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Firms will grow organically (driven by internal expansion using reinvested profits or loaned) to the point where they are in a financial position to…
integrate (merge or takeover)
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)
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 a company may choose to pursue mergers and takeovers
Strategic fit - a company may acquire another company to expand into new markers. diversify its product offerings, or gain access to new technology
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)
Synergies - the benefits that result from the combination of two or more companies, such as increased revenue, cost savings, or improved product offerings
Elimination of competition - takeovers are often used to eliminate competition and the acquiring company increases its market share
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
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)
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)
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)
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
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
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
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
