2. External (Inorganic) Business Growth

How do firms reach a position to integrate with others?

Growing organically until they are financially able to merge or takeover other businesses

What is a merger?

Two or more companies combining to form a new company (the original companies cease to exist and their assets and liabilities are transferred to the new company)

What is a takeover?

When one company purchases another company, often against its will - the acquiring company buys a controlling stake in the target company’s shares (>50%) and gains control of its operations

Why might a company choose to pursue mergers and takeovers?

1. Strategic fit - a company may acquire another company to expand into new markets. diversify its product offerings, or gain access to new technology

2. Lower unit costs - larger companies are able to achieve lower unit costs as they receive many benefits from being large (e.g. bulk purchase discounts on supplies and better interest rates from bank on loans)

3. Synergies - the benefits that result from the combination of two or more companies, such as increased revenue, cost savings, or improved product offerings

4. Elimination of competition - takeovers are often used to eliminate competition and the acquiring company increases its market share

5. Shareholder value - mergers and takeovers can also be used to create value for shareholders By combining companies, shareholders can benefit from increased profits, dividends(a sum of money paid each year by a company to its shareholder from its profits) and higher stock prices

What are the types of external (inorganic growth)?

• Vertical integration (forward or backwards) - a merger/takeover of another firm in the supply chain/different stage of the production process

• Horizontal integration - a merger/takeover of a firm at the same stage of the production process (e.g. a shoe manufacturer buying another shoe manufacturer)

What is forward vertical integration?

When a company moves downstream in the supply chain, meaning it starts to take over businesses that are closer to the final consumer (a car manufacturer buying a network of car dealerships. The car manufacturer is now selling directly to consumers, cutting out the middleman - dealerships)

What is backward vertical integration?

When a company moves upstream in the supply chain, meaning it takes over or merges with a supplier of raw materials or components (a bakery buying a wheat farm. The bakery now controls the supply of wheat, reducing reliance on suppliers and possibly reducing costs)

What are the advantages of vertical integration (inorganic growth)?

• Reduces the cost of production as middleman profits are eliminated

• Lower costs makes the firm more competitive

• Greater control over the supply chain reduces risks as access to raw materials is more certain

• The quality of raw materials can be controlled

• Forward integration adds additional profit as the profits from the next stage of production are assimilated

• Forward integration can increase brand visibility

What are the disadvantages of vertical integration (inorganic growth)?

• There may be unnecessary duplication of employee or management roles

• There can be a culture clash between the two firms that have merged

• Possibly little expertise in running the new firm results in inefficiencies

• The price paid for the new firm may take a long time to recoup

What are the advantages of horizontal integration (inorganic growth)?

• The rapid increase of market share

• Reductions in the cost per unit due to receiving more beneficial terms for bulk purchases

• Reduces competition

• Existing knowledge of the industry means the merger is more likely to be successful

• The firm may gain new knowledge or expertise

What are the disadvantages of vertical integration (inorganic growth)?

• Unit costs may increase for example due to unnecessary duplication of management roles

• There can be a culture clash between the two firms that have merged