Business Growth
Unit 3: Business Decisions and Strategy
Business Growth
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Economies of scale are the fall in cost per unit as a business grows. Internal economies come from the firm's own size: how it buys, produces, manages, borrows and markets.
The objectives of growth are what a business hopes size will bring. The first is economies of scale: as output rises, the cost per unit (average cost) falls, because many costs rise more slowly than output does.
Internal economies of scale arise inside the business, from its own size. Five kinds are usually named. Purchasing: large orders win discounts from suppliers. Technical: a larger firm can afford bigger, more efficient equipment and spread its cost over more units. Managerial: it can employ specialists, such as a full-time buyer or accountant, instead of managers who do a bit of everything.
Financial: lenders see a large firm as less risky, so it can borrow more, and more cheaply. Marketing: the cost of a campaign is spread over more sales, so each sale carries less of it.
Tanjong Bakes, a Singapore bakery-café chain, supplies its 40 cafés from one central bakery. Its flour order is large enough to win a discount a single café never could, and the cost of its head-office team and its advertising is shared across every café.
Economies of scale lower cost per unit, not total cost. A bigger firm spends more in total; each unit simply costs less to make and sell.
Real Example: A shipping line in Hong Kong ordered container ships twice the size of its old ones. Each voyage cost more to run, but it carried so many more containers that the cost of moving each one fell sharply.
Exam Matters: Name the particular economy the case gives evidence for, such as bulk buying or a larger machine, and explain how it lowers cost per unit for that business rather than listing all five.
External economies of scale are cost savings a firm gains because its whole industry has grown in an area, not because the firm itself is bigger.
External economies of scale come from outside the business. When an industry grows and gathers in one place, every firm there can gain, whatever its own size.
The main sources are a pool of skilled labour, because workers have already been trained by other firms and local colleges teach the industry's skills; specialist suppliers and repair firms that set up nearby because the industry is big enough to support them; and shared infrastructure, such as roads, ports and research centres built with the industry in mind.
Singapore's food industry supports firms that service ovens, print packaging and train bakers. Tanjong Bakes can hire a qualified pastry chef, or get an oven repaired within a day, because so many food businesses operate nearby. A bakery in a remote town would pay more for both.
The difference matters when a firm is deciding how to grow. Internal economies grow with the firm; external economies depend on where it operates and on the health of its industry, neither of which it controls.
Real Example: Makers of surgical instruments clustered in one Pakistani city share specialist steel suppliers, polishing workshops and a pool of skilled workers, so even small firms there can produce at low cost.
Exam Matters: Decide whether a saving comes from the firm's own size or from its industry and location; that reason decides whether it is internal or external, and whether the firm can control it.
Beyond lower costs, firms grow to gain market power over customers and suppliers, a larger market share and brand recognition, and higher profitability.
Economies of scale are one objective of growth. Businesses grow for three further reasons.
Increased market power over customers and suppliers. A larger firm buys more, so its suppliers depend on its orders and accept lower prices or longer payment terms. With fewer rivals left, customers have fewer alternatives, so the firm can hold or raise its prices.
Increased market share and brand recognition. Market share is a firm's sales as a percentage of all sales in its market. More outlets and more advertising make its name familiar, and a familiar brand wins customers who would not try an unknown one.
Increased profitability. Lower costs, firmer prices and more sales can all raise profit. Growth is usually judged on this objective in the end: size that adds nothing to profit has achieved little for the owners.
Tanjong Bakes has 8% of Singapore's bakery-café market and makes a profit of S$6m a year. By growing it hopes to bargain harder with its flour supplier, become the chain shoppers think of first, and turn both into higher profit.
Real Example: A ride-hailing company in Southeast Asia grew until most drivers in its cities worked through its app. Its size let it set the commission drivers paid, and its name became the word passengers used for booking a ride.
Exam Matters: Link each objective to the case: which supplier the firm would have power over, which customers would recognise its brand, and what that would do to its profit.
