Firms grow both organically and through acquisitions for several strategic and financial reasons. Strategically, firms seek to achieve economies of scale, improve market power, and diversify risks. Financially, growth can improve profits and shareholder returns. Firms may integrate horizontally within their industry, vertically along the supply chain, or diversify into unrelated businesses. Both large and small companies pursue organic expansion by developing new products and entering new markets.

1. Why and how do firms grow?
Topic 3.3.2

2. Why and how do firms grow?
Topic 3.3.2
Students should be able to:
• Discuss how and why firms grow
• Distinguish between forward, vertical and conglomerate
integration, and know reasons for mergers/ takeovers.
• Know why some firms remain small and others grow
• Understand the reasons for demergers

3. Economies of Scale
(Lower Unit Costs)
Build and Sustain
Your Market Power
Improve Shareholder
Returns from higher
Operating Profits
Reduced the Risk of
Hostile Takeover
The Pursuit of
Managerial
Objectives
Synergy Effects – i.e.
from Bigger Sales
Platforms
Key Motivations for Business Growth

4. Motivations for Business Growth
• Profit motive:
– Businesses grow to provide better returns for shareholders
– Stock valuation is influenced by expectations of future sales and profits
• Cost motive:
– Economies of scale increase the productive capacity of the business
leading to lower average costs. They help to raise profit margins at a given
market price
• Market power motive:
– Firms may wish to increase market dominance giving them pricing power
– This power can be used as a barrier to entry in the long run
– Larger businesses can build and take advantage of monopsony power
• Risk motive:
– Diversification across products & markets helps to reduce investor risk
• Managerial motives:
– Managers whose objectives differ might accelerate business expansion

5. The Relentless (?) Growth of Facebook?
0
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1200
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'11
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'15
Numberofusersinmillions
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RevenueinmillionU.S.dollars
Facebook continues to grow their base of active users – one of the key
business challenges for them is to turn these users into revenue generators

6. • Organic:
– Growth from “within the business” e.g. new products;
expansion into new markets
• External:
– Growth from takeovers & mergers
• Mergers and Takeovers
– Takeover: Where one business acquires a controlling
interest in another business = a change of ownership
– Merger: a combination of two previously separate
businesses into a new business
• Diversification: expanding into new markets with
new products – the riskiest growth strategy
Organic and External Growth

7. External Growth for Amazon

8. Prices Paid for Facebook’s Acquisitions
19,000
2,000
1,000 500 150 60 50 47.5 15 10 2.5
0
2000
4000
6000
8000
10000
12000
14000
16000
18000
20000
PriceinmillionU.S.dollars
Acquisition into virtual reality
March 2014 saw Facebook’s acquisition of
the makers of the virtual reality headset
Oculus Rift, which is launching its first
commercial product in January 2016

9. 1. Rapid technological change / creative destruction
in industries and markets
2. Need for economies of scale to remain cost and
price competitive in world markets
3. Need to be able to supply customers globally
4. Low demand growth in mature economies – need
to have a presence in faster-growing countries
5. Access to more distribution networks
6. Investment in faster-growing emerging markets
where per capita incomes are rising quickly
7. By-pass non-tariff barriers such as import quotas
Key Drivers of Mergers & Takeovers

10. What is the primary reason for the acquisitions you intend to initiate in
2015? (US Corporations only)
21
19
16
15
11
5
5
4
4
0 5 10 15 20 25
Opportunistic - target becomes available
Expand geographic reach
Expand customer base
Enter into new lines of business
Financial buyer looking for profitable…
Enhance intellectual property
Defend against competition
Invest in another function in the supply chain
Other
Share of respondents
Takeover Motivation – US Evidence

11. Strategic
motives
• Improve &
develop the
business
• Closely linked to
competitive
advantage
• E.g. economies
of scale
Financial
motives
• Make best use
of financial
resources for
shareholders
• Improve
financial
performance
• E.g. higher
profits
Managerial
motives
• Self-interest of
managers
• Not necessarily
in the best
interest of
shareholders
• E.g. want to
lead a bigger
business
Strategic Motives for Acquisitions
It is important to realise that many of the mergers and takeovers that hit the news
headlines are driven by managerial motives. Few minority shareholders have any influence

