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Growth of Firms
Firms can grow
internally by:
• By investing in more capital goods by
borrowing more money, raising more
funds from owners or by keeping some
of the profit back in business.
Firms can grow
externally by:
• Through INTEGRATION-when one firm
combines with another business.
• This can happen in any two ways:
• By a merger-a friendly deal where two
businesses join together (each business owns
a share of the other business for mutual
benefit or,
• By a takeover-a forced and sometimes
hostile deal where one firm buys a share of
the other business.
Integration can take
place in two directions• HORIZONTAL integration. This occurs
when firms in the same industry and at
the same stage of the production
process combine to form a larger
business.
• For example: a merger between two
banks - Westpac and Trustbank
=WestpacTrust
Advantages
• It reduces competition, thus increases market
share
• Increase in market power
• It has greater control on prices to make more
profit
• Gain new ideas from the other business
• As its scale of operations is greater, it may
experience economies of scale (decrease in
average costs=efficient use of resources=more
profit
• The new business may not need all of the workers.
They could remove some workers to become
efficient and make more profit
Disadvantages
For Firms
• The businesses may have different
objectives and targets
• It costs a lot of money to merge with or
takeover another business
• Communication problems
For Consumers
• They may have to pay higher prices due to
lack of competition
• Less choice
VERTICAL integration
• This occurs when a firm expands by
combining with an existing business in the
same industry but at a different stage of
the production process.
• This can be Backward or Forward
1st Type
• Forward Vertical Integration - where a
firm buys into another in a later stage of
production.
• For example, a group of farmers buys
the local milk processing plant.
2nd Type
• Backward Vertical Integration - where
a firm buys into another firm in an
earlier stage of production. For
example, when KFC (takeaways) buys
the country’s biggest poultry processing
plant.
Why vertical
integration?
• Forward integration involves
integrating with customer
firms to ensure retail outlets
for products.
Frank Allen
Tyres
Dunlop
• Backward integration
involves integrating with a
“input” supplier to reduce
supply costs (or guarantee
their quality).
Rubber
plantation
Advantages of vertical
integration:
• It has the advantage of cutting costs by reducing the
profits, or reducing costs made at different stages of
production.
•
It also controls the quality and delivery of materials
right through the production process.
•
• Increase entry barriers to potential competitors
• Increased control of the market.
• Better able to deal with any periods of shortage.
Disadvantages of vertical
integration
• Increase in costs e.g. May need to
appoint staff to run the business
• Inexperience in the field could prove
costly
• Possible diseconomies of scale that
may arise in terms of administration
• Decreased ability to increase product
variety
Diversification



Firms can also expand by diversification.
This involves take over or merger with
another firm in an unrelated industry.
When a firm increases the range of
businesses it is involved in, it may develop
into an industrial combine, or
conglomerate.
For example: Mitsubishi
Why Diversify?
Advantages

Firms diversify for a number of reasons:
 to spread their risks. When sales in one
industry are depressed, other industries
provide more buoyant sales
 to obtain other revenue sources, (so that it is
not dependent on one market).
 To increase the range of products they make
or sell.
 To develop into a conglomerate.
 Take advantage of existing expertise,
knowledge and resources in a company.
Example
• A market gardener whose property is
next to a McDonalds car park. The
market gardener turns part of his
property into a mini-golf course to make
additional income from the crowds who
stop for takeaways.
Disadvantages
• May result in the slowing growth of its
core business.
• Adding management costs.
• Losses may incurred during the market
consolidation process.
• Complex dealings with the legal
requirements of different countries.