Chapter-11

Methods of development
What is growth?
An organization’s growth may be expressed in a number of ways, for example:
 Sales revenue (a growth in the number of markets served)
 Profitability (in absolute terms, and as a return on capital)
 Number of goods/services sold
 Number of outlets/sites
 Number of employees
 Number of countries

Growth may be achieved by a number of mechanisms:

 Develop the business from scratch
 Acquire or merge with an already existing business
 Co-operate in some way with another firm

The main issues involved in choosing a method of growth are these:

 A firm may not be able to go it alone, or it may have plenty of resources to invest
 Two different businesses might have complementary skills
 Does a firm need to move fast?
 A firm might wish to retain control of a product or process
 Is there a potential acquisition target or joint venture partner with compatible people
and organization culture?
 Risk: A firm may either increase or reduce the level of risk to which it is subject

Expansion method

Lynch summarized possible expansion methods in the matrix below:

Company
New
location Internal development External development

Joint venture
Internal Merger
Home country domestic Acquisition
development Alliance
Franchise/license
Exporting Joint venture
Overseas office Merger
Abroad Overseas manufacture Acquisition
Multinational operation Alliance
Global operation Franchise/license
Organic growth: Expansion of a firm's size, profits, activities achieved without taking over
other firms.

Benefits Drawbacks
 Process of developing  Intensify competition
 Genuine technological innovations  Slow
 No suitable target for acquisition  Not gain access to the knowledge and
 Current resources systems
 Style of management  Lack economies of scale/experience
 Hidden or unforeseen losses effects
 Career development  Prohibitive barriers to entry in new
 Cheaper markets
 Less risky

Reasons for overseas expansion

Some of the reason’s management cites for expanding overseas are the following:
 Chance
 Life cycle
 Competition
 Reduce dependence
 Economies of scale
 Variable quality
 Finance
 Familial
 Aid agencies

Involvement overseas
Reasons supporting involvement Reasons for avoiding involvement
overseas
 Profit margins  Control
 Sales volume  Adaptations
 Product life cycle  Cost effective
 Seasonal fluctuations  Opportunity costs
 Disposing of excess production  Anti-dumping duties
 Spread the risk
 Obsolescent products
 Global image

Issues for management to consider in internal expansion or involvement

Strategic issues Tactical issues
 Acceptable financial return  Understand customers' needs and
 Company's overall mission and preferences in foreign markets
objectives  Conduct business abroad, and deal
 Resources effectively with potential partners
 Risk profile there
  Method of entry  Foreign regulations and associated
hidden costs
 Management skills and experience

Mergers and acquisitions

A merger is the joining of two separate companies to form a single company.
An acquisition is the purchase of a controlling interest in another company.

Classic reasons for mergers/acquisitions:

 Marketing advantages
 Production advantages
 Finance and management
 Risk-spreading
 Retain independence
 Overcome barriers to entry
 Outplay rivals

The acquirer should attempt an evaluation of the following:

 The prospects of technological change in the industry
 The size and strength of competitors
 The reaction of competitors to an acquisition
 The likelihood of government intervention and legislation
 The state of the industry and its long-term prospects
 The amount of synergy obtainable from the merger or acquisition

Porter's attractiveness tests

An acquisition at a bargain price is unlikely to make up for a long-run lack of profits due to a
flawed industry structure. For reasons of cost, the ideal acquisition is in an industry not yet
attractive but capable of being made attractive.

Porter proposes two tests:

The 'cost of entry' test: Unfortunately, attractive industries tend to have high costs of entry.
Premiums likely to be paid for the acquisition of companies are an important consideration.

The 'better off' test: The acquisition must do something for shareholders that they cannot do
for themselves. Diversification for its own sake will not increase shareholder wealth. Asset
stripping brings only one-off benefits and is not a sound basis for long-run investment.