12. • Director rewards may be linked to growth
• Big takeovers attract media – boosts ego / reputation?
• Takeovers as “vanity projects” for CEOs and COOs
Personal ambition & financial reward
• Pressure to do takeovers (if competitors are too)
• Concern that firm may be being left behind
• Over-confidence of senior management (hubris)
• Pressure from advisers & the media (e.g. investment
bankers who stand to make millions from deals)
Bandwagon effect / peer pressure
Managerial Motives for Acquisitions

13. Takeover / merger Main motives for the transaction
Kraft / Cadbury
Establish global market leadership in confectionery & access
emerging markets (stronger growth potential), strategic fit
Google / Motorola
Acquire valuable smartphone patents & manufacturing
expertise
Tata / JLR
Economies of scale & acquire expertise, brands, capacity and
distribution
RBS / ABN-Amro
Management vanity and hubris; continue reputation for big
deals; over-confidence at the top of a speculative bubble, cheap
money
Santander / Abbey
Market entry (UK) & establish base for further acquisitions to
build market share in reformed financial system
WM Morrison &
Safeway
Increase market share & exploit economies of scale to improve
competitiveness
British Airways / Iberia
Consolidation; economies of scale & survival: positioning for
further takeovers
Motives for Acquisitions - Examples

14. Organic Business Growth
• Organic growth is also known as internal growth.
• It happens when a business expands its own
operations rather than relying on takeovers and
mergers. Organic growth can come about from:
1. Increasing existing production capacity through
investment in new capital & technology
2. Development & launch of new products
3. Finding new markets for example by exporting into
emerging countries such as India and South Africa
4. Growing a customer base through marketing

15. Organic Business Growth
Under Armour generates
turnover of around $2bn
per year and is
consistently growing at
over 20% per year. It is
doing this by expanding
the product range,
extending into retail
operations and pushing
into emerging markets
Under Armour
Whitbread owns Costa
Coffee and Premier Inn -
two brands that have
performed exceptionally
well despite the
economic downturn. The
company is Britain’s
biggest coffee shop
chain.
Whitbread
The Lego business has
never made an
acquisition. It focuses on
using new product
development and
innovation as the driver
of revenues and profits.
Since 2007, Lego has
tripled its revenues
globally
Lego

16. Rapid Organic Growth at Costa
881
1,069
1,217
1,392
1,578
1,755
1,931
0
500
1000
1500
2000
2500
2008/09 2009/10 2010/11 2011/12 2012/13 2013/14 2014/15
NumberofCostaCoffeestores

17. Adidas – Growth from Retail Platforms
1,019
1,203
1,352 1,355
1,437
1,661
1,746681
755
725 734
730
779
851
184
254 193
295 279
300
316
0
500
1000
1500
2000
2500
3000
2008 2009 2010 2011 2012 2013 2014
Numberofstores
Year
Concept stores Factory outlets Concession corners and other

18. Number of Paying Spotify Subscribers
0.5 1 1.5
2.5 3
4
5
6
10
12.5
15
20
0
5
10
15
20
25
Jul '10 Mar '11 Jun '11 Nov '11 Jan '12 Aug '12 Dec '12 Mar '13 May '14 Nov '14 Jan '15 Jun '15
Payingsubscribersinmillions

19. Twitter – Active Users and Revenues
30
40
49
54
68
85
101
117
138
151
167
185
204
218
231.7
241
255
271
284288
302304307
0
50
100
150
200
250
300
350
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Q4'14
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Q2'15
Q3'15
Numberofmonthlyactiveusersinmillions
Twitter – Monthly Active Users
28.28
106.31
316.93
644.89
1,403
0
200
400
600
800
1000
1200
1400
1600
2010 2011 2012 2013 2014
Annualrevenue(inmillionU.S.dollars)
Twitter – Global Annual Revenues

20. Key Concepts – Business Growth
Backward vertical
integration
Acquiring a business operating earlier in
the supply chain – e.g. a retailer buys a
wholesaler, a brewer buys a hop farm
Conglomerate integration
A merger between firms that are
involved in unrelated business activities
Forward vertical
integration
Acquiring a business further up in the
supply chain – e.g. a vehicle
manufacturer buys a car parts distributor
Horizontal integration
When companies from the same industry
amalgamate - firms are at the same stage
of the production process
Internal (organic) growth
When a business gets larger by increasing
the scale of its own operations

