The Growth of Firms (Cambridge International IGCSE Economics)
Internal and External Growth
Spec point —
3.5.3· Internal growth, for example increased market share. External growth, for example mergers.
Internal and External Growth
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The growth of firms can be organic (internal) or inorganic (external)
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Organic growth is usually generated by
- Gaining greater market share
- Product diversification
- Opening a new store
- International expansion
- Investing in new technology/production machinery
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Inorganic growth usually takes place when firms merge in one of three ways
- Vertical integration (forward or backwards)
- Horizontal integration
- Conglomerate integration
A diagram that illustrates how a firm can grow through forward or backward vertical integration
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Forward vertical integration involves a merger or takeover with a firm further forward in the supply chain
- E.g. A dairy farmer merges with an ice-cream manufacturer
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Backward vertical integration involves a merger/takeover with a firm further backward in the supply chain
- E.g. An ice-cream retailer takes over an ice-cream manufacturer
Types of Mergers
Spec point —
3.5.3· Examples, advantages and disadvantages of different types of mergers: horizontal, vertical, and conglomerate.
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Firms will often grow organically to the point where they are in a financial position to integrate with others
- Integration speeds up growth but also creates new challenges
An Explanation of the Advantages and Disadvantages of Each Type of Growth
| Type of Growth | Advantages | Disadvantages |
|---|---|---|
| Organic | - The pace of growth is manageable - Less risky as growth is financed by profits and there is expertise in the industry - Avoids diseconomies of scale - The management know and understand every part of the business | - The pace of growth can be slow and frustrating - Not necessarily able to benefit from economies of scale - Access to finance may be limited |
| Vertical Integration (Inorganic growth) | - Reduces the cost of production as middle man profits are eliminated - Lower costs make the firm more competitive - Greater control over the supply chain **reduces risk **as access to raw materials is more certain - Quality of raw materials can be controlled - Forward integration adds additional profit as the profits from the next stage of production are assimilated - Forward integration can increase brand visibility | - Diseconomies of scale occur as costs increase e.g. unnecessary duplication of management roles - There can be a culture clash between the two firms that have merged - Possibly little expertise in running the new firm results in inefficiencies - The price paid for the new firm may take a long time to recoup |
| Horizontal Integration (Inorganic growth) | - Rapid increase of market share - Reductions in the cost per unit due to economies of scale - Reduces competition - Existing knowledge of the industry means the merger is more likely to be successful - Firm may gain new** knowledge or expertise** | - Diseconomies of scale may occur as costs increase e.g. unnecessary duplication of management roles - There can be a culture clash between the two firms that have merged |
| Conglomerate Integration (Inorganic growth) | - Reduces overall risk of business failure - Increased size and connections in new industries opens up new opportunities for growth - Parts of the new business may be sold for profit as they are duplicated in other parts of the conglomerate | - Possible lack of expertise in new products/industries - Diseconomies of scale can quickly develop - Usually results in job losses - Worker dissatisfaction due to unhappiness at the takeover can reduce productivity |
Exam Hint Paper 1 MCQ frequently tests your ability to differentiate between forward vertical and backward vertical integration. This is all about a supply chain for a good/service. If a firm takes over another at an earlier stage in the supply chain - it is vertical backward integration.
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