2 Q3 Output

So how can businesses grow? Theory bit…

Internal and external growth Internal or organic growth occurs when a firm increases their own scale of operation eg they open a new plant or production line. External growth is where a company expands through acquisitions ie mergers or takeovers.

Internal or Organic growth

Internal growth Expansion of existing production facilities Opening of new retail outlets Taking on more staff Investment in new technology Widening of the product range

How has Tesco grown? All Internal growth! Built new retail outlets Opened express stores Expanded current stores Opened in other countries Recruited more staff On line store Catalogue Diversify into new products…. Bank acquisition: http://www.guardian.co.uk/business/2008/jul/29/tesco.royalbankofscotlandgroup All Internal growth!

External Growth

What’s the difference between a merger & a takeover? Merger = where 2 companies combine to become one new company Takeover = where one company wants to buy another company and make it part of its existing business

Can you name me any recent merger or takeovers? Corus steel & Tata (Indian) http://news.bbc.co.uk/1/hi/world/south_asia/6071090.stm

Kraft strategic objectives Build a High-Performing Organization: It’s no coincidence that our first strategy is about our people – since our employees are the ones powering our success. We have a strong leadership team. We have a simplified organization that puts local business units at the heart of the company so decisions are made closer to the consumer. Reframe Our Categories. We market many of the world’s leading and most beloved food brands. And we want our delicious products to give consumers millions of smiles every day. We’re doing this by focusing on building a global powerhouse in snacks, confectionery and quick meals … more delicious than ever. Exploit Our Sales Capabilities. We’re taking full advantage of our size and broad reach. We have one of the largest and most powerful sales forces in the food industry. This gives us an advantage that other competitors simply can’t match. In the U.S., store managers have a single sales representative who handles all of our products. In developing markets, we're expanding our distribution in smaller traditional outlets. And we’re working closely with our global customers like Carrefour, Tesco and Wal-Mart. Drive Down Costs Without Compromising Quality. For us, product quality always comes first. But we’re also always looking for ways to reduce costs, so we can invest more in making truly delicious products that people love.

UK M&A stats

Types of Integration

Types of Integration Before Vertical = Different stage of supply chain Horizontal = at the same stage of supply chain Firm After Customer

Types of Integration Backwards VERTICAL integration Integrate with a business that comes before in the chain of production of a good Conglomerate integration [Diversification] Integrate with another different business/product line H o r i z o n t a l Integration Integrate with another similar business Forwards VERTICAL integration Integrate with a business that comes after in the chain of production of a good

Types of Integration Backwards vertical integration Wheat Farmer Flour Miller A Horizontal Integration Flour Miller B Diversification Purchases a perfume manufacturer Forwards vertical integration Bakery

What are the benefits of integration? Why do some firms prefer external to internal growth? Quicker to achieve EoS – managerial, financial & production Achieves greater concentration ratio/ reduces competition Rationalisation reduces costs

Whiteboards ready? Choose which type of integration Label one side horizontal, the other vertical (with arrow up = forward or down = backward)

What type of integration is this? J Sainsbury buying a breakfast cereal manufacturer? Vertical Backward integration

What type of integration is this? Ford Motor Company buying a steel works? Vertical Backward integration

What type of integration is this? Merger of Lloyds Bank with Barclays bank? Horizontal integration

What type of integration is this? A bakery buying a bread shop? Vertical Forward integration

What type of integration is this? ICI chemical manufacturer takes over a specialist chemical sector of Unilever? Horizontal? integration

What type of integration is this? Milk Marque (farmer co-operative) which collects and sells 60% of raw milk buys Aeron Cheese, A Welsh maker of farmhouse cheeses? Vertical Forward integration

What type of integration is this? Phoenix Inns chain of 1800 pubs buys Spring Inns with 4300 pubs? Horizontal integration

Reasons for demerger

Reasons for demerger Why did Fosters get into the wine market? How much were their earning from wine to start with? What has changed the situation? What are the benefits of splitting the businesses?

Why and How do firms grow? Explain internal and external growth Explain two growth drivers for M&A transactions Distinguish between forward, vertical and conglomerate integration Explain why firms demerge