. 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

Vertical Markets: The Book Industry Supply Chain

Amazon – Huge Market Power VolumeValue % Chain bookshops*2936 Independent bookshops45 Bargain bookshops94 Supermarkets1310 Other shops128 Book clubs66 Internet-only retailers#2731 * Waterstone’s, WHSmith, Blackwell # Internet only – e.g. Amazon, Play.com Internet Only Book Sales in UK (2011) Market share Amazon70% The Book Depository4-5% Play.com3-4% Others (including publishers’ direct) 22%

Hotel Chocolat A 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?

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 motives Takeover / mergerMain motives for the transaction Kraft / CadburyEstablish global market leadership in confectionery & access emerging markets Google / Motorola Acquire valuable smartphone patents & manufacturing expertise Tata / JLREconomies of scale & acquire expertise, brands, capacity and distribution RBS / ABN-AmroManagement 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£25mSOLD£25m

Some truly awful deals (2) £10bn Written Off + New Liabilities £15bn+ £15bn+

Examples of deals that failed Failed 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 International Film and TV Fox News 20th Century Fox Sky Fox Television Publishing 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 and more profitable? 5 marks 10 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 points Horizontal 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.