Organic growth is a business expanding from within, using its own resources. Inorganic growth is expanding by joining with another business through a merger or takeover.
There are two routes to a bigger business. Organic growth, also called internal growth, means expanding from within: selling more, opening new sites or launching new products, using the firm's own resources and profits.
Inorganic growth, also called external growth, means expanding by combining with another business through a merger or a takeover. The firm grows at once by acquiring sales, staff and assets that someone else built.
The distinction between inorganic and organic growth is about how the extra capacity is obtained, not about how fast it arrives or how it is paid for. A firm that borrows to build its own new factory is still growing organically; a firm that buys a rival with cash it has saved is still growing inorganically.
Tanjong Bakes faces exactly this choice. It can open 15 cafés of its own over two years, or buy Golden Crust, a rival chain with 30 cafés, in a single deal.
Real Example: Two budget airlines in Southeast Asia chose different routes: one added aircraft and routes step by step from its own profits, while the other bought a smaller rival, with its aircraft and landing slots, in one deal.
Exam Matters: Classify the growth in the case by whether the business builds the new capacity itself or acquires another business, and quote the evidence in the case that shows which.
A business grows organically by adding outlets or capacity, launching new products, entering new markets or selling online, each built with its own resources.
The methods of growing organically all build on what the business already has. More outlets and capacity: more shops or branches, a bigger factory, longer opening hours. New products: developing items to sell to existing customers.
New markets: selling existing products to new customers, in a new region, a new country or a new group of buyers. Selling online: a website, an app or a delivery platform that reaches customers who never visit a shop.
Some firms spread their name faster by letting other businesses run outlets under it, through franchising or licensing; franchising as a form of business is covered in 2.3.1.
Tanjong Bakes is using several of these at once. Its plan is 15 new cafés over two years at S$400,000 each, paid for from retained profit. It has added an app for office deliveries, and it has agreed to sell frozen dough to supermarkets, a new market for something it already makes.
Each method uses resources the firm already has or can build step by step. That is what makes organic growth controllable, and also what makes it slow.
Real Example: A tea-shop chain in Kuala Lumpur grew from 12 outlets to 60 without buying anyone: it opened branches near universities, added a bottled-tea range for supermarkets and launched its own delivery app.
Exam Matters: Choose the method that suits the firm in the case, given its products, customers and resources, and explain why it would work for that firm, rather than listing every method.
Organic growth is lower-risk and keeps control and culture intact, but it is slow, limited by the firm's own finance, and may let rivals reach the market first.
Advantages of organic growth. The owners keep control: they choose each new site and product and can pause if one disappoints. Growth builds on what the firm already knows, so the risk of each step is lower. The culture stays the same, because no other workforce has to be absorbed. It can often be financed from retained profit, so no new debt is needed.
Disadvantages of organic growth. It is slow: each outlet has to be found, fitted out and filled with customers. It is limited by the finance the business can generate, so growth may not keep up with the market. Rivals that grow faster, especially by takeover, may win the best sites, the biggest customers and the economies of scale first.
For Tanjong Bakes, 15 new cafés keep the risk small and its kitchens working the way they always have. But the plan reaches only 55 cafés in two years, while buying Golden Crust would reach 70 at once.
Real Example: A family-run pharmacy chain in Nairobi grew only as fast as its profits allowed, opening two or three branches a year. It never took on debt, but a better-funded rival bought up the best high-street sites first.
Exam Matters: Weigh the speed organic growth gives up against the control it keeps, using the case: how fast the market is moving, and whether the firm can fund enough growth from its own profits.
In a merger two firms agree to combine into one on roughly equal terms; in a takeover one firm buys control of another by acquiring over half of its shares.
Mergers and takeovers are the two ways of growing inorganically. The distinction between mergers and takeovers is about how control changes. In a merger, two businesses agree to join into a single firm, usually on roughly equal terms, and the owners of both swap their shares for shares in the combined business.
