The growth of firms

Firms may wish to increase their size in order to gain market power within an industry. A firm that can gain market share, and perhaps become dominant within a market, may be able to exercise some control over the price of a product, and thereby influence the market. However, firms may wish to grow for other reasons.

Organic growth

Some firms grow simply by being successful. For example, a successful marketing campaign may increase a firms market share and provide it with profits which can be reinvested to expand the firm even more. Some firms may choose to borrow to increase their market share, perhaps by issuing shares (equity).

Such organic growth may encounter limits. A firm may find is market is saturated, meaning that it can only grow further at the expense of other firms in the market. If its competitors are able to maintain their own market shares, the firm may need to diversify its production activities by finding new markets for existing products, or perhaps offering new products.

However, diversification may be a dangerous stratergy: moving into a market in which the firm is inexperienced, with mature rival firms may pose quite a challenge. In such circumstances, much may depend on the quality of the management team.

Mergers and acquisitions

Instead of growing organically, i.e. though a firms own resources, may firms choose to grow by merging with, or acquiring, other firms. A merger is the coming together of equals, with each firm committing to form a single entity. An acquisition is a hostile takeover.

Growing in this way has a number of advantages. It may overcome the management problem, and allow some rationalisation to take place. On the other hand, firms tend to develop their own corporate culture, and some mergers have foundered because of an incompatability of distinct corporate cultures.

Mergers and acquititions can be of three different types:

  • Horizontal merger: Merger between firms that are competing in the same industry, at the same stage of production. A horizontal merger can affect the degree of market concentration, because after the merger takes place there are fewer independent firms operating in the market. This may increase the market power of the new firm. For example, the merger of Rover and BMW.
  • Vertical merger: Merger between firms that are in the same industry, but are different stages of production. Vertical mergers can be upstream or downstream. Upstream is integration with a firm involved in an earlier part of the production process, while downstream is integration with a firm later in the production process. For example, a firm which produces car engines would perform upstream integration by merging with a steel production firm, and it would perform downstream integration by merging with a car manufacturing firm.Vertical integration may allow rationalisation of the process of production. Car producers often work on a just-in-time basis, ordering components for the production line as and when they are required. The creates a potential vulnerability, as if the firm producing these components is not able to fulfil this order, then cars will not able to be produced. If the supplier was part of the firm, instead of an independent producer, then it may improve the reliability, and the confidence in, the just-in-time process, and in consequence make life more difficult for competing firms. Furthermore, if integrating upstream, it also reduces the firms costs, as they no longer have to pay the markup required for the upstream firm to make a profit. However, vertical mergers have different implications for concentration and market power.
  • Conglomerate merger. The merger of two firms in unrelated industries. One argument in favour of a conglomerate firm is that they reduce the risks faced by firms. Many industries follow cycles which are in line with the business cycle, but not fully synchronised. The fall in demand in one industry may be made up for by a rise in demand in another. However, it is not an efficient way of doing business, as the different activities undertaken require completely different skills and specialisations.

Not all mergers are successful, and there may be circumstances in which merged firms choose to demerge and split. A common factor which can lead to this is where firms from different countries merger, only to find their corporate cultures are incompatible. However, this can happen even to firms in the same country, where the management styles of the two mergees are completely at odds.  In other situations, it may be that the expected synergies between the production activities of the firms are not as strong as thought. Demergers can turn out to be costly and acrimonious.

Globalisation

Globalisation, which has been on the increase since the 1980s, has had a significant effect on the growth of firms. In particular, transactions have become quicker and easier with the development of transportation and communication technology. The whole process of marketing goods and services has been revolutionised with the speed of the internet and e-commerce.

In some markets, this has led to the growth of giant firms operating in global markets. One motive for mergers and acquisitions has been defensive to try to compete with other large firms in the global market.

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