The Growth of Firms
Key definitions
• Organic growth: growth from “within the
business” e.g. new products; expansion into
new markets
• External growth: use of takeovers & mergers
With strategy – firms have a CHOICE
Strategy
Innovation
Methods
Organic growth
Diversification
International
Expansion
Takeovers / mergers
Cost leadership
Joint ventures or
strategic alliances
Types of Integration
• Horizontal Integration: two businesses in the
same industry at the same stage of production
becoming one
Horizontal Integration
•
•
•
•
•
•
Tata buying Jaguar Land Rover from Ford
Volkswagen buying Porsche
Asda buying Netto (food supermarkets)
Amazon buying LoveFilm
Virgin Money buying Northern Rock
Verizon’s $130bn purchase of Vodafone’s interest in
its US mobile joint venture
• Suntory of Japan paid £1.35bn to buy
GlaxoSmithKline’s drinks brands Lucozade & Ribena
Microsoft - Nokia
Advantages of Horizontal + Lateral
Integration
•
•
•
•
Internal economies of scale
Cost savings from rationalisation
Potential to secure revenue “synergies”
Wider range of products - (diversification) Opportunities for economies of scope
• Reduces competition by removing rivals – increases
market share and pricing power
• Can make the entry barriers higher for new rivals
Types of Integration
• Vertical integration: acquiring a business in
the same industry but at different stages of
the supply chain
– Forward vertical: Closer to the consumers e.g. a
manufacturer buying a retailer
– Backward vertical: Closer to the raw materials in
the supply chain e.g. a manufacturer buying a raw
material supplier
Vertical Markets: The Book Industry Supply
Chain
Authors/Agents
Publishers/Distributors
Wholesalers
Book Clubs
Retailers
Bookstores
Chains
Independent
Bookstores
Supermarkets
Consumers
Internet
Retailers
Amazon – Huge Market Power
Volume
Value
%
%
29
36
Independent bookshops
4
5
Bargain bookshops
9
4
Supermarkets
13
10
Other shops
12
8
Book clubs
6
6
27
31
Chain bookshops*
Internet Only Book Sales
in UK (2011)
Amazon
Market
share
70%
The Book Depository
4-5%
Play.com
3-4%
Others (including
publishers’ direct)
22%
Internet-only retailers#
* Waterstone’s, WHSmith, Blackwell
# Internet only – e.g. Amazon, Play.com
Hotel
Chocolat
A vertically integrated
business that owns
and operates cocoa
plantations in St Lucia
(the Rabot Estate
pictured above) and
which roasts and
manufactures
chocolate in
Cambridgeshire +
owns many retail units
across the UK
Amazon – Market Power
Volume
Value
%
%
29
36
Independent bookshops
4
5
Bargain bookshops
9
4
Supermarkets
13
10
Other shops
12
8
Book clubs
6
6
27
31
Chain bookshops*
Internet Only Book Sales
in UK (2011)
Amazon
Market
share
70%
The Book Depository
4-5%
Play.com
3-4%
Others (including
publishers’ direct)
22%
Internet-only retailers#
* Waterstone’s, WHSmith, Blackwell
# Internet only – e.g. Amazon, Play.com
Other examples of vertical integration
• Film distributors owning cinemas + digital streaming platforms
• Brewers owning/operating pubs (forward vertical) or buying
hop farms (backward vertical)
• Record labels and radio / online music stations
• Drinks manufacturers integrating with bottling plants
• Pig processing business buying a pig farm
• Technology companies growing vertically through hardware,
software and services
– PayPal, acquired by eBay for $1.5bn in 2002
– Google buying Motorola, a phone maker
Recent Deals
Advantages of Vertical Integration
• Control of the supply chain – this helps to reduce
costs and improve the quality of inputs into the
production process
• Improved access to key raw materials perhaps at the
expense of rival businesses
• Better control over retail distribution channels
• Removing suppliers and information from
competitors which helps to make a market less
contestable
Types of Integration
• Lateral integration: companies joining
together that produce similar but related
products
• Conglomerate: Disparate businesses
What type of integration here?
What type of integration here?
