1. Chapter 6 Ownership, Expansion and Integration of Firms
Economics
Chapter 6
Ownership, Expansion and Integration of Firms

2. Firm
Definition
A firm is a unit that makes decisions regarding the employment of factors of production and the production of goods and services
Types
Public enterprise – owned by the government
Private enterprise – privately owned

3. Public enterprise 2 kinds of management Managed by the government
Directly run by the government
Department under governmental structure
E.g. The Hong Kong Police Force, The Fire Service Department, The Water Supply Department…
See reference: Organisation Chart of the Gov’t of HKSAR

4. Public enterprise 2 kinds of management
Managed by the public corporations
Established with government funds
Managed by government-appointed directors
Operation funds come from service charges
E.g. The Airport Authority of Hong Kong, Hospital Authority, Hong Kong Art Centre, Urban Renewal Authority 8 universities…
See reference: Government and Related Organisations

5. Characteristics of public enterprise
Management
Directly by government
Managed by the public corporations
Capital
Receiving capital from the government
Independent account
Public corporations are responsible for the success or failure to their own business.
Provision of lowly-priced services and facilities to the public
Might not be aiming at profit maximization
Services or facilities provided might be free of charge
Provide services or facilities which are necessary to the society but not be given by private sectors
E.g. Police Force to keep social order Housing Department to provide lowly-priced public housing Water Supplies Department to provide stable and reliable water supply

6. Characteristics of public enterprise
Advantages
Provision of necessary services to the citizens, more stable living environment
Lower the living cost
Disadvantages
Not aiming at profit maximization  no response to market changes  lack incentive to modify (lower the cost or improve management)
Mismatch with market demand / price, violate the postulate of maximization
High cost of complaints

7. Private enterprise Forms of business ownership Sole proprietorship
Partnership
Limited company

8. Main differences   Legal entities Limited liability
Sole proprietorship 
Partnership
Limited company 

9. Legal entities
An independent entity with rights and obligations like an ordinary individual.
To sole proprietorship and partnership
the owner of the firm needs to bear all obligations from any legal dispute
can’t initiate or receive lawsuit
To limited company
the company bears the legal obligation
owner(s) of the firm need not to be legally responsible
Can initiate or receive lawsuit

10. Liability Limited liability
Owner is liable to the amount of investment he has in the firm.
Illustration: 1. An investor invested $100,000 into the Firm A 2. The firm applied debt from Bank L 3. When time was due, Firm A couldn’t pay for the debt. 4. Bank L demanded Firm A liquidation, assets were sold to pay for the debt. 5.The investor needed not to pay for more, his $100, investment will be the upper limit of his loss. [ In conclusion: The investor loses $100,000 in maximum.]

11. Liability Unlimited liability
Owner(s) of sole proprietorship and partnership is/are liable to all debts of the firm.
Illustration: 1. An investor invests $50,000 into the Firm B 2. The firm applies debt (let say $200,000) from Bank M. 3. When time is due, Firm B can’t pay for the debt. 4. The investor needs to sell the assets of the firm (let say $100,000). 5. If not enough pay for the debt, the investor needs to sell personal assets (let say $50,000). 6. If still not enough, the owner goes bankrupt. [ In conclusion: The investor loses more than $50,000.]

12. Types of ownership Sole proprietorship Single owner
No independent legal entity.
Unlimited liability.
Advantages:
Simple set-up procedure
Registration: Inland Revenue Department
Quick decision making
No requirement of information disclosure
All profit belongs to the sole owner
Disadvantages:
Limited ways of / Difficulties in fund raising
Unlimited liabilities
Bear all legal obligations
Lack of continuity
Death
Retirement
Ownership transfer
Bankruptcy of owner

13. Types of ownership Partnership 2 or more owners
No independent legal entity.
Unlimited liability.
Advantages:
Simple set-up procedure
Registration: Inland Revenue Department
Quick decision making (comparing with limited company)
Sharing risk and work, or benefit from division of labour (experience sharing)
No requirement of information disclosure
Disadvantages:
Slower decision making (comparing with sole proprietorship)
Limited ways of / Difficulties in fund raising
Unlimited liabilities
Bear all legal obligations
Lack of continuity, as if one of the partners…
Death
Retirement
Ownership transfer
Bankruptcy of owner

14. Types of ownership Limited Company (Ltd. Co.) Private limited company
Public limited company
Common features
Complicated set-up procedures
To Companies Registry: Memorandum and Articles of Association
To Inland Revenue Department: Business registration
Ownership
Divided into a number of shares
Decision making by voting
Shareholders ( w/ > 50% shares, absolute control)

15. Types of ownership Common features Structure Legal entity
Ownership ≠ Management
General meeting  Vote for decision
Board of directors  Formulates policies, supervises operations & ensures the resolution of general meeting
Legal entity
The company itself is a legal entity
Lasting continuity
Death of one owner does not mean end of company
Ended unless liquidation
Limited liability
Information disclosure
Must be audited by authorized accountants