In a takeover, also called an acquisition, one business buys a controlling interest in another: more than half of its voting shares. The target's directors may welcome the bid, a friendly takeover, or oppose it, a hostile one. In a hostile bid the buyer goes directly to the shareholders, and normally has to pay them well above what their shares were worth before the bid.
Reasons for mergers and takeovers. Speed: capacity, customers and staff arrive at once. Market power and market share: a rival bought is a rival removed. Cost savings from combining, such as one head office and bigger orders, sometimes called synergy. Access to products, brands, skills or markets the firm lacks. Securing supplies or outlets. Spreading risk across more than one market.
Buying Golden Crust would give Tanjong Bakes 30 cafés, their customers and their bakers at once, lift its share of the market from 8% to 14%, and let one central bakery supply both chains.
Real Example: Two regional banks in the Gulf merged to form one of the region's largest lenders. Neither bought the other: the owners of both received shares in the new bank, and branches serving the same neighbourhoods were closed.
Exam Matters: When firms in the case combine, decide whether it is a merger or a takeover from how control changes, then explain the reason for the deal that the case gives evidence for.
Horizontal integration joins firms at the same stage of production. Vertical integration joins firms at different stages: backward towards suppliers, forward towards customers.
Every product passes through stages of production: raw materials, processing or manufacturing, distribution, and selling to the consumer. A merger or takeover is classified by where the two businesses sit in that chain.
Horizontal integration combines two firms at the same stage of the same industry, usually rivals. It brings market share, market power and economies of scale most directly, and it is the kind a country's competition authority is most likely to examine.
Vertical integration combines firms at different stages of the same chain. Backward vertical integration moves towards the raw materials: owning a supplier secures supplies, controls quality and removes the supplier's profit margin from the buyer's costs. Forward vertical integration moves towards the consumer: owning a distributor or retailer secures outlets and brings the firm closer to its customers.
For Tanjong Bakes, buying Golden Crust is horizontal, since both run bakery-cafés. Buying Straits Flour Mill, which supplies its flour, would be backward vertical; buying a delivery company that carries its dough to supermarkets would be forward vertical.
Real Example: A palm oil refiner in Malaysia bought plantations to secure its supply of fruit, and later bought a cooking-oil brand sold in supermarkets, extending the business in both directions along the same chain.
Exam Matters: Place both firms in the chain from raw materials to consumer, state which stage each occupies, and name the direction; then explain what that kind of integration gives this particular buyer.
A conglomerate is a business that owns firms in unrelated markets. Growing this way spreads risk, but gives little of the cost savings a linked takeover brings.
A conglomerate is a business made up of firms operating in unrelated markets. Conglomerate integration is a merger or takeover between businesses with no link in the chain of production: neither supplies, buys from nor competes with the other.
Why grow this way? Chiefly to spread risk: if demand falls in one market, profits from the others keep the group going. It can also put spare cash to work, or buy a way into a growing market the firm could not enter from scratch.
The drawbacks. Few cost savings are available, because the businesses share no suppliers, factories or customers. Managers may not understand the markets they have bought into. And investors can often spread their own risk more cheaply by holding shares in several firms, so the stock market may value a conglomerate at less than its parts would be worth separately.
If the owners of Tanjong Bakes bought a laundry chain, that would be conglomerate integration. It would protect them if the café market weakened, but the laundries would share nothing with the bakeries except their owners.
Real Example: A family-owned group in Nigeria runs cement plants, sugar refineries and a salt business side by side. A slump in building work hurts one division, while food sales keep the group's cash flowing.
Exam Matters: When a buyer in the case enters an unrelated market, weigh the risk it spreads against the savings and expertise it gives up, and say which matters more for that business.
A takeover's rewards are the profit and cost savings it adds; its risks are paying too much, the cost of financing the deal, and savings that never appear.