Diversification
Diversification means a change of both products and markets from the company’s present base.
The reason of diversifications are the followings:
 Objectives can go no longer be met without diversification
 The firm has more cash than it needs for expansion
 Firms may diversify even id their objectives are being or could be met within their
industry
Synergy: The benefits gained from two or more businesses combining that would not have been
available to each independently. Sometimes expressed as the 2 + 2 = 5 effect. Synergy arises
because of complementary resources which are compatible with the products or markets being
developed and is often realized by transferring skills or sharing activities.

Synergies arise from four sources:

 Marketing and sales synergies
 Operating synergies
 Financial synergies
 Management synergies

Joint ventures, alliances and franchising

The following factors should be considered in choosing business partners for joint ventures,
alliances and franchising.
 Drivers
 Partners
 Facilitators
 Components
 Effectiveness
 Market-orientation

Consortia: Organisations that co-operate on specific business prospects. Airbus is an example, a

consortium including British Aerospace, Dasa, Aerospatiale and Casa.
Joint ventures: Two or more organisations set up a third organisation or co-operate in some
other structured manner to share control. This is very common in entering normally closed
markets. For example, Jardine Matheson (historically based in Hong Kong, from where it derives
much of its profits, but now registered in Bermuda with shares traded in Singapore) has a joint
venture with Robert Fleming the UK merchant bank, in the firm Jardine Fleming, which amongst
other things, is involved in securities trading.
A joint venture: is a contractual arrangement whereby two or more parties undertake an
economic activity which is subject to joint control.
Franchising is a method of expanding the business on less capital than would otherwise be
possible. Franchisers include IKEA, McDonald's, Starbucks and Pizza Hut.
A license grants a third-party organization the rights to exploit an asset belonging to the
licensor.
Agency arrangements
These can be used as the distribution channel where local knowledge and contacts are
important, e.g. exporting. The agreements may be restricted to marketing and product support.
Other situations where agents are used include:
 Sales of cosmetics (Avon)
 Holidays
 Financial services, e.g. insurance
The main problem for the company is that it is cut off from direct contact with the customer.

Case 1: Ponda Ltd

Ponda Ltd is the second largest vehicle manufacturing firm in Europe. The board was recently
concerned about the lack of 'infant' products in the firm's portfolio, and so decided to launch an
electric car – the Greencar. Early research has shown that the demand is expected to be much
higher in the US market than in the European market. This is at least partially due to the well
publicised failure of a similar vehicle in Europe launched in the 1970s, having a top speed of
only 30 mph and requiring recharges at the rate of at least three per hour.

For the initial trial launch Ponda has decided to distribute the car using the American dealer
Envirofriend Inc. The firm was keen to participate in the venture to bolster its environmental
credentials in the market. If the launch proves to be successful, the arrangement will be
reviewed. If the new product proves to be as popular as the board of Ponda hopes, it may be
necessary to enlist additional distribution networks. However, the managing director has
assured Envirofriend that the networks will include Envirofriend (so long as the Greencar
continues to be sold in American markets).

Ponda had originally wanted to invoice Envirofriend in sterling, but reluctantly agreed to do so
in dollars, on the understanding that all the cars would be paid for, whether sold or not.
Envirofriend accepted this risk, as the car's remarkable technical properties were expected to
result in near certain sales (according to research).

If the car is popular in the initial market, Ponda has decided to penetrate the mass market as
quickly and efficiently as possible by setting up a manufacturing subsidiary in the US. It has
never been the intention of the firm to distribute its own products; Ponda will continue to do so
via third parties. Franchising is currently being considered as part of the distribution mix.

Ponda's strategic planning department has investigated the possible effect of US Government
policy on the Greencar venture. You have been given a rough draft of the research.