16. Types of ownership Private vs. Public limited company Private company
Public / Listed company
No. of shareholders
1 to 50
Unlimited
Transfer
Consent from the BoD
Preference to existing shareholders
Shares not traded on the HKEx
Free transferal
No need to have consents from the BoD
Exchange through HKEx.
Ways to raise Capital
-Can’t invite public to buy shares and bonds
-Rely on debts
Shares and bonds to public
Equity and debt funding
Disclosure of financial info.
To shareholders only
Can keep secret to the public
- Disclose to public

17. Ways for Ltd. Co. to raise capital
Debts from financial institutes
Bank loan
Loan from financial companies
Payment: Interest
Issuing shares (both Private and Public Ltd. Co.)
Selling of ownership
Investors buy the shares of the companies
Share companies’ profit
Payment: Dividends
Issuing bonds (only Public Ltd. Co.)
Bonds to creditors as certificates
A bond is a statement of debt info.: Amount / interest rate / due date
Borrower = Bond issuer
Lender (Creditor) = Bondholder

18. Bond

19. Bond

20. Shares vs. Bonds   Shares Bonds Nature Proof of ownership
Certificates of debt
Return
Different in price (exchange market)
Dividends
Different in price (bond market)
Interest
Priority for obtaining returns  
Priority to get back the capital if liquidation
Voting right

21. Pros and Cons Issuing shares Issuing bonds Advantages
Capital kept forever
No need to repay
Dividends are not mandatory.
Ownership and control not to be weaken.
Signal of rapid growth
Disadvantages
Risk of price drop, decrease in asset value
Spread of ownership and controlling power
Slow economic growth
Risk of liability
Interest payment
Payback of loan on due date

22. Return and Risk ∴Risk  Return Risk  Return
Once you want to invest:
Expected rate of returns
Shares > Bonds > Bank Deposit > Cash
Risks
∴Risk  Return
Risk  Return

23. Expansion Expansion Ways of expansion Enlarge the scale of production
Aim at achieving economies of scales
Ways of expansion
New branches
New products
New business

24. Integration Integration Types of integration
Take over or merge with other companies
Aim at achieving economies of scales
Types of integration
Horizontal
Vertical
Lateral
Conglomerate

25. Integration Horizontal Integration
Merge with another firm producing the same type of products
Reasons:
Defeat competitor, more market share
Same product  Lower cost of production
New market
Example:
A mobile service company takes over another mobile service company
Cases:
Cathay Pacific took over Dragonair (2006)
Sony & Ericsson (2005)
HP took over Compaq (2002)
IBM took over Lotus (1995)
Panasonic and Rasonic (1994)

26. Integration Vertical Integration
Merge with another firm in different stage of production
Backward integration
Another firm in the preceding/earlier stage of production
Reason:
Ensure the supply of resources or services
Lower the cost of supply of resources
Example: A clothing company takes over a button company
Cases:
Dairy Farm and Nestle
Reliance Industries (Garment producer): from textiles into polyester fibres and further into petrochemicals.
Esso+Exxon+Mobil: SeaRiver Maritime, a petroleum shipping company.

27. Integration Vertical Integration
Merge with another firm in different stage of production
Forward integration
Another firm in the next stage of production
Reason:
Ensure the channel of product and service sales
Lower the cost of information from market
Example:
A clothing company takes over a retailer
Cases:
Cathey Pacific & Hong Kong Air Cargo Terminals Limited
Vodafone Airtouch PLC took over Mannesmann (Germany)

28. Integration Lateral Integration
Merge with another firm producing related nut not directly competing products
Reason:
Risk diversification
Lower the cost of sales of products and services (market economies, R&D economies)
Example:
A garment company takes over a shoe factory
A mp3 player factory takes over a headphone factory
Cases:
Citigroup & Travelers Group (1998)
China Strategic Holdings(中策集團) & Primus Financial Holdings Limited (博智金融控股) suggested acquisition over AIG Nan Shan Life Insurance Company, Ltd. (南山人壽) (2009)

29. Integration Conglomerate Integration Example: Cases:
Merge with another firm with different business
Reason:
Risk diversification
Lower the cost of sales of products and services (market economies, R&D economies)
Example:
A garment company takes over a toy factory
Cases:
Hutchison Whampoa Ltd. owns:
Hong Kong International Terminals
Hutchison Whampoa Property
A.S. Watsons Group
Cheung Kong Infrastructure Holding Ltd.
Hutchison Telecommunications International Limited
CITIC Group owns:
CITIC Ka Wah Bank Limited
CITIC Pacific
CITIC Resources Holdings Ltd.
中信文化傳媒集團
Asia Satellite Telecommunications Co. Ltd.
CITIC Travel Co.
China CITIC Press
Western Harbour Tunnel Co. Ltd.

30. The motives of expansion
General motives
Economies of scale
 scale of production   Lower the production
 market share   profit
Simplify structure
Reorganizing business
Efficiency in management
Flexible allocation of resources
Cut down over-abundant expenditure
Acquisition of technology
New technology
R & D
Acquisition of brands
Takeover the brand from other firms
Save time and cost to develop new brand

31. The motives of expansion
Specific motives
Types
Motives
Horizontal
Defeat competitors
Market share
Influence on the market
Vertical
Backward
Ensure supply of resources
Forward
Stable sales outlets
First-hand market information
Lateral
Risk diversification
Extension of brands, save cost
Conglomerate