Business Expansion (AQA GCSE Business)

Revision Note

Written by: Lisa Eades

Reasons why Businesses Grow

Many firms start small and go on to grow into large companies or even multi-national corporations (Amazon started in a garage)
Growth can involve a business changing its form of legal ownership
- E.g. A sole trader looking to grow may seek a partner, while a private limited company may pursue flotation to become a public limited company

Reasons why Businesses grow

Some owners have a desire to run a large business and continually seek to grow it	The desire for strong market power (monopoly) over its customers and suppliers	Growth provides opportunities for product diversification
Shareholders demand higher levels of market share and profitability	The desire to reduce costs by benefiting from lower unit costs as output increases e.g suppliers offer bulk order discounts	Larger firms often have easier access to finance

In some cases, a business may look to become smaller
- Retrenchment involves a business scaling down its operations as it evolves and can involve
  - Reducing the size of the workforce
  - Closing less profitable outlets
  - Exiting existing markets
- Retrenchment can help a business reduce costs and is particularly relevant for businesses whose objective is to survive

Organic Growth

Business growth can be achieved by growing organically, or inorganically (mergers and takeovers)

Organic growth is driven by internal expansion using reinvested profits or loans
- Organic growth is usually achieved by
  - Gaining a greater market share
  - Product diversification
  - Opening new outlets
  - Franchising
  - Outsourcing production to other trusted businesses
  - International expansion (new markets)
  - Investing in new technology/production machinery
  - Using e-commerce

Examples of Organic Growth

Business	Example
Apple	International Expansion (new markets) Apple expanded into new markets by opening its stores in new countries, such as China and India, and by partnering with telecom providers to sell its products. This helped them to increase their market share, sales revenue and profitability
Google	Product Innovation Google introduced new products, such as Google Drive and Google Maps, to complement its search engine and advertising businesses. This helped them to increase their market penetration, sales revenue and profitability
Disney	Product Diversification Disney has diversified into several areas, such as theme parks, cruise lines, television networks, and movie studios. Their brand strength has helped them achieve sales growth in each of these markets, resulting in higher sales revenue and profitability

Product diversification opens up new revenue streams for a business
- Firms may spend money on research and development, or innovation to existing products to help create a new revenue stream
Franchising is a method of organic growth where a business sells the rights to operate its business model, including its branding, to business owners called franchisees
- Brand recognition can grow quickly, as franchisees take on the responsibilities and financial risks of opening and operating new outlets
- Business income is generated from the payment of an initial lump sum plus ongoing fees
- The franchisee operates the business under the franchisor's established system and usually receives training, marketing support, and ongoing assistance
  - Examples of businesses that have achieved growth through franchising include Domino's Pizza, KFC and Burger King
- The disadvantages of franchising as a method of growth include
  - The franchisor loses some control over the operation of branded outlets
  - Should one franchisee fail to meet customer expectations of the brand, the whole business can be negatively affected
- Increasingly, businesses use e-commerce to sell greater volumes of goods and services without the need to operate or expand physical stores
  - E-commerce can provide access to a large number of customers, potentially on a global scale
  - However, it must establish effective means of distribution to avoid customer dissatisfaction

Advantages & Disadvantages of Internal (Organic) Growth

Advantages	Disadvantages
The pace of growth tends to be relatively manageable It is less risky as growth is financed by profits and there is existing business expertise in the industry Managers know and fully understand every part of the business	The pace of growth can be slow and frustrating for ambitious entrepreneurs Organic growth is less likely to lead to lower unit costs, such as bulk purchasing discounts from suppliers, as larger firms could negotiate better deals A lack of finance may limit growth

Inorganic (External) Growth

Inorganic (external) growth involves integrating with one or more other businesses through mergers or takeovers
- A merger occurs when two or more companies combine to form a new company
  - The original companies cease to exist and their assets and liabilities are transferred to the newly created entity
- A takeover occurs 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
There are several reasons why companies may choose to grow through mergers or takeovers

Diagram: Reasons for Takeovers and Mergers

Businesses integrate with other businesses for a range of reasons, including synergies, lowering costs and strategic fit

Strategic fit
- A company may acquire another company to expand into new markets, diversify its product offerings, or gain access to new technology
- E.g. in 2010 Kraft Foods purchased Cadbury's to increase its product offering and expand business sales in the United Kingdom
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 banks on loans
Synergies
- Synergies are the benefits that result from the combination of two or more companies
- E.g. 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
- E.g. Meta, the parent company of Facebook purchased WhatsApp in 2014 and continued to run the messaging service alongside their own Facebook Messenger
Shareholder value
- Mergers and takeovers can also be used to create value for shareholders
- By combining companies, shareholders can benefit from increased profits, dividends and higher share prices