(1) It is likely that indigenous firms will be awarded preferential taxation treatment, such as
100% tax depreciation, on research-related expenditure.
(2) Government grants for the purchase of the robotic machinery required for the manufacture
of the electric cars are to be awarded to firms buying from US companies.
(3) Legislation is currently being planned to increase redundancy payments required in the hi-
tech manufacturing industries. It is felt that this may lead to firms investigating ways in which
to utilise their spare capacity.
(4) Unfortunately for Ponda the potential competitors are all government suppliers.
(5) The regulatory bodies in the US are likely to bring severe pressure to bear on Ponda –
particularly with regard to price and environmental performance indicators.
(6) The Government has already decided to buy a large number of electric motorbikes for the
state education sector, to provide free transport to children from low income families (as an
alternative to public transport). The scheme has proved extremely popular in rural areas. The
US supplier has profited considerably from the deal, and is considering diversification into
related areas.
(7) Import tariffs are to be levied on all 'environmental' goods manufactured by firms which are
not resident in the US.
(8) A network of 'recharging points' is to be set up by the US Government, designed for use by
all types of 'electric vehicle'. The government is keen to set up the system as quickly as possible,
and is therefore planning to develop a system ensuring compatibility with the first firm offering
marketable vehicles.
(9) Output tax is to be levied on petrol, but not on electricity obtained from the 'recharging
network'.
Apart from political research Ponda has also commissioned research into the environmental
movement in the US. There is a board consensus in favour of electrically-powered vehicles,
particularly in urban areas. The main lobby against such products argues that the switch from
petrol engines to electrical engines merely transfers the pollution problem from the car to the
power station. Ponda is finding it difficult to judge which lobby will win the greater support in
the long term.
The technology associated with the Greencar is far superior to that developed by other
manufacturers to date: the electric car is no longer the poor relation of the petrol car. In fact, the
Greencar has consistently outperformed its 'petrol using' rivals in respect of
 Miles per $ of 'fuel'
 Top speeds
 Quietness inside the car
 Reliability of the engine
 Servicing frequency required
 Environmental pollution
Ponda is concerned about the expected speed of competitive reaction if the car causes the
revolution in the industry which its performance specification would merit. Unfortunately, a
patent could not be obtained for the design, so Ponda is expecting its rivals to introduce
'copycat' versions a year or so after the initial launch. One strategy, currently under serious
consideration, would be to sell the manufacturing technology to allow production of the
Greencar under licence. In any case the directors are sure of the need to establish a strong brand
image as quickly as possible, so that the generic product – the electric car – becomes strongly
identified in the mind of the consumer with the brand name Greencar, rather as the generic
product 'vacuum cleaner' is strongly associated with the brand 'Hoover'.

Requirement
Write a memorandum to the managing director of Ponda concerning the strategic aspects of the
Greencar project.
Your memorandum should include the following.
 US Government policy
 A discussion on whether the manufacturing plant should be constructed by Ponda or
acquired or whether manufacturing should be licensed.
 Consideration of the appropriateness of franchising as a distribution strategy for the
Greencar.

Case-2: Kultivator Ltd

Kultivator Ltd was founded ten years ago by Jamie Dimmock and Charlie Oliver, when they
opened their first garden centre in Hampshire. Since then the business has grown, both
organically and through the acquisition of other privately-owned businesses. The largest
acquisition took place in the year ended 31 July 20Y0, following an injection of capital by a small
number of institutional investors, who now own 15 per cent of the company's share capital. As a
result, Kultivator Ltd currently operates a chain of 25 garden centres across the south of
England, employing 1,250 staff. In order to expand further, it is now considering raising more
capital, either through borrowing or by floating on the London Stock Exchange to obtain a full
listing.

The industry backgrounds

Over the past fifteen years a growing proportion of consumer spending in the UK has been
devoted to gardening. This has been matched by a rapid growth in the number of garden centres
and an increasing number of TV programmes and 'lifestyle' magazines dedicated to the pastime.
Today, two out of three people in Britain admit to gardening as a hobby, which makes it the
country's most popular pastime, and the industry now employs 60,000 people.

Most garden centres are privately-owned businesses, usually operating from one site.
Frequently they buy in bedding plants and specialist services, sometimes franchising retailers to
offer particular services (e.g. mower repairs and garden equipment sales; garden furniture;
fencing; greenhouses and huts; fountains and water garden facilities; etc). Others have
developed expertise in growing certain types of plants and trees, which has enabled them in
part to capture a niche in the market and partially integrate their production activities into one
or more retailing outlets.