21. Different Types of Business Integration
Backward vertical Forward vertical Horizontal
Lateral Conglomerate
The oil and gas industry is
deeply vertically integrated
Brewers own chains of pubs Two airlines merging is
horizontal integration
Major software companies
buying games developers
Minnesota Mining and
Manufacturing Company

22. Business Growth – Google Acquisitions
12,500
3,200
3,100
1,650
1,100
750
700
625
500
500
0 2000 4000 6000 8000 10000 12000 14000
Motorola Mobility (Aug 2011)
Nest Labs (Jan 2014)
DoubleClick (Apr 2007)
YouTube (Oct 2006)
Waze (Jun 2013)
AdMob (Nov 2009)
ITA Software (Jul 2010)
Postini (Jul 2007)
Skybox Imaging (Jun 2014)
DeepMind (Jan 2014)
Price of acquisition in million U.S. dollars

23. Acquisitions made by Amazon
1,200
970
775
545
370
312 300
250
150
110
0
200
400
600
800
1000
1200
1400
Zappos
(7/09)
Twitch
(8/14)
Kiva
Systems
(3/12)
Quidsi
(11/10)
Annapurna
Labs (1/15)
LOVEFiLM
(1/11)
Audible
(1/08)
Alexa
(5/99)
Goodreads
(3/13)
Woot
(6/10)
PriceinmillionU.S.dollars

24. Acquisitions made by Alibaba
1,220
1,165
829
692
586
280
250
249
240
194
171
120
100
20
0 200 400 600 800 1000 1200 1400
Youku Tudou
AutoNavi Holdings
ChinaVision Media Group
Intime Retail
Weibo
TangoMe
Lyft
SingPost
Gooddaymart
Guangzhou Evergrande
CITIC 21CN
Kabam
TutorGroup
Beijing Byecity Technology Development
Value of stake in million U.S. dollars
Jack Ma – Founder of Alibaba
“Harvard rejected me 10 times”

25. • Horizontal Integration: Two businesses in the
same industry at the same stage of production
becoming one
• Some recent examples:
– Tata buying Jaguar Land Rover from Ford
– Volkswagen buying Porsche
– Asda buying Netto (food supermarkets)
– Amazon buying LoveFilm
– Virgin Money buying Northern Rock
– Suntory of Japan paid £1.35bn to buy
GlaxoSmithKline’s drinks brands Lucozade & Ribena
Horizontal Integration

26. Recent Examples of Horizontal Integration
• Dec 2015: Domino's buys largest German pizza chain in
$86m deal
• Dec 2015: US chemical giants DuPont and Dow Chemical Co
agree to merge in deal valuing combined company at £86bn,
with plans to split into three.
• Nov 2015: Pfizer's $150bn purchase of of Dublin-based
Allergan (the manufacturer of Botox products)
• Nov 2015: Marriott agrees $12bn merger with Sheraton
hotels owner to create one of world’s biggest hotel chains
• Nov 2015: AB InBev's £71bn bid for SABMiller
• Nov 2015: AstraZeneca agrees $2.7bn deal for US biotech
firm ZS Pharma
• 2015: Horizontal mergers in the betting industry: Ladbrokes
and Gala Coral, Betfair and Paddy Power and GVC and
Bwin.party

27. 1. Exploit internal economies of scale
2. Cost savings from the rationalization of the
business – often this involves big job losses
3. Potential to secure revenue “synergies”
4. Wider range of products - (i.e. diversification) –
creates opportunities for economies of scope
5. Reduces competition by removing key rivals –
this increases market share and pricing power
6. Buying a existing and well-known brand can be
cheaper than growing a brand – this can then
make the entry barriers higher for new rivals
Horizontal Integration - Advantages

