Pros & Cons of External Expansion
Economics: Edexcel A A Level, topic 5.1.3
Advantages of Integration
External expansion is growth achieved by acquiring another business. Mergers happen when 2 firms combine to make 1 large company (e.g. Disney and Pixar in 2006). In takeovers, 1 firm buys a controlling stake (50%+) of another firm (e.g. Virgin Active and Esporta in 2011). Advantages of external expansion are:
Rapid expansion
- The key benefit of external expansion is the speed with which firms can expand.
- For example, in 2014 Facebook bought WhatsApp for $19 billion. This is a large amount of money but it instantly gave Facebook 700 million customers. This was an example of horizontal integration.
Reduce competition
- A firm can merge with or take over a competitor.
- This can reduce the amount of competition that a business faces. It can also increase market share and let the company benefit from economies of scale.
- For example, in 2004, the Morrisons supermarket company took over Safeway supermarkets. This increased the number of Morrisons stores to over 500 from 120. Morrisons’ market share rose from 6.4% to almost 15%. This was another example of horizontal integration.
Diversify (spread) risk
- A firm can merge or take over a firm in a different industry. This makes the company less reliant on its existing products/services and can diversify (or spread) a company’s risk.
- For example, in 2011, Microsoft (an operating system company) bought Skype (a video calling company). This was either a conglomerate integration or a horizontal integration.
Disadvantages of Types of Integration
Mergers and takeovers can be extremely risky. More than half of mergers and takeovers are unsuccessful.
Complicated
- The costs of a merger/takeover can outweigh the benefits.
- For example, the two businesses’ operations will have to merge.
- If 2 businesses employ 5,000 people in 30 countries, combining this operations would not be easy or straightforward. This can lead to diseconomies of scale.
Demotivated employees
- Employees may be demotivated due to different management style and culture.
- When Virgin Active took over Esporta Health Clubs, personal trainers and other gym staff became frustrated with new working practices. Staff turnover increased significantly after this takeover.
- Daimler (the company that makes Mercedes cars) merged with Chrysler in the late 1990s. The company had very different cultures and in 2007, Chrysler was sold by Daimler to an investment company.
Tension and lost jobs
- Mergers and takeovers often lead to attempts to cut costs.
- Attempts to cut costs often lead many people to lose their jobs and this can create tension in a workforce.
- This happened when Morrisons took over Safeways supermarkets in the UK in 2004.
Test yourself on Pros & Cons of External Expansion
What is a merger?
What are some advantages of external expansion?
What are 3 disadvantages of mergers and takeovers?
Daimler (the company that makes Mercedes cars) merged with Chrysler in the late 1990s. The companies had very different cultures with regards to staff treatment and, in 2007, Chrysler sold Daimler to an investment company. Why was this merger unsuccessful?