Business Expansion

Business Expansion -growth of a business is called expansion -expansion may be organic or inorganic -similarly to why a business might ever be created, there are different reasons as to why a business may want or need to expand, these reasons fall into three broad categories -business expansion is m...

Business Expansion -growth of a business is called expansion -expansion may be organic or inorganic -similarly to why a business might ever be created, there are different reasons as to why a business may want or need to expand, these reasons fall into three broad categories -business expansion is monitored and controlled by the Competition and Consumer Protection Commission in Ireland as well as the EU Commission through European Competition Law to prevent monopolies, cartels and any anti-competitive business behaviours (Unit 1 Notes page 26) (Unit 7 Notes page 4) Reasons for Business Expansion 1. Defensive Reasons (to protect the business from competitors and changing economic cycles) 2. Offensive Reasons (growing the business to increase profits and market share) 3. Psychological Reasons (entrepreneurial ambition) Psychological Reasons for Business Expansion 1. Entrepreneurial Ambition (entrepreneurs are driven, hard-working and successful people, ambition and the desire to build a business empire by the owner or managers might be a motivating force for business expansion, some entrepreneurs are hungry for success and will not stop until they have reached self-actualisation eg Richard Branson has already made millions, but he wants to be the first entrepreneur to sell consumers tickets to travel to space with Virgin Galactic) (Unit 2 Notes page 1) Defensive Reasons for Business Expansion 1. Diversification (expanding to spread the risk the business faces, if a business was reliant on only one type of product in one market or in only one country for sales, it would be very risky, if a business sells only in Ireland, it is reliant on the domestic 49 market and if Ireland had a downturn in the economy, the business might be hit badly, so it could offset this risk by exporting to other countries eg Dyson once just sold vacuums, it has since diversified into electrical products like hair dryers, had it been only reliant on the vacuum market it would have struggled huge when new competitors like Shark vacuums entered the market) 2. Supply Chain Reverse Integration (a business might have found a great supplier of products or raw materials and wants to guarantee the continued supply, so it could take over the supplier, this is called reverse integration of the supply chain or protecting stock supply, this would also give the business a competitive edge over other businesses, as it could prevent them from sourcing the same goods or raw materials eg Amazon bought books from publishers to sell online, but then decided to grow by becoming a publisher, increasing its profit margins on books and reducing its reliance on other publishers) 3. Economies of Scale (as a firm expands, the average cost of producing each unit falls because of factors such as bulk buying, savings in transport and lower storage costs in larger warehouses, the lower cost per unit means much higher profit margins per product or lower sales prices to drive out competition) Offensive Reasons for Business Expansion 1. Acquisition of Potential Threats (instead of developing a product to compete with a competitor, an option for a larger firm is to take over the smaller competition in order to own their products and sell them eg one of the reasons Google took over Motorola was that it had lots of patents and copyrights that Google wanted to own) 2. Competition Elimination (a business might try remove competition entirely by taking over another business that sells a similar product or service eg Ryanair tried to take over Aer Lingus, which would have removed it as a competitor on many of Ryanair's routes but the takeover was blocked by the European Union's Competition Authority as the EU Commission said the under competition laws the merger would harm consumers by creating a dominant company on 46 routes on which the carriers currently compete) 3. Asset Stripping (a business might be purchased so that the buyers can sell off all the company's assets to increase the return for the buyer’s investors eg Phones4U was 50 taken over by BC Partners in the United Kingdom in 2011, BC Partners then sold off Phones4U's assets, and Phones4U eventually failed) 4. New Markets (businesses may expand into or acquire existing businesses to expand into new markets which they previously never competed in eg Google bought YouTube to enter the online video market) 5. Synergy (expansion through merging provides a synergetic outcome, the combined effect of firms merging will give a greater overall benefit than if they remained separate, 2 + 2 = 5, savings can be made through selling duplicates and surpluses and competing products can be discontinued) Organic Expansion -organic growth is the natural expansion of a business as it makes profits and ploughs these back info the business -a business chooses to grow by using its own products, staff or brands -the profits retained by the firm can be used to buy new machinery, expand its premises, develop new products, open new outlets or to invest in R&D -this expansion happens from within the business and does not involve outside firms -a firm can expand through increasing sales, licensing or franchising Organic Expansion Methods 1. Increasing Sales 2. Licensing 3. Franchising Increasing Sales -a business could expand by increasing what it sells and where it sells -it can increase sales from within by releasing new products, launching new advertising campaigns or sales promotions, or exporting its products to other countries -this type of organic growth usually happens more slowly -eg