28. Horizontal Integration – UK Cinemas
879
813
780
264
167
82
62
58
39
35
23
23
21
663
0 100 200 300 400 500 600 700 800 900 1000
Odeon
Cineworld
Vue
National Amusements
Empire Cinemas
Omniplex
Reel Cinemas
Cineworld/Picturehouse
Movie House Cinemas
Merlin Cinemas
Everyman Media Group
Light Cinemas
Curzon Cinemas
Others (19 major exhibitors and 290…
Screens

29. • Vertical integration is acquiring a business in the
same industry but at different stage of the
supply chain
• The merger of two firms at a different stage of
the same industry or process of production or
same final product
1. Forward vertical: Closer to the consumers e.g. a
manufacturer buying a retailer
2. Backward vertical: Closer to the raw materials in
the supply chain e.g. a manufacturer buying a raw
material supplier
Vertical Integration

30. • Film distributors owning cinemas + digital streaming
platforms
• Brewers owning/operating pubs (forward vertical)
or buying hop farms (backward vertical)
• Record labels and radio / online music stations
• Drinks manufacturers integrating with bottling
plants
• Pig processing business buying a pig farm
• Technology companies growing vertically through
hardware, software and services
– PayPal, acquired by eBay for $1.5bn in 2002
– Google buying Motorola, a phone maker
Vertical Integration - Examples

31. Recent Examples of Vertical Integration
• Nov 2015: Apple buys Star Wars motion-capture
company Faceshift
• Nov 2015: Ikea Buys Romanian, Baltic Forests to Control
Its Raw Materials
• Oct 2015: Oct 2015: Dell makes $67bn bet on EMC in
tech history's largest acquisition. US computer giant Dell
agrees to buy data storage company EMC
• Sept 2015: (Wholesaler) Booker given green light for
takeover deal worth £40m of Budgens and Londis
grocery chains

32. 1. Control of the supply chain – this helps to
reduce unit costs and improve the quality of
inputs into the production process
2. Improved access to key raw materials perhaps
at the expense of rival businesses (example?)
3. Better control over retail distribution channels +
adding new channels to your sales platforms
4. Removing suppliers and market intelligence
from competitors which then helps to make a
market less contestable (increases market
power)
Vertical Integration - Advantages

33. Conglomerates
• A conglomerate has a
large number of
diversified businesses.
• The world’ s biggest
conglomerates include
businesses such as
General Electric and
3M in the United States
and Siemens from
Germany
• Another is Samsung –
the electronics giant
also makes military
hardware, apartments,
ships and Samsung also
operates a Korean
amusement park!
253.5
107.1
105.1
97.7
81.6
60.1
59.8
50.3
47.6
43.2
27.7
21.2
20
17.9
16
0 50 100 150 200 250 300
General Electric (U.S.)
United Technologies (U.S.)
3M (U.S.)
Siemens (Germany)
Honeywell International (U.S.)
Danaher (U.S.)
Hutchison Whampoa (Hong Kong)
ABB (Switzerland)
CK Hutchison (Hong Kong)
Jardine Matheson (Hong Kong)
Philips (Netherlands)
Itaúsa (Brazil)
Swire Pacific (Hong Kong)
Ingersoll-Rand (Ireland)
Sime Darby (Malaysia)
Market value in billion U.S. dollars
World's largest conglomerates as of April 6, 2015, based on market
value (in billion U.S. dollars)

34. Why do many mergers/takeovers fail?
1. Huge financial costs of funding takeovers including deals that have relied
heavily on loan finance - this leaves a big debt overhang after the deal
2. Integrating systems – companies might have very different technology
systems that are expensive or impossible to marry e.g. eBay & Skype
3. Share price: The need to raise fresh equity through a rights issue to fund
a deal which can have a negative impact on a company's share price
4. Many mergers fail to enhance shareholder value because of clashes of
corporate cultures, priorities and personalities
5. The enlarged business may suffer a loss of customers and skilled workers
post acquisition
6. Paying too much: With the benefit of hindsight we see the ‘winners
curse’ - i.e. companies paying over the odds to take control of a business
7. Bad timing – mergers and takeovers that take place towards the end of a
sustained boom can often turn out to be damaging for both businesses.