Mergers and Takeovers
• Takeover: Where one business acquires a controlling
interest in another business = a change of ownership
• Merger: a combination of two previously separate
businesses into a new business
• Diversification: expanding into new markets with
new products – the riskiest growth strategy
Some key strategic drivers of M&A activity
•
•
•
•
•
•
Rapid technological change
Need for scale to remain competitive
Need to be able to supply customers globally
Low demand growth in mature economies
Access to wider distribution networks
Invest in faster-growing emerging markets
Takeovers: 3 main motives
Strategic
motives
• Improve &
develop the
business
• Closely linked to
competitive
advantage
• E.g. economies
of scale
Financial
motives
• Make best use
of financial
resources for
shareholders
• Improve
financial
performance
• E.g. higher
profits
Managerial
motives
• Self-interest of
managers
• Not necessarily
in the best
interest of
shareholders
• E.g. want to
lead a bigger
business
Takeovers: 3 main motives
Strategic
motives
• Improve &
develop the
business
• Closely linked to
competitive
advantage
• E.g. economies
of scale
Financial
motives
• Make best use
of financial
resources for
shareholders
• Improve
financial
performance
• E.g. higher
profits
Managerial
motives
• Self-interest of
managers
• Not necessarily
in the best
interest of
shareholders
• E.g. want to
lead a bigger
business
Takeovers: 3 main motives
Strategic
motives
• Improve &
develop the
business
• Closely linked to
competitive
advantage
• E.g. economies
of scale
Financial
motives
• Make best use
of financial
resources for
shareholders
• Improve
financial
performance
• E.g. higher
profits
Managerial
motives
• Self-interest of
managers
• Not necessarily
in the best
interest of
shareholders
• E.g. want to
lead a bigger
business
Shareholder value - example
£15m
16
Business Value (£m)
14
12
£10m
10
8
6
4
£2m
2
0
Original
Target
Combined
Examples of successful deals
Successful takeovers and mergers
L’Oreal & The Body Shop (more shops, higher profits)
Google & YouTube (rapid growth & advertising revenue)
Tata & Jaguar Land Rover (£1bn profits in 2011)
Santander & Abbey, Alliance & Leicester, Bradford & Bingley (higher
profits & market leadership in UK)
Taylor Woodrow & George Wimpey (economies of scale for two
leading house builders merged together)
Kraft / Cadbury – market leadership
Cadbury’s strategic fit with Kraft
Key financial motives for M&A
Make use of surplus cash and high share price
• E.g. businesses with high cash balances can
potentially earn a better return by investing in other
firms
Bargain hunting & Asset Stripping
• Can the target be bought at a knock-down price?
• Potential to sell surplus assets & cut costs & still
retain the business that was wanted in the first place
Key financial motives for M&A
Make use of surplus cash and high share price
• E.g. businesses with high cash balances can
potentially earn a better return by investing in other
firms
Bargain hunting & Asset Stripping
• Can the target be bought at a knock-down price?
• Potential to sell surplus assets & cut costs & still
retain the business that was wanted in the first place
Key managerial motives for M&A
Personal ambition & financial reward
• Director rewards may be linked to growth
• Big takeovers attract media – boosts ego / reputation?
• Takeovers as “vanity projects”
Bandwagon effect / peer pressure
• Pressure to do takeovers (if competitors are too)
• Concern that firm may be being left behind
• Over-confidence
• Pressure from advisers & media (e.g. investment bankers)
Key managerial motives for M&A
Personal ambition & financial reward
• Director rewards may be linked to growth
• Big takeovers attract media – boosts ego / reputation?
• Takeovers as “vanity projects”
Bandwagon effect / peer pressure
• Pressure to do takeovers (if competitors are too)
• Concern that firm may be being left behind
• Over-confidence
• Pressure from advisers & media (e.g. investment bankers)
Some examples of motives
Takeover / merger Main motives for the transaction
Kraft / Cadbury
Establish global market leadership in confectionery & access emerging
markets
Google /
Motorola
Acquire valuable smartphone patents & manufacturing expertise
Tata / JLR
Economies of scale & acquire expertise, brands, capacity and distribution
RBS / ABN-Amro
Management vanity; continue reputation for big deals; over-confidence
Santander /
Abbey
Market entry (UK) & establish base for further acquisitions to build market
share
WM Morrison &
Safeway
Increase market share & exploit economies of scale to improve
competitiveness
British Airways /
Iberia
Consolidation; economies of scale & survival: positioning for further
takeovers
The most important evaluation point
Strategic Fit
Does the takeover or merger fit with the objectives of
the business?
Does it make sense?
The next most important evaluation
point….
1
Will shareholders gain
3
Can 1 + 1 = 3?
from synergy?
1
What
Is
SYNERGY?
An example of synergy…
Similar concept
to “adding value”
Two kinds of “synergy”
Cost Savings
Revenues
Eliminate duplicated
functions & services
Cross-selling to customers
of both businesses
Better deals from suppliers
New distribution channels
Higher productivity &
efficiency from shared
assets
Brand extensions
New geographic markets
opened up
Two kinds of “synergy”
Cost Savings
Revenues
Eliminate duplicated
functions & services
Cross-selling to customers
of both businesses
Better deals from suppliers
New distribution channels
Higher productivity &
efficiency from shared
assets
Brand extensions
New geographic markets
opened up
Overview of the takeover process
Target Identification
& Choice
Valuation & Offer
Due Diligence
Integration
Key evaluation point: Things can go wrong
in each part of the takeover or merger
Wrong target
Target
Identification
& Choice
Pay too much
Valuation &
Offer
Don’t check what
you are buying
Due Diligence
Integration
Poor integration
planning
E.g. Paying too much!
Valuation has to strike a balance
Don’t pay too
much!
Get the best
price!