Cadbury’s could expand by introducing new flavours of chocolate (cinnamon flavour), introducing new packet sizes (mini bars), selling to new segments (zero sugar chocolate bars aimed at diabetics or health conscious) or selling the product in new markets 51 Licensing -the licensor makes an agreement with a local licensee (an enterprise operating in the local market already), giving the right to manufacture a product or use a certain process in the manufacture of a product -in return the licence is paid an initial fee plus agreed percentage of sales revenue -eg a drug patent owner granting a drug manufacturer a license to use the patented formula in manufacturing and selling a prescription drug Franchising -a business arrangement whereby the franchisor (the existing business with the proven business model) grants permission to the franchisee (the person setting up the business) to use its name, logo and business idea in return for a fee or a percentage of profits or sales, and often an initial payment upfront -franchising allows the franchisor to expand their business without having to invest further capital or take additional risks, as these are passed on to the franchisee in the contractual arrangement -it is a cost-effective form of expansion for the franchisor, which is useful if raising finance is an issue -it can be risky for a franchisor; if standards are not maintained by the franchisee, the image of all of the franchise's stores could be affected -eg McDonalds outlets in Ireland are all franchised Franchising Benefits -low capital investment = franchising is a form of expansion that requires low investment from the franchisor, as the capital used to expand the business comes from franchisees paying for the licensing -fast expansion = franchising permits a more rapid expansion, by using the franchisees' capital, the franchisor is able to establish a large number of outlets in a short period of time. Rapid expansion can be achieved without incurring the overheads and costs associated with opening company-owned outlets -motivation = an owner will be more attentive than a manager, this is the central point that makes franchising so attractive, the franchisor can be assured that the person operating 52 their business will be as involved as they would, by franchising the business, the franchisor places its expansion in the hands of people who are motivated to make it work and are therefore more likely to succeed -economies of scale = there is strength in numbers, the franchise can command deals with various suppliers and control supplies to various franchisees, bulk buying leads to cost savings for all the stores, making them more competitive Franchising Disadvantages -less control = control is lost over the day-to-day management of the franchise businesses, the franchisor has to trust franchisees to operate their own stores, whereas if they opened up new stores themselves they would have more control of decisions -reputational risk = the reputation of the whole business could be affected by the actions of one franchisee with poor-quality standards or staff, a good franchisor vets potential franchisees thoroughly before granting permission to them -training = a training programme for franchisees is required, this can be expensive and time-consuming for the franchisor, but it is crucial to up skill new franchisees on the processes and ethos of the company -supervision = franchisees have to be monitored regularly to ensure they are operating at a satisfactory level and maintaining the quality standards of the brand Inorganic Expansion -usually quick expansion -it is growth from external sources, not from within the business -achieved by merging, taking over or forming a strategic alliance with other firms Inorganic Expansion Methods 1. Merger 2. Acquisition 3. Strategic Alliance 53 Merger -a merger is a friendly or voluntary amalgamation of two or more firms for their mutual benefit -they join together as one new single legal entity -a single new legal entity is formed once it is approved by the owners or shareholders, and neither company has control over the other -eg Avonmore PLC and Waterford PLC merged to form Glanbia PLC Merger Benefits -diversification = merging is a defensive strategy, as the merger might involve diversification into new product areas, this reduces the risk of the firm 'having all its eggs in one basket’, if the market for a particular product collapsed, then a firm could survive because of its other products in other markets -allows rapid expansion = a merger can see businesses grow very quickly, as they are combining resources with one or more other business, this is much faster than trying to grow organically themselves, so it would enable them to gain a dominant share of a market much more quickly -lower costs = costs per unit will be lower after a merger with another business due to economies of scale and the sharing of costs and resources -new markets/technology = firms can access new technology and new markets quickly eg a firm could gain instant access to a bigger market after merging with a business operating in a different market Merger Disadvantages -industrial relations issues = mergers can cause industrial relations problems, redundancies could be necessary due to surplus labour skills, leading to industrial disputes, management roles might be duplicated and tension between top management might carry on into the future -clash of cultures = different organisational cultures in two firms can lead to conflict between competing management teams, who are used to their own work practices and management styles and systems, this might cause a lack of co-operation within the new merged entity, leading to poor management decision-making 54 Acquisition -also known as a takeover -when one business takes control of another, with or without the other