Despite the rapid growth in this part of the consumer market, amongst large companies only a
few DIY chains have ventured into the field. A major inhibiting factor appears to have been the
general lack of horticultural skills amongst potential employees. Such skills, however, are often
possessed by the owners of smaller, locally-based businesses. Some of these – such as Kultivator
Ltd – have been able to expand successfully, either growing organically by opening up new
outlets, or – more usually – by acquiring other ready-made family businesses. This has enabled
them to take advantage of economies of scale in retailing (e.g. in providing deliveries), and their
buying power when dealing with larger specialist suppliers (e.g. of plants and trees and of
garden equipment).

The flotation options

A merchant bank consulted by Kultivator Ltd has estimated the most likely flotation value of the
business would be CU94,200,000. This is based on the estimated 20Y0/20Y1 pre-tax profit
growing at 4 per cent per annum over the next three years and thereafter at 2 per cent per
annum.

The bank has proposed that the company should be floated on The London Stock Exchange. This
means that Jamie Dimmock and Charlie Oliver will together receive over CU20 million for part
of their holding in the business, but still leave them with a controlling interest of 63%.
The views of the owners of Kultivator Ltd
Jamie Dimmock is disappointed with the merchant bank's advice. He believes that it is unduly
pessimistic to assume that the growth rate in pre-tax profits will be as low as 4 per cent per
annum over the next three years, falling thereafter to a mere 2 per cent. After all, in recent years
profits have grown faster than the increase in revenue, reflecting the company's ability to reap
the rewards of economies of scale, while at the same time being able to exercise greater
bargaining power when negotiating with suppliers. He believes that the merchant bank's rather
pessimistic forecasts are based on an unrealistic assumption that the large DIY groups will take
a growing share of the market at the expense of independents such as Kultivator Ltd. Already
they face an effective barrier to entry inasmuch as they are having difficulty in employing skilled
horticulturalists. Customers are increasingly anxious to have appropriate advice, and the
existing well-rewarded staff at Kultivator Ltd have the appropriate expertise. In the
circumstances, he would prefer either to rely on further bank borrowing or to seek advice from
another merchant bank.

Charlie Oliver does not entirely agree. She is not so sure that the barriers to entry facing the
large DIY groups are that high, and anyway she cannot quite see what competitive edge
companies such as Kultivator Ltd have over these groups when it comes to recruiting skilled
personnel. Equally, she would favour growth by pursuing an alternative production strategy
rather than only by expanding retail sales. This could be achieved if Kultivator Ltd were to grow
its own plants and shrubs or sought a tie-up with a nursery or seed merchant. Capital could also
be used to increase holdings of inventories and reduce short-term borrowings, thus
strengthening the company's working capital position.

Requirement
As an assistant to a partner in the firm of accountants which advises Jamie Dimmock and Charlie
Oliver, draft a memorandum for them which deals briefly with the following issues:
 An assessment of how floating the company might affect the objectives of the company,
even though Jamie Dimmock and Charlie Oliver would still control the business.
 The validity of the assumptions which appear to underlie the growth projections
implicit in the merchant bank's calculation of the company's flotation value, dealing in
particular with:
– Barriers to entry and the threat of competition from large DIY groups
– Whether growth should be via vertical integration or horizontal expansion
 Whether organic growth should be preferred to expansion via acquisition.

Note: Ignore taxation.

Solution of case 1: Ponda Ltd

Memorandum
To: The Managing Director, Ponda Ltd
From: F Smith
Date: Today
Subject: The strategic aspects of the Greencar project

Government policy
According to research present policy favours the US firms over foreign competition. Import
tariffs for non-resident companies in the sector, preferential taxation treatment relating to R&D
expenditure, grants to aid the purchase of equipment from US firms, and heavy government
expenditure on Ponda's competitors all mean that Ponda has an inherent disadvantage
compared to the US competition. The extent of the government support is well illustrated by the
government contract to buy electric motorbikes for the state sector. This has resulted in the
supplier making large profits, and thus being able to finance new developments internally,
which may include the production of a Greencar-like product.