35. • High cost involved in
the final acquisition
• Problems of valuation
• Clash of cultures
• Upset customers
• Problems of integration
(change management)
• Resistance from
employees
• Loss of good
employees
• Non-existent synergy
• Incompatibility of
management styles,
structures and culture
• Questionable motives
• Diseconomies of scale
Factors Behind Many Failed Mergers
The accepted data says that most mergers and acquisitions don’t work out. It is estimated
that the range for failure of mergers and takeovers is between 50% and 80%.

36. Factors behind survival of small firms
• The median profit of small & medium sized enterprises in the UK in
2014 was £8,000. Yet many small businesses survive and grow.
1. Many smaller businesses act as a supplier / sub-contractor to much
larger enterprises e.g. in the construction industry
2. They might take advantage of a low price elasticity of demand and high
income-elasticity for specialist ‘niche’ products which can be sold at a
higher price and with a bigger profit margin
3. Smaller businesses can avoid diseconomies of scale
4. Many smaller businesses run as lifestyle enterprises, their owners are
looking to achieve a satisfactory return rather than maximum profits
5. Small-scale businesses are often more innovative, flexible and nimble in
responding to changes in market demand conditions
6. Small businesses have benefitted from the rising percentage of
consumers willing to buy online – the barriers to entry in the market
have come down because of digital technology (e.g. tech start-ups)

37. Activist Shareholders
• Activist shareholders look to put intense pressure on existing
management or force through changes to management boards.
• Some insist on businesses using profits to buy-back shares to
increase returns to existing shareholders.
• An activist shareholder uses an equity stake to put pressure on its
existing management.
• The goals of activist shareholders range from financial (e.g.
increase of shareholder value through changes in dividend
decisions, plans for cost cutting or investment projects etc.) to
non-financial (e.g. dis-investment from particular countries with a
poor human rights record, or pressuring a business to speed up
the adoption of environmentally friendly policies and build a
better reputation for ethical behaviour, etc.)

38. • Joint ventures occur when businesses join
together to pursue a common project
• The businesses remain separate in legal terms
• Joint ventures are becoming common as firms
want to benefit from collaborative work in
reaching a mutually-agreed strategic target.
• An example might be joint-research projects to
share the fixed costs
Joint Ventures

39. • Vodafone & Telefónica agreed to share their mobile network
• BMW and Toyota co-operate on research into hydrogen fuel
cells, vehicle electrification and ultra- lightweight materials
• West Coast – joint venture between Virgin Rail & Stagecoach
• Google and NASA developing Google Earth
• Hollywood studios combining to fight internet piracy
• Alliances in airline industry e.g. Star Alliance and One World
• Renault-Nissan
• Docklands-Light Railway - a joint venture between French
transport group Keolis and infrastructure services provider
Amey, part of Spanish multinational Ferrovial.
Joint Ventures – Recent Examples

40. • When a firm decides to split into separate firms
• Some of the key motivations for de-merger include:
1. Focusing on core businesses to streamline costs and improve
profit margins
2. Reduce the risk of diseconomies of scale and diseconomies of
scope by reducing the range of functions in a business, and
achieve lower management costs
3. Raise money from asset sales and return to shareholders
4. A defensive tactic to avoid the attention of the competition
authorities who might be investigating possible monopoly
power in an industry / market
De-Mergers

41. • Fosters Group de-merging its two main operating divisions –
one focusing on beer, the other on wine
• US food giant Sara Lee sold off coffee business Douwe Egberts
• Qantas demerged their airline business and run stand-alone
domestic and international airline businesses
• News International demerged Film/TV & Publishing businesses
• Demerger of Clydesdale and Yorkshire banks
• Pfizer sold their infant nutrition business to Nestle
• Severn Trent Water demerged waste management Biffa
• PepsiCo demerged their food and drinks business by creating
Yum Brands (which owns KFC, Pizza Hut and Taco Bell)
• In 2015 Yum Brands announced a demerger to create two
separate businesses: Yum China and Yum Brands
De-Mergers – Recent Examples

42. News International DemergerFilmandTV
• Fox News
• 20th Century Fox
• Sky
• Fox Television
Publishing
• Dow Jones
• Wall Street Journal
• New York Post
• The Times
• The Sun
• Harper Collins

43. Why and how do firms grow?
Topic 3.3.2