Methods of Growth
Organic and Inorganic Growth
Unit 2.1.1 covers why firms grow. This page is about how. There are two routes.
Organic growth: growth from within the business, using its own resources, such as selling more, launching new products or opening new sites. It is also called internal growth.
Inorganic growth: growth by joining with another business through a merger or a takeover. It is also called external growth.
- A merger is when two firms agree to combine into one.
- A takeover (or acquisition) is when one firm buys enough of another's shares, more than half, to control it.
| Organic | Inorganic | |
|---|---|---|
| Speed | Slow, one shop or product at a time | Fast: customers, staff and brands arrive at once |
| Finance | Often paid for out of retained profit | Expensive, as buyers usually pay above the firm's market value; often needs loans or new shares |
| Risk | Lower: the firm grows in markets it knows | Higher: the firm may overpay or fail to combine well |
| Control and culture | Owners keep control and the culture stays intact | Shares issued to pay can dilute control; two cultures must be merged |
The trade-off, as chains:
- Organic: growth paid for from profit → little debt and no clash of cultures → lower risk. But it is slow → a rival may win the market first, and the firm takes years to reach the scale where average cost is lowest.
- Inorganic: buy another firm → instant market share and economies of scale. But the price is high and often borrowed → interest costs rise, and if the two firms do not combine well → the promised savings never arrive.
Which route is better depends on:
- The finance available: a small firm with modest profits may have no choice but to grow organically.
- How fast the market is moving: in a fast-growing market, waiting years to build up can mean losing it to rivals.
Horizontal, Vertical and Conglomerate Integration
Integration: two businesses coming together under one owner, through a merger or a takeover.
The type of integration depends on what the other firm does. The examples follow a brewery, which buys malted barley, brews beer and sells it to pubs and shops.
| Type | Joins with | The brewery buys |
|---|---|---|
| Horizontal | A firm at the same stage of the same industry | Another brewery |
| Backward vertical | A supplier, at an earlier stage | A maltings that supplies its barley |
| Forward vertical | A customer, at a later stage, closer to the consumer | A chain of pubs |
| Conglomerate | A firm in an unrelated market | A bicycle maker |
Horizontal Integration
Horizontal integration: joining with a firm in the same industry at the same stage of production, usually a competitor.
- For the firm: two breweries become one → bigger orders and shared costs → economies of scale and a larger market share → lower average cost and more market power.
- For consumers: one fewer competitor → less pressure on price → higher prices and less choice, unless the cost savings are passed on.
- For workers: two head offices and two sales teams doing the same job → one is cut → job losses.
This is the type the competition authorities watch most closely. In April 2019 the CMA blocked a merger of Sainsbury's and Asda, finding it would lead to higher prices and lower quality and range for shoppers (unit 4.2.2).
Vertical Integration
Vertical integration: joining with a firm at a different stage of the same supply chain. It runs in two directions.
- Backward vertical integration: buying a supplier. The brewery buys a maltings → a secure supply of malt, and control over its quality and cost → it keeps the profit the maltings used to make, and can stop rivals getting the best malt.
- Forward vertical integration: buying a customer or outlet. The brewery buys a chain of pubs → a guaranteed place to sell, and control over how its beer is served → it keeps the pub's profit margin and learns directly what drinkers want.
The risk is that the firm is now running a business it does not know: a good brewer is not automatically a good publican. It also loses flexibility: if another maltings becomes cheaper, it is tied to its own.
Conglomerate Integration
Conglomerate integration: joining with a firm in an unrelated market.
The main reason is to spread risk. The brewery buys a bicycle maker → a fall in beer sales no longer hits the whole business → profits are more stable. But there are few shared savings, and managers who know little about bicycles → poor decisions and diseconomies of scale.
Whether any integration pays off depends on:
- Its purpose: a deal with a clear source of savings or market power, such as horizontal integration, is easier to justify than one made mainly to get bigger.
- Culture: a clash between the two workforces can wipe out the gains (unit 2.1.1).
- The regulators: a deal that cuts competition may be blocked, or allowed only if the firm sells part of the business.
Name the type from what the two firms do. A supermarket buying a bakery that supplies it is backward vertical, not horizontal, even though both sell bread. Then let the type pick your analysis: market power for horizontal, control of the supply chain for vertical, spreading risk for conglomerate.
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