The planned legislation concerning increasing the redundancy payments in the high-technology
sector effectively acts as an exit barrier, as firms will incur high costs if they attempt to close
down manufacturing plant. Therefore, excess capacity in the industry is to be expected. Some
firms may use this spare capacity to produce rival products to the Greencar. Alternatively,
Ponda can use this resource to 'contract out' its productions.

The output tax treatment of electricity from the recharging network (at 0%) gives the electric
car product an advantage over its petrol-engine rivals. This is an advantage for the entire
industry, but is most significant for Ponda, which, as the pioneering manufacturer, will be the
first to realise the benefits. Similarly, the government-funded recharging network will prove
advantageous to Ponda, particularly as the technical capability (with Ponda) will inevitably
force Ponda's rivals to alter their designs.

The manufacturing plant

The manufacturing facility, whether acquired or constructed, will only be required if the initial
sales go well. This is expected because of the extraordinary technical specification of the
Greencar. Therefore, given a successful result in the test market, the company should proceed
with a 'fast growth' strategy in order to capture the mass market before the competition has a
chance to enter the market. Ponda could achieve this by
(i) Buying an existing manufacturing firm (bearing in mind that the process of adoption
may be onerous and lengthy)
(ii) Allowing other firms to manufacture the Greencar under licence (essentially a joint
venture)
(iii) Setting up its own plant.

The case in favour of Ponda setting up its own plant is weak: to build up the necessary capacity
quickly by internal means could be difficult. However, the overwhelming case against Ponda
setting up its own plant is found in the US Government policy of favouring US firms. Because of
increased redundancy payment legislation, many suitable firms will have spare capacity that
they are anxious to use. It should be possible to enter into a very favourable joint venture with a
US firm. (It is assumed that if a US firm were taken over by Ponda, it would lose its favoured
position as a US firm.)

Franchising as a possible distribution a strategy

Assuming that the test market is a success, the firm should attempt to reach the mass market as
soon as possible. Assuming that Ponda has arranged sufficient production capacity to achieve
this, distribution networks must be set up quickly. The main choice appears to be between
established dealers and franchisees (since Ponda has expressed an intention not to set up its
own networks). There is an additional constraint: under either scenario Envirofriend must be
included in the distribution mix.

Franchising is an arrangement whereby a company distributes products – usually of a 'famous'

brand type (as Greencar is expected to become). For the privilege the franchisee pays a capital
sum (at the start of the arrangement) plus a stream of royalty payments, dependent on the
success of the franchise.

Franchising would be a suitable component of distribution for Ponda for the following reasons.
 The arrangement typically involves tight control over the marketing elements of the
business such as brand name, unique selling points to employ, in-store promotions, etc.
A unified marketing effort across the outlets is essential for the firm to penetrate the
market, and this is arguably easiest to achieve by franchising.
 The franchisees are strongly motivated to sell a high volume of cars (since their success
depends on it).
 Ponda does not have to invest in any capital (this is provided by the franchisee), thus the
strategy is low risk (for Ponda) if the project fails no capital has been wasted, whereas if
the project succeeds the franchisees suffer (and Ponda is not affected).
 Franchise systems have been associated with a high rate of growth (e.g. McDonald's in
the 1980s)
– ideal for Ponda.

The disadvantages include the following.

 Selection of the franchisees may be difficult (given the new type of products).
 Since the Greencar has no track record, setting the balance between the initial fixed
capital and the variable royalty payments could be difficult.
 The time spent in training the franchisees could result in a drain on resources.
Nevertheless, these disadvantages are not insurmountable, and therefore the
franchising strategy is to be recommended.

