1.
The Growth of Firms

2.
Key definitions
• Organic growth: growth from “within the
business” e.g. new products; expansion into
new markets
• External growth: use of takeovers & mergers

3.
With strategy – firms have a CHOICE
Innovation
Diversification
International
Expansion
Cost leadership
Strategy Methods
Organic growth
Takeovers / mergers
Joint ventures or
strategic alliances

4.
Types of Integration
• Horizontal Integration: two businesses in the
same industry at the same stage of production
becoming one

5.
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

6.
Microsoft - Nokia

7.
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

8.
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

9.
Authors/Agents
Wholesalers
Retailers
Consumers
Publishers/Distributors
Bookstores
Chains
Independent
Bookstores
Supermarkets
Internet
Retailers
Book Clubs
Vertical Markets: The Book Industry Supply
Chain

10.
Amazon – Huge Market Power
Volume Value
% %
Chain bookshops* 29 36
Independent bookshops 4 5
Bargain bookshops 9 4
Supermarkets 13 10
Other shops 12 8
Book clubs 6 6
Internet-only retailers# 27 31
* Waterstone’s, WHSmith, Blackwell
# Internet only – e.g. Amazon, Play.com
Internet Only Book Sales
in UK (2011)
Market
share
Amazon 70%
The Book Depository 4-5%
Play.com 3-4%
Others (including
publishers’ direct)
22%

11.
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

12.
Amazon – Market Power
Volume Value
% %
Chain bookshops* 29 36
Independent bookshops 4 5
Bargain bookshops 9 4
Supermarkets 13 10
Other shops 12 8
Book clubs 6 6
Internet-only retailers# 27 31
* Waterstone’s, WHSmith, Blackwell
# Internet only – e.g. Amazon, Play.com
Internet Only Book Sales
in UK (2011)
Market
share
Amazon 70%
The Book Depository 4-5%
Play.com 3-4%
Others (including
publishers’ direct)
22%

13.
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

14.
Recent Deals

15.
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

16.
Types of Integration
• Lateral integration: companies joining
together that produce similar but related
products
• Conglomerate: Disparate businesses

17.
What type of integration here?

18.
What type of integration here?

19.
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

20.
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

21.
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

22.
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

23.
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

24.
Shareholder value - example
0
2
4
6
8
10
12
14
16
Original Target Combined
BusinessValue(£m)
£10m
£2m
£15m

25.
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)

26.
Kraft / Cadbury – market leadership

27.
Cadbury’s strategic fit with Kraft

28.
Key financial motives for M&A
• E.g. businesses with high cash balances can
potentially earn a better return by investing in other
firms
Make use of surplus cash and high share price
• 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
Bargain hunting & Asset Stripping

29.
Key financial motives for M&A
• E.g. businesses with high cash balances can
potentially earn a better return by investing in other
firms
Make use of surplus cash and high share price
• 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
Bargain hunting & Asset Stripping

30.
Key managerial motives for M&A
• Director rewards may be linked to growth
• Big takeovers attract media – boosts ego / reputation?
• Takeovers as “vanity projects”
Personal ambition & financial reward
• 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)
Bandwagon effect / peer pressure

31.
Key managerial motives for M&A
• Director rewards may be linked to growth
• Big takeovers attract media – boosts ego / reputation?
• Takeovers as “vanity projects”
Personal ambition & financial reward
• 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)
Bandwagon effect / peer pressure

32.
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

33.
The most important evaluation point
Strategic Fit
Does the takeover or merger fit with the objectives of
the business?
Does it make sense?

34.
1
1
3
The next most important evaluation
point….
Will shareholders gain
from synergy?
Can 1 + 1 = 3?

35.
What
Is
SYNERGY?

36.
An example of synergy…
Similar concept
to “adding value”

37.
Two kinds of “synergy”
Eliminate duplicated
functions & services
Better deals from suppliers
Higher productivity &
efficiency from shared
assets
Cost Savings
Cross-selling to customers
of both businesses
New distribution channels
Brand extensions
New geographic markets
opened up
Revenues

38.
Two kinds of “synergy”
Eliminate duplicated
functions & services
Better deals from suppliers
Higher productivity &
efficiency from shared
assets
Cost Savings
Cross-selling to customers
of both businesses
New distribution channels
Brand extensions
New geographic markets
opened up
Revenues

39.
Overview of the takeover process
Target Identification
& Choice
Valuation & Offer
Due Diligence
Integration

40.
Key evaluation point: Things can go wrong
in each part of the takeover or merger
Target
Identification
& Choice
Valuation &
Offer
Due Diligence
Integration
Wrong target
Pay too much
Don’t check what
you are buying
Poor integration
planning

41.
E.g. Paying too much!
Valuation has to strike a balance
Don’t pay too
much!
Get the best
price!

42.
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

43.
Some truly awful deals (1)
SOLD
£25m

44.
Some truly awful deals (2)
Written
Off + New
Liabilities
£15bn+

45.
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

46.
The problems of
Merger
Integration

47.
Imagine we are all responsible
for managing this takeover…
Identify three areas that would be likely to
be the hardest part of integrating the
takeover
Marks & Spencer Poundland

48.
Imagine we are all responsible
for managing this takeover…
Identify three areas that would be likely to
be the hardest part of integrating the
takeover
Marks & Spencer Poundland

49.
Building analysis & evaluation on
takeover integration…
• Importance of synergies
• Extent to which firms are similar (e.g. products, markets)
• Quality of integration planning and action (e.g.
communication, leadership)
Success of takeover integration will depend on…
• 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
Evaluating the importance of culture in a takeover

50.
Building analysis & evaluation on
takeover integration…
• Importance of synergies
• Extent to which firms are similar (e.g. products, markets)
• Quality of integration planning and action (e.g.
communication, leadership)
Success of takeover integration will depend on…
• 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
Evaluating the importance of culture in a takeover

51.
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

52.
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

53.
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

54.
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

55.
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

56.
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

57.
News InternationalFilmandTV
• Fox News
• 20th Century Fox
• Sky
• Fox Television
Publishing
• Dow Jones
• Wall Street Journal
• New York Post
• The Times
• The Sun
• Harper Collins

58.
The Reality of Market Power
Pricing
Power
Entry
Barriers
Monopsony
Supply
Chain
Control
Economies
of Scale

59.
The Reality of Market Power
Industry Leadership Benchmark Businesses
Profits to re-invest Habitual consumption