Financial rewards. The buyer gains the target's profit, plus any cost savings from running the two businesses as one. Greater market power may also raise prices or lower input costs. If these gains are worth more than the deal cost, the owners are better off.
Financial risks. The buyer usually pays a premium: more than the value of the target's net assets, and more than its shares were trading at, to persuade the owners to sell. If the expected profit and savings do not arrive, that premium is lost. A deal financed by borrowing adds interest that must be paid whatever happens, and raises gearing. One financed by issuing new shares dilutes the existing owners' control and their share of future profit.
A worked case. A gym chain pays S$50m for a rival whose net assets are worth S$32m, a premium of S$18m. The rival earns S$4m a year, and combining the two should save S$1m a year. The chain borrows S$30m at 5%, so interest is S$1.5m a year, and the yearly gain after interest is S$3.5m, provided the savings arrive.
So the reward is uncertain and arrives over years, while the premium and the debt are fixed on the day the deal is signed.
Real Example: A listed food group in Hong Kong paid well above market value for an overseas snack brand. Its sales fell short of the forecast, and within three years the group had written off most of the premium as a loss.
Exam Matters: Where the case gives figures, set the yearly gain (the target's profit plus any savings, less interest) against the price paid, and judge how certain each part of that gain is.
Inorganic growth is fast and brings market share, skills and economies of scale at once, but it is costly, risky and hard to integrate.
Advantages of inorganic growth. It is fast: a firm can double in size in one deal. It buys an established market share, customers and brand, and may remove a rival. It brings skills, products or technology the buyer lacks, and it can deliver economies of scale sooner than building capacity would.
Disadvantages of inorganic growth. It is expensive, and the premium may never be recovered. It is risky, because the buyer knows its target less well than its own business. Integration is hard: two sets of systems, pay scales and ways of working must become one, and where the two cultures clash, staff leave and the expected savings shrink. A deal between rivals may also be blocked, or allowed only on conditions, by the competition authority.
Golden Crust would take Tanjong Bakes to 70 cafés at once, but its bakers are used to their own recipes and routines, and Tanjong Bakes's standardised kitchens may not suit them.
Real Example: When two airlines in Southeast Asia merged, joining their booking systems and pay scales took several years. Cabin crew from each airline kept working different rosters long after the deal.
Exam Matters: Balance the speed and market share a takeover brings against its cost and the difficulty of combining the two businesses, using what the case says about each firm.
Choosing between organic and inorganic growth depends on how fast the market is moving, what the firm can afford, and how well the two businesses would fit.
A question on growth often asks for a judgement: should this business grow organically or by taking over another? A strong answer weighs both routes against the firm's circumstances and says what the choice depends on.
For organic growth at Tanjong Bakes. Fifteen new cafés over two years are paid for from retained profit, with no debt. Each café can be placed where Tanjong Bakes chooses and run its way, and if one site disappoints, the next can be changed.
For the takeover. Golden Crust brings 30 cafés, a larger share of the market and trained staff at once. Baking for 70 cafés in one central bakery should lower the cost of each loaf, and a rival would be gone.
The judgement. The takeover is better only if its extra speed and share are worth the premium and the debt. That depends most on whether the savings from combining actually arrive, which depends in turn on how readily the rival's bakers adapt. If rivals are racing for sites, speed matters more and the takeover is stronger; if not, organic growth delivers much of the gain for less risk.
Real Example: A pharmacy chain in the Gulf grew organically for years, then bought a smaller rival when a change in health rules opened its market quickly. For that one decision, speed mattered more than control.
Exam Matters: End with the condition your judgement depends on, such as whether the savings from combining are likely to be achieved, rather than a flat recommendation.
Diseconomies of scale are rises in cost per unit when a business grows too large, caused by problems of coordination, communication and motivation.
Growth does not lower costs for ever. Beyond some size, diseconomies of scale set in: cost per unit starts to rise as the business grows, because it becomes harder to run.
