Reasons for Expansion
This is a natural progression for a business. It involves opening new plants or retail outlets that are financed from the company’s own resources. It often is a slow process and a business may not be able to respond quickly enough to short term changes in demand. The company would have complete control and there would be no problems in trying to merge different company cultures.
This involves a firm going outside and buying or merging with another business. A business may lack production capacity, staff, market share, etc. Examples of this type of growth include: Merger/Take-over, Diversification, Management Buyout, Strategic Alliance, Joint Venture, Licensing, Franchising and Exporting.
Mergers and Take-overs
A merger occurs where two businesses join together with common ownership and management and is as a result of agreement reached between the two parties e.g. Irish Permanent and Irish Life. A take-over may be a less friendly arrangement where one firm takes over another. The firm taken over may lose it’s identity and become a subsidiary.
The process can result in one of the following:
2 businesses producing or providing the same product/service at the same
stage of production joining together e.g. two banks coming together.
Vertical Integration: occurs where two firms producing or providing the same product/service but at different stages of production agree to come together e.g. a firm buying out a supplier.
Lateral Integration:happens where 2 businesses come together who are not producing similar distribution outlets e.g. Waterford and Wedgewood.
This arises where 2 businesses come together who produce unrelated products. The primary purpose for this type of expansion is profit. There is no effort to achieve a strategic fit, as it is a finance driven approach. It may occur due to a business being in financial difficulty or its assets being undervalued. Arguments for this form of growth include spreading the risk, best profit returns and counter cyclicality. A business can also diversify with its product range e.g. BIC pens, razors, surf boards and lighters.
This emerges when the management of a firm buy the business that they presently manage. It is usually financed by a high level of debt which is known as a leveraged buyout. Management may buy because the firm may be near to closure or they may have a great ambition to secure their future.
This involves firms in a similar industry coming together on a grand scale e.g. Telecom have formed an alliance with their counterparts in Sweden and Holland. The emergence of strategic alliances are a strong indicator of globalisation. To succeed on a global basis one cannot afford to go it alone due to the high level of finance required. Many alliances are formed to share technology and Research and Development costs. Difficulties may emerge with different cultures and strategies.
This is an equity partnership of two or more participating firms which have joined forces for marketing, financial, technical and managerial reasons. It is particularly important in international business where local knowledge and capital can reduce the risk. Shared technology is also a common reason for joint ventures. The success of a joint venture depends upon trust and the level of control that can be exercised by either side.
This happens where a firm assigns the right to a patent or a trademark to another firm for a fee or a royalty. There is no need for an equity capital input but a fixed capital sum in addition to royalties are required from the licensee. The license is for a fixed time period. A firm is capable of expansion without major financial commitment. Advantage can be taken of the licensee’s market knowledge and capital input.
Dangers for this method of expansion tend to relate to lack of uniformity in quality and possible future competition from the licensee.
This is a special form of licensing in which the franchisor makes a total marketing programme available, including the brand name, logo, products and method of operation. It is more comprehensive than a licensing arrangement. It is very popular in retailing especially fast food. Expansion can be achieved with minimal equity and the franchisee’s local knowledge.
Direct Exporting: Results in the exporter being in total control of the distribution process.
Indirect Exporting: This involves several intermediaries helping the exporter in contacting foreign markets or buyers. Examples include export merchants, export agents and international firms.
Implications of Expansion
This represents the investment of the owner’s capital into a business. For a company it means ordinary share capital while for a sole trader or partnership it means each individual supplying their own capital. This finance is the most popular method of raising finance for a firm. Equity capital is the biggest risk capital in a business and does not have to be repaid. Shareholders in limited companies only get dividends after all other financial commitments have been met.
This capital is known also as loan capital and can usually be secured from merchant/commercial banks. It is currently very popular due to the low level of interest rates and is probably cheaper and more available than equity capital. Loan capital must be repaid with interest. Interest on loan capital is a tax deductible business expense. Acquiring high debt may result in a business becoming highly geared which is not good if profits are low. Financial institutions may also dictate how the business is run.
This is the cheapest form of finance to invest in a business. It involves ploughing profits back into a business. It is part of equity capital and no control is lost using this source. Shareholders may not be happy if this source is used extensively on a regular basis with little or no funds left for dividend payments.
Grants are viewed by Irish business as a very important source of finance. Certain conditions such as job creation and length of time in existence must be complied with. Otherwise they may have to be repaid. They are available from County Enterprise Boards, Forbairt etc.