Assess the ways in which a firm can grow. (25)
Firms grow in order to achieve their objectives, including increasing sales, maximising profits or increasing market share. Firms grow in two ways; by internal expansion and through integration. To grow internally, a firm will need to retain sufficient profits to enable it to purchase new assets, including new technology. Over time, the total value of a firm's assets will rise, which provides collateral to enable it to borrow to fund further expansion. Another way a firm can grow internally is through branding. This is achieved through marketing schemes, such as television and online advertisements. Once a brand, and through the brand, a customer base, is established, less advertising is required to launch new products. Internal growth often provides a low risk alternative to integration, although the results are often slow to arrive. Firms can also grow internally through the development and launching of new products, expanding their line and potentially generating new revenue. Finally, firms grow internally through finding new markets to sell their products, for example, exporting into emerging markets.
The second route to achieve growth is through external expansion, namely, integration with other firms. Firms integrate through mergers, where there is a mutual agreement, or through acquisitions, where one firm purchases shares in another firm, with or without agreement. The first type of integration a firm can use is known as vertical integration. Vertical integration occurs when firms merge at different stages of production. There are two types of vertical integration, backwards and forwards. Backward vertical integration occurs when a firm merges with another firm which is nearer to the source of the product, such as a car producer buying a steel manufacturer. Forwards vertical integration occurs when a firm merges to move nearer to the consumer, such as a car producer buying a chain of car showrooms. Another type of integration a firm can use is horizontal integration. Horizontal integration occurs when firms merge at the same stage of production, such as a merger between two car producers, or two car showrooms. Firms can also diversify as a means of external expansion. Diversification occurs when firms operating in completely different markets, merge - such as a car producer merging with a travel agency. Another way a firm can grow externally is through integrating with foreign firms. For example, the proposed merger between Chiquita and Fyffes in 2014 would have brought the American and Irish firms together, and expanding the business of what could have been ChiquitaFyffes to span both Europe and America.
The merging of firms comes with several advantages and disadvantages. One advantage is that firms that merge can take advantage of a range of economies of scale. The firm may save money in its fixed costs, as the merger results in a lower average cost. In addition, the larger firm may save more money bulk buying than it did previously. Finally, it is far more efficient to have one head office than two, in the sense that the new firm saves costs by laying off workers who would otherwise operate in a duplicate role with another (e.g. two CFO's, two marketing heads, etc.). Firms who merge will share their knowledge of the market they operate in, and potentially benefit from each other's experience. With vertical integration, information asymmetries can be reduced or removed. Firms that merge may be able to allocate more funds to generating new products as a consequence. This may increase their competitiveness and profitability in the long run through internal expansion.
While there is indeed a significant case to say that mergers are beneficial to the firm, there are also certain disadvantages associated with the practice, for the firm, the consumer, and other businesses. One disadvantage of merging for the firm is that in an attempt to invoke economies of scale, firms that merge may in fact experience diseconomies of scale, such as difficulties with co-ordination and control. This is because the managerial task of controlling a larger company is far more difficult and complex than the smaller company. This will increase average cost in the long run, and reduce profitability. The merging of two firms may also hurt the consumer, as increased concentration and reduced competition result in
higher prices, as demand is more inelastic (due to more monopoly power) and raising price will raise revenue.
One disadvantage of firms merging for consumers is that they are likely to suffer from reduced choice following a merger of two close competitors. For example, supermarket mergers are often the subject of regulatory scrutiny for this very reason, as shoppers would no longer have the choice between the two supermarkets anymore when looking for cheaper alternatives.
Finally, a disadvantage of merging to new market entrants is that the economies of scale and scope derived from a merger may increase barriers to entry and make the market less contestable. In the case of forward vertical integration, new entrants may be denied access to outlets for its products. With backwards vertical integration, new entrants may find it difficult to secure a source of supply of materials or products.
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