External growth (AQA GCSE Business): Revision Notes
External growth
What is external growth?
When businesses want to accelerate their expansion, many choose external growth as their strategy. This approach involves growing through mergers or takeovers rather than expanding organically from within the company.
Understanding External Growth Methods
External growth represents a strategic alternative to organic expansion, allowing companies to achieve rapid growth by combining with existing businesses rather than building new capabilities from scratch.
Takeovers occur when one company purchases a controlling interest in another business. In practical terms, this means acquiring more than half of the target company's shares. Sometimes the business being acquired agrees to this arrangement, but in other cases, they may resist (creating what's known as a hostile takeover). Once the takeover is complete, the acquired firm will no longer exist as an independent entity, and all its staff and resources become part of the acquiring business.
Mergers happen when two companies voluntarily decide to combine their operations and create a entirely new business entity. Unlike takeovers, mergers are collaborative arrangements where both parties agree to join forces.
These external growth strategies can occur between various types of businesses - they might be competitors, suppliers, customers, or companies with completely different products and services. The key motivation is that combining forces can help both businesses achieve their growth objectives more quickly than they could independently.
Advantages and disadvantages of external growth
External growth brings both opportunities and challenges that businesses must carefully consider before proceeding with mergers or takeovers.
General benefits and drawbacks of business growth
| Advantages | Disadvantages |
|---|---|
| Lower costs per unit (economies of scale) | Higher costs per unit if the business becomes too large (diseconomies of scale) |
| Easier to raise finance and get cheaper materials (bulk buying) | Business may become inefficient or demotivated if it grows too fast or too large |
Growing larger through external means can help businesses achieve economies of scale, which reduces the cost of producing each individual unit. This happens because fixed costs can be spread across a larger volume of production, making the business more efficient. Additionally, larger companies typically find it easier to secure funding and have greater purchasing power, allowing them to negotiate better prices for raw materials and supplies.
Critical Growth Considerations
However, growth isn't without its risks. Diseconomies of scale can emerge when businesses become too large, actually increasing production costs per unit. This often occurs alongside management inefficiencies and declining worker motivation, particularly when growth happens too rapidly or extensively.
Specific advantages and disadvantages of mergers and takeovers
| Advantages | Disadvantages |
|---|---|
| Less competition and more market share can allow higher prices and more security | Culture clashes between businesses can reduce success |
| Spreads risk if the businesses offer different products | Some workers (especially managers) may be made redundant, affecting motivation |
| Businesses can share skills, knowledge, and technology | The buying business may not understand the other well enough to succeed |
| Cost savings possible by removing duplicated sites or departments | Cost savings may be hard to achieve – staff and assets may need to be removed |
The benefits of external growth through mergers and takeovers are particularly compelling for many businesses. By combining operations, companies can significantly reduce competition in their market, leading to increased market share and greater pricing power. This enhanced market position provides more security and stability for the business.
Risk management also improves through diversification - when businesses merge with companies offering different products or services, they spread their risk across multiple areas. If one product line struggles, others can compensate. Additionally, mergers and takeovers facilitate valuable knowledge transfer, allowing businesses to share expertise, skills, and technology that can benefit both operations.
Cost Advantages of External Growth
Cost savings represent another major advantage, as merged businesses often discover they have duplicate facilities, offices, or functions that can be consolidated or eliminated entirely.
Unfortunately, external growth also presents significant challenges. Cultural clashes frequently occur when businesses with different working styles, values, or management approaches try to integrate. These conflicts can create resentment among employees and reduce the overall effectiveness of the merger or takeover.
Common Pitfalls to Avoid
Workforce redundancies often become necessary, particularly at management levels where roles may overlap. This can severely impact employee motivation and create uncertainty throughout the organisation. Furthermore, the acquiring company may lack sufficient knowledge about the target business, making successful integration difficult and potentially leading to poor decision-making.
Finally, the anticipated cost savings may prove harder to achieve than expected, as redundancy payments and the costs of selling off assets or premises can be substantial.
Real-world examples of mergers and takeovers
Understanding how external growth works in practice helps illustrate these concepts. Several major deals from recent years demonstrate different motivations and outcomes for mergers and takeovers.
Worked Example: Facebook's Acquisition of WhatsApp
Facebook's acquisition of WhatsApp in February 2014 for $19 billion represents one of the largest technology takeovers in history. WhatsApp had built a user base of over 450 million monthly active users who valued the service's approach to avoiding text messaging charges. For Facebook, this acquisition provided crucial access to international markets and, importantly, to younger demographics who were increasingly using WhatsApp instead of Facebook's main platform.
Worked Example: Microsoft's Purchase of LinkedIn
Microsoft's purchase of LinkedIn in June 2016 for $26.2 billion demonstrated how companies can use takeovers to strengthen their market position. Microsoft recognised that LinkedIn's business-focused social network would complement its existing software offerings, particularly Office and other business applications. This deal was mutually agreed upon, showing how takeovers can benefit both parties when strategic alignment exists.
Worked Example: Heinz and Kraft Foods Merger
The merger between Heinz and Kraft Foods in March 2015 illustrates how companies in traditional industries can combine to create market leaders. Heinz, famous for condiments and baked beans, joined with Kraft Foods, known for products like macaroni and cheese, to form the third-largest food company in the United States. This merger involved a complex arrangement where shares were exchanged and cash dividends paid to shareholders, with ownership split between the two companies' previous shareholders.
Key Points to Remember:
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External growth through mergers and takeovers allows businesses to expand more quickly than organic growth, but requires careful planning and execution
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Takeovers involve one business buying control of another, while mergers are voluntary combinations of two businesses into a new entity
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Economies of scale can reduce costs per unit, but diseconomies of scale can increase costs if businesses become too large or grow too quickly
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Cultural integration is often the biggest challenge in mergers and takeovers, as different business cultures may clash and reduce effectiveness
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Real-world examples like Facebook/WhatsApp, Microsoft/LinkedIn, and Heinz/Kraft Foods show how external growth strategies work across different industries and market conditions