Types of Inorganic Growth

Businesses join together in one of three ways
- Vertical integration
- Horizontal integration
- Conglomerate integration
Vertical integration involves a business merging with or taking over another firm in the supply chain or at a different stage of the production process

Diagram: Vertical Integration

3-1-2-how-businesses-grow_edexcel-al-economics

A business can grow by integrating with another firm in the supply chain or at a different stage of the production process

Forward vertical integration involves a merger or takeover with a business further forward in the supply chain
- E.g. A dairy farmer merges with an ice cream manufacturer
Backward vertical integration involves a merger or takeover with a business further backwards in the supply chain
- E.g. An ice cream retailer takes over an ice cream manufacturer

Advantages & Disadvantages of Vertical Integration

Advantages	Disadvantages
Reduces the cost of production as middleman profits are eliminated, which increases competitiveness Greater control over the supply chain reduces risk as access to quality raw materials and components is more certain Forward integration adds additional profit as the profits from the next stage of production are assimilated Forward integration can increase brand visibility	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

Horizontal integration involves a business merging with or taking over a business at the same stage of the production process
- E.g An ice cream manufacturer buys another ice cream manufacturer

Advantages & Disadvantages of Horizontal Integration

Advantages	Disadvantages
Taking over a rival reduces competition and can lead to a rapid increase of market share The cost per unit can fall as a result of being able to buy in greater bulk Existing knowledge of the industry means the merger is likely to be successful The firm may gain new intellectual property , knowledge or expertise, leading to process improvements	Unit costs may increase due to the duplication of management roles, machinery and production premises There can be a culture clash between the two firms that have merged, leading to inefficiency A business may have to withdraw some well-known brands to avoid internal competition

Conglomerate Integration involves a business taking over or merging with an other, unrelated, business
- Businesses use this type of integration to spread risk across more than one market
- E.g. Online retailer Amazon's takeover of Whole Foods supermarket in 2017 is an example of conglomerate integration, as Amazon had no presence in the grocery market before this time

Benefits & Drawbacks of Expansion

Business expansion has a number of benefits and drawbacks

Benefits & Drawbacks of Expansion

Benefits	Drawbacks
Increased business recognition and status This can be satisfying for business owners and staff who have led its growth It may be easier for a well-known business to attract highly qualified staff and launch new products Greater market power Larger businesses are in a good position to persuade retailers to stock their products They may be able to charge higher prices for their recognised brands They are less likely to be taken over by rivals They can benefit from lower unit costs Unit costs fall as a result of being able to buy stock in greater bulk, employ experienced managers and install more efficient machinery	Loss of control Its founders may lose some control over the business, as growth often involves sharing ownership with others, e.g. shareholders Maintaining control and communication Keeping track of the operations of a larger business is likely to be difficult, as the organisational structure will be more complex Making decisions Decision making may slow as a result of managers and employees being spread across more locations and increased layers of hierarchy If growth is too fast, it could lead to overtrading, where a business does not have enough cash to fund its operations and risks failure

Benefits

Drawbacks

Increased business recognition and status
- This can be satisfying for business owners and staff who have led its growth
- It may be easier for a well-known business to attract highly qualified staff and launch new products
Greater market power
- Larger businesses are in a good position to persuade retailers to stock their products
- They may be able to charge higher prices for their recognised brands
- They are less likely to be taken over by rivals
They can benefit from lower unit costs
- Unit costs fall as a result of being able to buy stock in greater bulk, employ experienced managers and install more efficient machinery

Loss of control
- Its founders may lose some control over the business, as growth often involves sharing ownership with others, e.g. shareholders
Maintaining control and communication
- Keeping track of the operations of a larger business is likely to be difficult, as the organisational structure will be more complex
Making decisions
- Decision making may slow as a result of managers and employees being spread across more locations and increased layers of hierarchy
If growth is too fast, it could lead to overtrading, where a business does not have enough cash to fund its operations and risks failure

Examiner Tips and Tricks

In the exam, you could be asked to recommend whether a business should take over or merge with another. To achieve top marks in these 9-mark questions, you need to make sure your answer:

Has a sustained line of reasoning, which weighs up both sides of the argument
Is coherent and relevant, making use of the question stem
Is substantiated, with suitable references made to the business context
Has a focused conclusion that fully answers the question

Last updated: 23 April 2024

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