External Growth

Key Terms
External Growth: When firms join together either through merger or aquisition.

Merger: When businesses agree to join together.

Aquisition: Where one firm takes control of another by buying at least 51% of shares.
Theory

What is External Growth?


External growth occurs when a company increases its sales and profits by buying other companies, rather than from its own operations.


Four main types of merger

1) Horizontal integration

Where two firms at the same stage of production combine e.g. two brewery’s combining


2) Vertical integration

Where firms at different stages of production combine:

Vertical backward: Where a firm combines with a firm in previous process E.g. Brewery integrating with hop growers

Vertical forward: Where a firm combines with firm in the next process e.g. Brewery taking over public house


3) Conglomerate merger

Where two firms with no obvious connection combine in order to:

  • Satisfy managerial ambitions

  • Diversify

    • Example: Brewery merging with a graphics design company


    4) Lateral merger

    A particular type of horizontal integration in that there is some similarities between businesses. Example: Google merging with YouTube.
    Advantages of External Growth
    1) Increase in capital

    Aquisition of other firms will lead to an increase in capital equipment. This may results in the exploitation of technical economies of scale. In turn this may result in:

  • Lower costs for consumers

  • Increased returns to shareholders


    • 2) External growth is rapid

    Takeovers and mergers are rapid in comparison to internal growth.


    3) Cheaper to buy firm than undertake investment

    In many cases external growth is cheaper than internal growth as it only requires the initial purchase of another firm, where as internal growth requires long-term investment.


    4) Acquisition of Brands

    The takeover of rival firms also involves the aquisition of brands thus ensuring the loyalty of consumers.
    Disadvantages of External Growth
    1) Lack of competition

    The takeover of rival firms will lead to a lack of competition. This could result in private monopoly and inefficiency.


    2) Clashing synergy

    When an aquisition takes place, two firms are moulded into one. Both firms may have very different management styles. This may result in hostility between managers and ultimately a fall in productivity.


    3) Monopsony power

    Mergers may result in a single firm have monopsony power (dominant buying power of labour). This could result in lower wages and lower employment, among other disadvantages.









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