theme 3 : growth of firms

2 ways firms can grow in size

• internal growth

• via integration

what is internal growth

• firms increasing their output

• e.g. through increased investment or an increased labour force

how is internal growth achieved

• achieved by re-investing profits

what is integration

• occurs when 2 firms join together to form one new company

• can be voluntary (merger) or forced (takeover)

4 types of integration

• vertical integration

• horizontal integration

• conglomerate integration

• lateral integration

vertical forward integration explanation

• firm buys another firm closer to the market

• e.g. primary buying secondary or secondary buying tertiary

vertical backwards integration explanation

• firm buys another firm closer to the source

• e.g. secondary buying primary

horizontal integration

• 2 firms in the same industry and the same stage of production

conglomerate integration explanation

• two firms in unrelated industries

• e.g. virgin gyms and virgin media

lateral merger explanation

• 2 firms merge which produce different but complementary products

motives for integration

• more profit

• less competition (horizontal integration) - could also keep the brand instead of changing it so you don’t have to compete but do get their profits (remove a threat from the market)

• higher market monopoly / increase market share

• backward integration could help regulate or reduce your costs of production

• more control over supply chain

• gain monopoly power

• to exploit further economies of scale

• horizontal integration - their systems may be more efficient than yours

what are the different sectors

• primary sector - closest to source e.g. farming, fishing

• secondary sector - e.g. construction, manufacturing

• tertiary sector - closest to market e.g. retail, banking, finished products

advantages of a horizontal merger

• already knows the industry

• have control over the competition

• could increase your profits and exploit economies of scale (financial, purchasing)

• rapidly increase market share

• rationalisation

disadvantages of a horizontal merger

• if output increases too much, could suffer diseconomies of scale

• may suffer congestion costs

• gov could step in and block it if its seen as anti competitive

advantages of a backwards vertical merger

• can lower you raw material costs if you also own the suppliers

• more price competitive as you can lower your prices if materials are cheaper

• control over supply chain (could stop supplying to rivals)
  lower price as no markup

disadvantages of a backward vertical merger

• lack of experience in other market

• may suffer congestion costs (to help with the merger, different systems etc)

• managers not skilled in that industry

advantages of a forward vertical merger

• more price competitive

• access to customer and always have someone to sell the good you’ve made

• guaranteed outlet for product

• can exploit financial economies of scale

disadvantages of a forward vertical merger

• lack of experience in other market

• congestion sots

• lack of skill in that new ‘sector’

advantages of a conglomerate merger

• get to sell to a new demographic of customers which could increase your profits / revenue

• risk bearing economies of scale

disadvantages of a conglomerate merger

• don’t have experience in those other markets

• congestion costs

• lack of market knowledge

• new competitors and high costs getting used to the market / researching it

• high risk of price war

advantages of a lateral merger

• customers are likely to buy some products together which can therefore increase profits

• brand recognition

• can exploit marketing and managerial economies of scale

disadvantages of a lateral merger

• lack of experience in other markets

• congestion costs

• same market area - if there’s a recession and people buy less hotel rooms, your other business also struggles, don’t spread your risk

• may not be able to exploit purchasing economies of scale

congestion cost definition

external costs / negative externalities