business's consent, by buying 51% or more of the business’ shares -the acquiring company absorbs the company it is taking over, this absorbed company then loses its identity and becomes part of the acquiring company -it is a hostile takeover if the directors of the company recommend to its shareholders not to accept the takeover offer given to them -it is a friendly takeover if the directors of the company recommend to its shareholders to accept the takeover offer given to them -eg Amazon acquired Whole Foods Acquisition Benefits -economies of scale = a business becomes bigger when it takes over another business, so it can get raw materials more cheaply if purchasing in bulk at higher quantities than before eg Adidas achieved economies of scale on raw materials when it acquired Reebok -access to new markets = a business could take over another business that operates in a market in which it does not normally operate, it is a very quick way of entering a market eg Google acquired Youtube, video streaming was not a market Google was directly involved in before -access to new products/ideas = a business might acquire another business to increase the number of products it sells, or to get access to the other company's copyrights, patents or ideas eg Google bought Motorola because the latter had registered patents on phone design that Google wanted to own -eliminate competition = a business might take over a competitor in order to stop it growing and becoming a larger threat in the marketplace eg Microsoft was famous for taking over small start-ups to prevent them from growing into a threat to the company Acquisition Disadvantages -capital required = a business making a takeover bid usually needs to offer a price higher than the current market price to incentivise enough shareholders to sell their shares, so it 55 is very costly eg Facebook's takeover of Instagram is reported to have cost around $1 billion in 2012 -hostility = if the takeover is hostile, there might be continuing conflict with the remaining directors, shareholders or staff, disrupting business operations eg Kraft's made a hostile takeover bid for Cadbury in 2009 -risk of failure = a takeover is very expensive so carries a large financial risk should it fail to be successful eg Google lost more than €10 billion when it took over Motorola and then sold it on a few years later Strategic Alliance -also known as a business alliance -it is an agreement between two or more businesses to pool resources and expertise to work together over a specified period of time or to complete a specified project (eg product launch) while remaining separate legal entities -eg in 2021, Uber and Spotify announced an alliance to allow Uber users to connect to Spotify and stream their favourite music while on a ride Strategic Alliance Benefits -cost effective = in an alliance, both companies' resources are shared, and associated costs incurred are divided between partners eg Barnes & Noble has an alliance with Starbucks to sell its coffee in some bookstores so that the companies can share the cost of renting the premises -reduces risks of expansion = instead of one company bearing all the risk of an expansion, two or more can agree to try to expand together so that each partner in the alliance will share the risk eg when TacoBell and T-Mobile announced an alliance, they undertook to share the financial risk of failure, while both aimed to grow their own brands and customer base -access to other networks/markets = a strategic alliance allows both companies to access each other's consumer and network base and to reach new consumers and markets that they might not have had before -easier to terminate = an alliance is easier to terminate if it does not work out well, there is less to untangle legally as far as assets are concerned, as both companies have remained 56 separate entities by entering the voluntary agreement eg Swatch and Tiffany decided to end their proposed 20 year strategic alliance early after neither party was happy with what the other brought to the alliance -shared resources = rather than having to develop a new idea independently, the businesses can share market research, machinery and skills with each other, which is a huge benefit eg Volkswagen has Microsoft working to develop its in-car technology, rather than hiring staff to develop its own systems Strategic Alliance Disadvantages -clash of cultures = different organisational cultures in two firms can lead to conflict between competing management teams, who are used to their own work practices and management styles and systems, this might cause a lack of co-operation within the new merged entity, leading to poor management decision-making -shared profits = earnings are shared between the companies -less control = control is shared between the companies who remain separate legal entities, thus compromises and negotiations may need to be made -reputational risk = the reputation of the whole business could be affected by the actions of one company in the strategic alliance Financing Expansion -a business must decide how to finance the expansion either through equity capital, debt capital or elements of both -whether it is paying for a new marketing campaign to boost sales or spending millions to take over a competitor, expansion can be expensive Equity Capital for Expansion -reserves/retained earnings = a firm might use its own profits, putting the company's reserves back into the business, this is jot available to new businesses -share capital = a firm might sell more shares to raise equity capital, giving away a percentage of control of its business 57 Debt Capital for Expansion -a company may not want to give away more control by issuing more shares, it might take on more debt capital instead, by getting a long-term loan or a debenture -long term loan = loan is paid back in instalments