Example of the Winner’s Curse - RBS
• In 2007, RBS was part of a
consortium that bid £49bn as
it competed to buy ABN-Amro
• RBS clearly overpaid for the
takeover
• The subsequent effect on RBS's
capital reserves led to the
forced nationalisation of RBS
in 2008 to avoid a collapse of
the UK banking system
Some truly awful deals (1)
SOLD
£25m
Some truly awful deals (2)
Written
Off + New
Liabilities
£15bn+
Examples of deals that failed
Failed takeovers and mergers
News Corp & Myspace (bought for £580m; sold for $25m)
ITV & FriendsReunited (bought for £175m; sold 3 years later
for £25m)
Cisco & Flip (bought for $590m; closed down in a year)
RBS & ABN-Amro (bought for £10bn; results in losses of at
least £15bn & nationalisation)
Terra Firma & EMI (bought for £4.2bn; sold 3 years later for
loss of £1.75bn) – one of biggest private equity failures
The problems of
Merger
Integration
Imagine we are all responsible
for managing this takeover…
Marks & Spencer
Poundland
Identify three areas that would be likely to
be the hardest part of integrating the
takeover
Imagine we are all responsible
for managing this takeover…
Marks & Spencer
Poundland
Identify three areas that would be likely to
be the hardest part of integrating the
takeover
Building analysis & evaluation on
takeover integration…
Success of takeover integration will depend on…
• Importance of synergies
• Extent to which firms are similar (e.g. products, markets)
• Quality of integration planning and action (e.g.
communication, leadership)
Evaluating the importance of culture in a takeover
• Are the two cultures significantly different?
• Type of takeover – e.g. cross-border, private equity
• Can be a short-term problem, but in the long-term, one
culture will prevail
Building analysis & evaluation on
takeover integration…
Success of takeover integration will depend on…
• Importance of synergies
• Extent to which firms are similar (e.g. products, markets)
• Quality of integration planning and action (e.g.
communication, leadership)
Evaluating the importance of culture in a takeover
• Are the two cultures significantly different?
• Type of takeover – e.g. cross-border, private equity
• Can be a short-term problem, but in the long-term, one
culture will prevail
Summary: drawbacks of acquisitions
•
•
•
•
•
High cost involved
Problems of valuation
Clash of cultures
Upset customers
Problems of
integration (change
management)
• Resistance from
employees
• Non-existent synergy
• Incompatibility of
management styles,
structures and culture
• Questionable motives
• High failure rate
• Diseconomies of scale
Joint ventures
• Joint ventures occur when businesses join
together to pursue a common project
• The businesses remain separate in legal terms
• Joint ventures are becoming common as firms
want to benefit from collaborative work in
reaching a mutually-agreed strategic target.
An example might be joint-research projects
to share the fixed costs
Examples of joint ventures
• Vodafone & Telefónica agreed to share their mobile network
• BMW and Toyota agreed in 2011 to co-operate on hydrogen fuel cells,
vehicle electrification, lightweight materials and future sports car
• West Coast – joint venture between Virgin Rail & Stagecoach
• Google and NASA developing Google Earth
• Hollywood studios combining to fight internet piracy
• Alliances in airline industry e.g. Star Alliance and One World
• Starbucks - JV with Tata Beverages to break into the Indian retail
market
• Joint Ventures between universities to deliver Massive Open Online
Courses (MOOCs) – a fast-expanding sector of the higher education
industry
De-mergers
• When a firm decides to split into separate firms
• Some of the key motivations for de-merger include:
– Focusing on core businesses to streamline costs and improve profit
margins
– Reduce the risk of diseconomies of scale and diseconomies of scope
by reducing the range of functions in a business, lower management
costs
– Raise money from asset sales and return to shareholders
– A defensive tactic to avoid the attention of the competition authorities
who might be investigating possible monopoly power in an industry /
market
Examples of de-mergers
• The US pharmaceutical company Pfizer sold their infant
nutrition business to Nestle
• Demerger of Cadbury's US drinks business creating a business
called Dr Pepper Snapple Group
• Severn Trent Water demerged its waste management
business Biffa
• Demerger of British Gas into a gas pipeline business Transco +
an oil and gas exploration company
• Talk Talk demerged from Carphone Warehouse in 2010
Examples of de-mergers
• Fosters Group de-merging its two main operating divisions –
one focusing on beer, the other on wine
• Punch and Spirit pub groups created out of demerger of
Punch Taverns in 2011
• US food giant Sara Lee sold off coffee business Douwe Egberts
• Quantas demerged their airline business and run stand-alone
domestic and international airline businesses with each
having their own profit and loss account
• News International demerged their Film and TV and
Publishing businesses
• Fox News
• 20th Century Fox
• Sky
• Fox Television
Publishing
Film and TV
News International
• Dow Jones
• Wall Street Journal
• New York Post
• The Times
• The Sun
• Harper Collins
The Reality of Market Power
Pricing
Power
Economies
of Scale
Supply
Chain
Control
Entry
Barriers
Monopsony
The Reality of Market Power
Industry Leadership
Benchmark Businesses
Profits to re-invest
Habitual consumption