Growth and Profitability

Growth and a firms long-run average costs

Growth Strategy

shape of the LRAC curve minimum efficient scale

Demand considerations
nature of the product possibilities for diversification

Relationship between growth & profitability

how growth depends on profitability how growth affects profitability

Q When compared to a profit-maximising firm, a growth maximising firm is likely to have

A. B. C.

Constraints on Growth
Financial considerations
internal sources of finance borrowing share issue

a lower level of advertising. a lower equilibrium output. a higher price elasticity of demand at the equilibrium output. a lower price relative to average cost. a lower level of investment.
A. B. C. D. E.
20% 20% 20% 20% 20%

Shareholder confidence
problem of retaining large proportion of profits excessive borrowing the takeover constraint share performance

D.

the valuation ratio

E.

Q Which of the following ways of financing growth is likely to result in reduced dividend payments in the short run?
20% 20% 20% 20% 20%

Constraints on Growth
Demand conditions
importance of market demand importance of promoting demand for the firm's product and

A. B. C. D. E.

Retained profits A new issue of shares Borrowing

increasing market share

Managerial conditions

A and B A, B and C

the composition of the managerial team management structure

A.

B.

C.

D.

E.

Alternative growth strategies

Alternative Growth Strategies

GROWTH OF A FIRM

Growth by internal expansion product differentiation vertical integration diversification Growth by external expansion types of external expansion
mergers and takeovers strategic alliances

Internal expansion

External expansion
Strategic alliances (1) Horizontal alliances
Informal or contractual alliance between firms at a technically similar stage of production that may lead to a joint venture

(1) Differentiation
Horizontal expansion (same product, increase in market share)

Mergers and acquisitions (1) Horizontal integration

Mergers and acquisitions between firms at the same stage of production

(2) Vertical integration

Different products, but belonging to different stages of same product

(2) Vertical alliances

Informal or contractual alliance between firms producing at different stages of same process that may lead to a joint venture.

(2) Vertical integration

Mergers and acquisition between firms producing at different stages of same process

horizontal expansion vertical expansion conglomerate expansion

(3) Conglomerate
Diversification - introduction of totally different products

(3) Networks
Informal alliance between firms across sectors and includes the development of supply chain clusters..

(3) Conglomerate
Diversification - merger or acquisition of firms producing totally unrelated products

Q If a car manufacturer merges with a car retailer, this is an example of

20% 20% 20% 20% 20%

Internal growth
Growth by vertical integration Types of vertical integration
backward integration ('upstream' integration) forward integration ('downstream' integration)

A. B. C. D. E.

a vertical merger. a horizontal merger. a conglomerate merger. upstream integration. a network.

Measuring the extent of vertical integration

primary production auxiliary operations

A.

B.

C.

D.

E.

Examples of vertically integrated firms

Internal growth
Why vertically integrate?
greater efficiency

Internal growth
Problems with vertical integration
lack of flexibility risks

production economies co-ordination economies managerial economies financial economies

reduced uncertainty monopoly power barriers to entry

Tapered vertical integration

partial vertical integration advantages

better cost information more leverage over suppliers smaller capital outlay
disadvantages

possible lack of economies of scale

Growth through Diversification

Growth through diversification Directions of diversification
using existing technological base & market area using existing technological base & new markets using new technological base & existing market using new technological base & new markets

Q Which of the following is NOT an argument for a brewer to diversify into crisps manufacture?
A.

It can achieve sales growth. It can use a common distribution network. It spreads risks. It can share production technology. It can increase its profits.

20%

20%

20%

20%

20%

B.

C. D.

Why diversify?
stability maintaining profitability growth

E.

A.

B.

C.

D.

E.

External Growth through Merger

Mergers and takeovers
distinction between mergers and takeovers

External Growth through Merger

Motives for mergers and takeovers (cont.)
opportunities other motives

Motives for mergers and takeovers

growth economies of scale monopoly power increased market valuation reduced uncertainty

to avoid being taken over White Knight strategy asset stripping empire building geographical expansion

Mergers and acquisitions by target

(deals valued at over $1 million)
5000 4500 4000 3500 billions 3000 2500 20 2000 15 1500 1000 500 0 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
Source: Mergers &Acquisitions Note (European Commission, DG ECFIN, April 2006)

Mergers and acquisitions by target

(deals valued at over $1 million)
45 5000 40 35 Number of deals (000s) 30 25 4500 4000 3500 billions 3000 2500 20 2000 15 1500 1000 500 0 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
Source: Mergers &Acquisitions Note (European Commission, DG ECFIN, April 2006)

Value: rest of world Value: USA Value: EU-25 Number worldwide

Value: rest of world Value: USA Value: EU-25 Number worldwide

45 40 35 30 25 Number of deals (000s)

10 5 0

10 5 0

Mergers and acquisitions by target region (% of total number)

60
1990-3 2000-3

Mergers and acquisitions by target region (% of total number)

60
1990-3 2000-3

50

50

Percentage of total

30

Percentage of total
N. America EU-15 Rest of Europe Asia Rest of world

40

40

30

20

20

10

10

0
Source: Mergers &Acquisitions Note (European Commission, DG ECFIN, October 2004)

0
N. America EU-15 Rest of Europe Asia Rest of world
Source: Mergers &Acquisitions Note (European Commission, DG ECFIN, October 2004)

Mergers and acquisitions by target region (% of total number)

60
1990-3 2000-3

50

Q Which one of the following results of a merger is most likely to be against the interests of consumers?
20% 20% 20% 20% 20%

A.
Percentage of total 40

Economies of scale. Increased revenue. Increased market power. Increased market value. Reduce uncertainty.

B.
30

C. D. E.

20

10

0
N. America EU-15 Rest of Europe Asia Rest of world
Source: Mergers &Acquisitions Note (European Commission, DG ECFIN, October 2004)

A.

B.

C.

D.

E.

External Growth through Strategic Alliance

Types of strategic alliance
horizontal
34.2%

Airline strategic alliances

Air Canada, Air New Zealand, AeroMexico, Air France / KLM, Alitalia, Continental, Czech Airlines, Delta, Korean Air Northwest Airlines, (Malaysia Airlines) ANA, Asiana Airlines, Austrian, bmi, Lot, Lufthansa, Scandinavian Airlines, Singapore Airlines, Spanair, TAP Portugal, Thai Airways, United, US Airways, Varig Aer Lingus, American Airlines, BA, Cathay Pacific, Finnair, Iberia, LanChile, Qantas, (JAL, Royal Jordanian, Malev)

36.6%

franchising licensing
vertical

consortia contractual arrangements outsourcing / subcontracting

networks

Figures show percentages of total alliance passenger numbers (2006) Airlines in brackets were applicants for Skyteam membership in 2006

multi-firm alliances across sectors

29.1% Star Alliance Oneworld

External Growth through Strategic Alliance

Why form strategic alliances?
new markets risk sharing capital pooling

External Growth: Transactions Costs

Transactions costs when firms deal with other firms through markets these costs can be high when there are:
large sunk costs high level of transactions between the firms information asymmetries between the firms

reliance on contracts
problem of moral hazard

Incentive for merger or alliance to reduce these

transactions costs

Q Which of the following would be likely to reduce transactions costs?

20% 20% 20% 20% 20%

A. B. C.

A vertical merger. A horizontal merger. Long-term contracts with suppliers. Greater asymmetry of information. Increased outsourcing.
A. B. C. D. E.

D.

E.