as well as interest in instalments -debenture loan = a type of loan for which interest only is paid back in instalments, with the original loan repaid in full at the end of the term -Unit 4 Notes page 6 Importance of Irish Business Expansion in Ireland -increase in tax revenue = if Irish businesses grow larger, they should make more profits, this means more direct tax (corporation tax/self-assessment tax) for the government to spend on health, education, grants, etc Debt v Equity Debt Equity Burden of Repayments If a business uses debt when expanding and then goes through a bad patch and is unable to make debt repayments, then it might lose its assets or close due to bankruptcy. If a business uses equity finance to expand, then there is less chance of it going bankrupt if it goes through a bad patch, as it will not have large repayments coming out of its cash flow.. Timing of Repayments I the business uses debt, then it must make each interest repayment on time or risk damaging its credit rating or going bankrupt. If a business uses equity finance to expand, it can choose when to issue dividends to its shareholders. If the business is not performing, then it does not have to pay dividends that year. Security If the business uses debt, then it must put up some assets as security. It risks losing its assets if it cannot repay the debt. If a business uses equity finance to expand, it does not need to provide any security to raise the capital, so it does not risk losing its assets. Control If the owners of a business use debt, they remain in full control of the business, as they do not give any part of the company away to the lender. If a business uses equity finance to expand, the owners lose some control of the workings of the company, as they give investors ownership and control in return for cash. Tax In contrast, if a business uses debt, it can claim back tax on any interest paid on loan repayments, so it would pay less tax with debt finance. If a business uses equity finance to expand, the dividends paid to its shareholders are not tax deductible, so no savings are made from equity finance. 58 -increase in employment = expansion should mean more production, so there should be more domestic employment available for people in Ireland to help manufacture the increased output -spin-off effect = if a business expands, it will need more service providers (electricity, legal advice, accounting, etc) and more raw materials and suppliers, some of whom will be Irish, thus increasing these firms’ sales too -lower prices for consumers = if businesses can expand and take advantage of economies of scale, they should be able to charge lower prices, meaning the cost of living could fall for Irish citizens -Unit 7 Notes page 7 Importance of Irish Business Expansion Abroad -increase in employment = increased exports by Irish businesses will lead to increased production, so extra goods and services produced in Ireland will generate more employment -improves international trade = Ireland's balance of payments (total exports - total imports) will improve if the export of goods increases, making the country richer -increase in foreign currency = some countries buying Irish exports will pay in foreign currency, which diversifies the risk for companies of dealing in just the Euro, foreign currency can also be used by companies to import stock and raw materials -improved international relations = exporting builds relationships between countries/ economies, which can lead to loyalty, expansion into foreign markets could lead to more inward foreign direct investment (FDI) by businesses that we have dealt with in other countries through exporting -Unit 7 Notes page 9 Implications of Business Expansion -organic and inorganic business expansion has many impacts on business organisational structure, product mix, profitability and employment levels -these implications can be both short term and long term 59 Implications Short Term Long Term Organisational Structure As the business expands, a new structure might be required, as more activities might need to be organised. It might need a formal organisational structure (for example, a functional structure) that identifies the chain of command and span of control within the business. This functional organisational structure might be replaced by a geographic structure to facilitate expansion into new geographic regions. Alternatively, it might be replaced by a product structure to facilitate the increased range of products. Product Mix Any products acquired during expansion that do not fit the company's business model might be sold off. Mergers and acquisitions will allow the business to satisfy the various niche markets if the owners choose the right business to partner with or take over. This may lead to the development of a wider product range. Profitability Restructuring costs: Initially, profits might fall as a result of the increased spending on machinery, buildings, ICT, premises, internal systems changes and training. Economies of scale might be achieved through bulk buying, increased market power, automation and elimination of duplication, leading to efficiency and greater profitability after expansion, as the business is larger. Employment Initial expansion might result in rationalisation as the business attempts to remove wasteful duplication of roles. This can lead to compulsory redundancies. The uncertainty and fear about the future could demotivate staff and management and cause industrial relations problems (for example, different pay and reward systems). Training and development opportunities could open up promotion possibilities for staff, improving morale and industrial relations. Bigger businesses could attract highly qualified personnel. Employees might become alienated and demotivated in a very large business, leading to inefficiencies.