Growth and Profitability

• Growth and a firm’s long-run average costs

– 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
 Constraints on Growth
• Financial considerations
– internal sources of finance
– borrowing
– share issue
• Shareholder confidence
– problem of retaining large proportion of profits
– excessive borrowing
– the takeover constraint
– share performance
• the valuation ratio
 Constraints on Growth
• Demand conditions

– importance of market demand

– importance of promoting demand for the firm's product

and increasing market share

• Managerial conditions

– the composition of the managerial team

– management structure
 Alternative Growth Strategies
• Growth by internal expansion
– product differentiation
– vertical integration
– diversification

• Growth by external expansion: mergers and takeovers

– horizontal mergers
– vertical mergers
– conglomerate mergers
 Alternative growth strategy

GROWTH OF A FIRM

Internal expansion External expansion

(1) Differentiation (1) Horizontal integration
Horizontal expansion Mergers of firms
(same product, increase producing the same
in market share) product

(2) Vertical integration (2) Vertical integration

Different products, but Mergers of firms producing
belonging to different at different stages of same
stages of same product process

(3) Conglomerate (3) Conglomerate

Diversification - Diversification - merger of
introduction of totally firms producing totally
different products unrelated products
Growth through Vertical Integration

• Types of vertical integration

– backward integration ('upstream' integration)
– forward integration ('downstream' integration)
• Measuring the extent of vertical integration
– primary production
– auxiliary operations
• Examples of vertically integrated firms
Growth through Vertical Integration

• Why vertically integrate?

– greater efficiency
• production economies
• co-ordination economies
• managerial economies
• financial economies

– reduced uncertainty
– monopoly power
– barriers to entry
Growth through Vertical Integration

• Problems with vertical integration

– lack of flexibility
– risks
• 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
• 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
• Why diversify?
– stability
– maintaining profitability
– growth
 Growth through Merger
• Mergers and takeovers
– distinction between mergers and takeovers

• Motives for mergers and takeovers

– growth
– economies of scale
– monopoly power
– increased market valuation
– reduced uncertainty
 Growth through Merger
• Motives for mergers and takeovers (cont.)
– opportunities
– other motives
• to avoid being taken over
• White Knight strategy
• asset stripping
• empire building
• geographical expansion
 Growth through Strategic Alliance

• Types of strategic alliance

– joint ventures

– consortia

– franchising

– licensing

– subcontracting

– networks
 Growth through Strategic Alliance

• Why form strategic alliances?

– new markets

– risk sharing

– capital pooling