External (Inorganic) Business Growth (Edexcel GCSE Business)

External (Inorganic) Business Growth

• Firms will often grow organically to the point where they are in a financial position to integrate (merge or takeover) with others

  • Integration in the form of mergers or takeovers results in rapid business growth and is referred to as external or  inorganic growth

• 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 pursue mergers and takeovers

  1. 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

  2. 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) 

  3. Synergies
     Synergies are the benefits that result from the combination of two or more companies, such as increased revenue, cost savings, or improved product offerings

  4. 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

  5. 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 stock prices

Types of External (Inorganic) Growth

• Inorganic growth usually takes place when firms merge in one of two ways

  • Vertical integration (forward or backwards)

  • Horizontal integration

A diagram that illustrates how a firm can grow through forward or backward vertical integration

• Forward vertical integration involves a merger or takeover with a firm further forward in the supply chain

  • E.g. A dairy farmer merges with an ice cream manufacturer

• Backward vertical integration involves a merger/takeover with a firm further backwards in the supply chain

  • E.g. An ice cream retailer takes over an ice cream manufacturer

An Explanation of the Advantages & Disadvantages of Each Type of Growth