Coordination. With more sites, products and departments, it is harder to keep everyone working to one plan, so duplication and waste creep in. Communication. Messages pass through more people and more layers, so they arrive later and are more often misunderstood. Motivation. In a very large organisation staff can feel like a small, unnoticed part of the whole, so effort falls and absence and staff turnover rise.
Together, economies and diseconomies explain why cost per unit tends to fall as a firm grows, level out, and eventually rise. Growth pays only while the savings from size outweigh the extra cost of managing it.
After a takeover, Tanjong Bakes would have 70 cafés and 1,500 staff under two brands. If café managers wait longer for decisions and staff at the former Golden Crust cafés feel overlooked, the cost of each loaf sold could rise even while the central bakery bakes each loaf more cheaply.
Real Example: A fast-growing budget hotel group in India opened hundreds of properties in a few years. Standards varied from hotel to hotel, complaints rose, and head office had to hire whole teams just to inspect its own sites.
Exam Matters: Identify the cause of diseconomies the case gives evidence for, whether coordination, communication or motivation, and explain how it would raise cost per unit for that business.
As a business grows, internal communication gets harder: more layers and more people slow messages down and distort them, and managers lose touch with the front line.
Internal communication is the passing of information within a business: instructions down, feedback and ideas up, and coordination across departments. A small firm does most of it face to face. Growth makes it harder in three ways.
More layers of hierarchy. Each extra layer of management between the top and the front line is one more point where a message can be delayed, shortened or misread. More people and sites. Information must reach more staff in more places, often in writing, so it travels more slowly and is discussed less. More specialist departments. Each develops its own priorities and jargon, so departments talk to each other less.
Tanjong Bakes has 3 layers of management today; running 70 cafés would take 5. A café manager who reports that customers dislike a new recipe would then wait while the message passes through two more people before anyone acts on it.
Firms respond with clear reporting lines, regular briefings, shared digital systems, and by letting local managers decide without waiting for head office.
Real Example: A bank in Kenya with branches across the country found that product changes decided in Nairobi reached rural branches weeks late. It set up a weekly video briefing for every branch manager, and complaints about wrong information fell.
Exam Matters: Explain how the growth in the case, whether more layers, more sites or more staff, damages communication, and what that does to decisions, costs or customers for that business.
Overtrading is growing faster than working capital can support: the firm pays for stock, staff and sites before customers pay, and runs short of cash while still profitable.
Overtrading happens when a business expands too quickly for the cash it has available. It takes on more orders, sites or staff than its working capital can fund, so it cannot pay suppliers and wages on time, even though it may be making a profit on paper.
The cause is timing. Growth means paying out first, for materials, wages and new premises, while the revenue from the extra sales arrives later, especially when customers are given credit. The faster the growth, the larger that gap. Profit is not cash, and a business that cannot pay its bills can fail however full its order book is.
Tanjong Bakes's supermarket deal shows the risk. The supermarkets pay for frozen dough 60 days after delivery, but Straits Flour Mill must be paid within 30 days. If Tanjong Bakes also pays for new cafés out of its cash, it could run short of money to pay its suppliers at the very time its sales and profit are rising.
Avoiding it. Forecast cash flow before expanding; grow in steps; arrange an overdraft or longer-term finance before it is needed; and negotiate shorter credit for customers or longer credit from suppliers.
Real Example: A furniture maker in Vietnam won a large order from an overseas retailer that paid 90 days after delivery. It bought timber and hired workers at once, and within two months could not pay its timber supplier, though the order itself was profitable.
Exam Matters: Show the timing gap from the case, when the firm pays out and when it is paid, and explain why that gap matters more the faster the business grows.
Economies of scale are the fall in cost per unit as a business grows. Internal economies come from the firm's own size: how it buys, produces, manages, borrows and markets.
External economies of scale are cost savings a firm gains because its whole industry has grown in an area, not because the firm itself is bigger.