Solution of case 2: Kultivator Ltd

Memorandum
To: AN Other & Co
From: Assistant to A Partner, AN Other & Co, Chartered Accountants
Date: Today
Subject: Objectives, assumptions and growth

An assessment of how floating the company might affect the objectives of the entity, even
though the existing majority shareholders would still control the business
Clearly at the present time Jamie Dimmock and Charlie Oliver, as controlling shareholders of
Kultivator Ltd, can run the business in a way which suits their own private objectives.
These might include maximising revenue, expanding the business, and/or maximising their
directors' salaries.
However, as soon as outside shareholders take a stake in the company the interests of Jamie
Dimmock and Charlie Oliver will be constrained to some degree, even if they retain a controlling
stake in the business.
In fact, Jamie Dimmock and Charlie Oliver will almost certainly already be constrained to some
extent, given that institutions have taken a 15% stake in the business.
It is unlikely that they will have done this without having some say in the way in which the
company is managed e.g. by appointing a director to the board. It is also probable that the bank
will also have placed restrictions on the way in which the directors may operate if it has lent
money to the business.
However, in the absence of any contractual constraints, in company law the fact that Jamie
Dimmock and Charlie Oliver would still own more than 50% of the share capital of Kultivator
Ltd would effectively mean that they could do very much as they pleased.
This follows from the 'majority rule' principle established in Foss v Harbottle in 1843.
The main constraint imposed by company law is that Dimmock and Oliver will no longer have a
75% majority of votes, which would enable them to pass a special resolution. But once a
company becomes a Ltd there is an implied assumption that the directors must run a business
in the best interests of all the shareholders, presumably meaning that the overriding goal is to
maximise the value of the company.
This is now formally recognized with respect to quoted companies in the Combined Code on
Corporate Governance that is included in The Stock Exchange's Listing Agreement.
Nevertheless, despite the introduction of the Code on corporate governance of listed companies,
the majority owners of a business exercise considerable power.

Consequently one could regard the overriding goal of shareholders' wealth maximization as
being severely constrained in the case of Kultivator Ltd by the fact that Jamie Dimmock and
Charlie Oliver would still in large part be able to pursue their own private objectives, even if this
might lower the value of the business to the detriment of the minority of shareholders.

However, Dimmock and Oliver will no longer be able to determine their directors' salaries
immune from criticism.

The validity of the assumptions which appear to underlie the growth projections implicit
in the merchant bank's calculation of the company's flotation value

a) Barriers to entry and the threat of competition from large DIY groups
With respect to the growth rates assumed, these depend on a number of factors. These include
the growth in demand in the industry and the level of competition (which will affect both the
volume of sales and the prices and profit margins that can be charged).
Estimates of the former will depend in part on the forecasts for the economy as a whole and on
consumer tastes and habits. The level of competition, however, will depend on a number of
factors (e.g. the rate of technological change and how easy it is for rivals to enter the industry if
it appears to be profitable).
It is the latter issue that is to be addressed here, i.e. are there significant barriers to entry? Jamie
Dimmock apparently takes the view that the merchant bank's assumption that the growth rate
in pre-tax profits over the next three years will only be 4% per annum and thereafter 2% per
annum is far too pessimistic.
He bases this assessment on the fact that in recent years profits of Kultivator Ltd have grown
faster than the increase in revenue reflecting the company's ability to reap the rewards of
economies of scale as it has expanded, while at the same time using its greater bargaining power
when negotiating with suppliers.
Nevertheless, he believes that there is still potential for further profitable growth. This is
because he does not believe that the large DIY groups will take a growing share of the
(expanding) market at the expense of independents because they face an effective 'barrier to
entry'. In particular, they do not possess one of the key 'core competences' possessed by
Kultivator, namely horticultural expertise.
Moreover, these groups are finding it difficult to employ personnel with the necessary skills,
which is a severe disadvantage when customers are anxious to have appropriate advice.
Further, he believes independents (such as Kultivator) have an in-built advantage here because
they pay well qualified staff appropriately.
However, as Charlie Oliver seems to be suggesting, there is nothing to stop the large DIY groups
matching these pay scales, so that alone is unlikely to be an effective 'barrier'.
Only if there is some other factor that enables independents to hold on to the scarce supply of
skilled labour will such a 'barrier' be effective. (And then presumably only in the short term as
the labour market adjusts, more individuals train as horticulturalists or where appropriately
trained personnel are recruited from abroad.)
In fact, there are several other possible barriers to entry that may thus far have prevented DIY
firms entering the industry, quite apart from the fact that they may not anticipate growth
prospects to be sufficiently attractive.

These include:
 The fact that existing garden centres have strong bargaining power with suppliers
and/or are vertically integrated, giving them a competitive edge
 Garden centres enjoy the maximum economies of scale, so DIY firms could not beat
them on efficiency grounds
 DIY stores are typically located at relatively expensive city centre or edge-of-town
sites, whereas garden centres are usually to be found out in the country.

Another difference is that DIY stores typically use the 'shed' format, as this facilitates rapid
throughput and the use of JIT inventory replenishment systems. By contrast, garden centres
tend to carry large ranges of plants, shrubs and trees, many of which will be slow moving.
Garden centres also often emphasise their ambience, tending to focus on a positive 'shopping
experience' (e.g. by offering refreshment facilities).

In other words, DIY stores and traditional garden centres appear to be catering for different
niche markets. On the other hand, DIY firms enjoy certain advantages, suggesting that there
would be synergies if they decided to expand their garden centre activities (e.g. they already
stock garden furniture, decking, huts, tools and garden equipment).

(b) Whether growth should be via vertical integration or horizontal expansion

Charlie Oliver appears to think that independents such as Kultivator may enjoy another
competitive advantage, namely through vertical integration by growing their own plants and
shrubs or seeking a tie-up with a nursery or seed merchant.
If this is so, it would provide an alternative means of expanding to horizontal integration, where
more and more garden centres are set up or are acquired. (However, it should be recognized, of
course, that the two means of growth are not mutually exclusive.)
The main disadvantage of vertical integration is that it reduces flexibility and tends to increase
operational gearing.
On the other hand, there should be opportunities to cut costs (e.g. by reducing the levels of
inventories of plants, shrubs and trees held at individual garden centres, although such savings
are likely to be minimal).
Another potential advantage, which may be important for Kultivator, is that it should be easier
to exercise quality control (potentially important where customers are likely to want plants
which grow vigorously and flower profusely).
The main benefits of horizontal integration are that it should provide opportunities to exploit
economies of scale, while at the same time slightly reducing risk exposure as a result of
diversification.
More generally, if Jamie Dimmock and Charlie Oliver really feel that the merchant bank has
undervalued their business, they could raise finance to expand the business in other ways.

Whether organic growth should be preferred to expansion via acquisition

In a perfect market there should be little to choose between expansion via organic growth
rather than via acquisition, regardless of whether the proposal involves horizontal or vertical
integration.
The additional costs that will be incurred setting up a business from scratch, including the
greater risks being taken, should be matched by the higher price one might expect to pay to
acquire a 'going concern' where someone has already taken those risks.
In practice, however, other strategic considerations are likely to determine which option will be
preferred. Thus, for instance, if speed is of the essence to secure a competitive advantage in a
market, expansion via acquisition is likely to be preferred.
Indeed, sometimes two independent entities will see it as being in their mutual interest to
engage in a defensive merger, in which case both sides should benefit by sharing the potential
synergistic gains.

However, at other times, where speed is not of the essence, it may be preferable for a business
to grow organically, particularly where it has an in-built competitive advantage (e.g. because it
has a technological superiority, backed up by patents).
In the circumstances relating to Kultivator, the main justification for opting for expansion via
acquisition, rather than via organic growth, would be to establish a strong position in the
market.

Given the fact that the DIY groups are an ever-present threat, there may be a strong case for
trying to expand as quickly as possible via acquisition, even though this may mean that a large
part of the potential synergistic gains may have to be paid for 'up front'.