ms. marshall 6th year business unit 51 1. reasons for expansion 2. methods of expansion 3. financing...

Ms. Marshall 6th Year Business Unit 5 1

Expansion

1. Reasons for Expansion

2. Methods of Expansion

3. Financing Expansion

4. Implications of Expansion

5. Importance of Expansion

Ms. Marshall 6th Year Business 2

Reasons for Expansion

Defensive Reasons

Offensive Reasons

Psychological Reasons


Defensive Reasons• Economies of Scale: this is the

idea that the bigger a company gets the lower its unit costs e.g. a big company may be able to get a cheaper rate from manufacturers because they buy in bulk.

• Protect Raw Materials Supplies: Backward Vertical Integration: a company might merge with or take over the firm it buys its supplies from, this will guarantee future supply, and at cost price. E.g. Fyffes have purchased its own banana plantations.

• To protect distribution: the business might merge with or take over the company that sells its products on to the consumer. E.g. a brewery buying a pub. This guarantees a market for their product, and may mean they can stop a competitor being supplied.

• Diversification: in order to defend itself from economic downturn a company may produce new products or take over or merge with a firm in a totally unrelated area. Diversification spreads the risk. E.g. Tesco supermarket also does insurance, mobiles. Gillette took over Parker Pens.


Offensive Reasons• Increase Profits: the desire to

increase profits for the owners is often motivation for expansion. If it grows large enough it may achieve a dominant position in the market, so it can increase prices without losing market share.

• Acquire new products: it may be cheaper or quicker to take over another company to get their new idea’s and products rather than start your own from scratch. E.g. Unilever bought Ben&Jerrys when they decided to enter the ice cream business.

• Eliminate Competition: trying to take over a competitor to gain control of the market. E.g. Ryanair tried to take over Aer Lingus in 2006.

• Asset Stripping: when a company is taken over and instead of continuing to run it, the assets are sold off for profit. E.g. in Wall Street Gordon Gekko buys an airline to sell off its assets.


Psychological Reasons

• Empire Building: Many business people are motivated by the desire to be ‘empire builders’, creating the largest business. E.g. Richard Branson of Virgin enjoy the challenge of setting up new businesses. When they are established, he puts managers in charge and moves onto the next company.

• http://ilovemarketing.com/episode-025-the-one-with-richard-branson/

• http://www.youtube.com/watch?v=DudfBIxw6do

• http://www.youtube.com/watch?v=BGwQjuD_8DA&feature=related

http://ilovemarketing.com/episode-025-the-one-with-richard-branson/




http://www.youtube.com/watch?v=DudfBIxw6do



http://www.youtube.com/watch?v=BGwQjuD_8DA&feature=related




Methods of Expansion

• 1. Develop New Products

• 2. Use Existing Products: Franchising, Exporting, Licensing.

• 1. Strategic Alliance• 2. Merger• 3. Takeover

ORGANIC INORGANIC


Organic Expansion

• Organic growth is also known as internally driven growth as it does not involve any outside firm.

• Strategy One: Develop New Products, i.e. Diversification. E.g. Glenisk yoghurt brought out products based on goats milk. Xtra Vision tried to bring in new products such as games and cards.

• Strategy Two: Use Existing Products: Franchising: means the renting of a complete business idea, including name, logo and product to someone else. E.g. McDonalds.


Franchising• Benefits to the Franchiser1. Quick and fairly risk free method of expansion. By using the franchisees'

capital, the franchisor is able to establish a large number of outlets in a short period of time. Rapid expansion can be achieved without incurring the overheads and costs associated with opening company-owned restaurants. The capital investment is therefore low.

2. The Franchiser still keeps control of the product. The franchisee must adhere to strict guidelines in order to maintain the license. E.g. in McDonalds the food has to be cooked the same way in all branches.

3. An owner will be more attentive than a manager. This is the central point which makes franchising so attractive. By franchising the business the franchiser places the expansion of his/her business in the hands of people who are motivated to make it work. Having invested, in many cases, their life savings in a franchise, franchisees will strive to make the co. successful. Their livelihood depends on it.


Benefits to the Franchisee• Benefits to the Franchisee• Less risk of the business failing: It has a proven success rate. The name is well

known and customers are readily attracted to the business because of the established brand.

• Access to advice and training : the franchiser gives the new owner training and guidelines in all aspects of the business, e.g. staff training and management. Ongoing support will be provided with accounts, running the business and marketing.

• Reduced Advertising Costs: The franchisee benefits from the use of the brand image which is built up on a national basis. The franchiser pays for this national advertising. E.g. Dominos Pizza sponsoring the Xfactor, very few small pizza places could afford to do this.

• Economies of Scale: Because the head office buys stock for all the franchisees, they will get a discount. This means costs are reduced, giving the franchisee a competitive advantage over small independent competitors.


Franchise

• Example of franchise in Ireland: • Supermacs is Ireland’s largest indigenous fast

food restaurant group with a policy of continued expansion and growth. It now has 90 stores throughout Ireland and Northern Ireland. Pat Mc Donagh, the founder, has created a success story in the Irish restaurant industry. It has a total staff of over 2,500.


Drawbacks of Franchises• For the Franchiser1. Loses some of the potential profit from the product. If he was

running the business himself he could keep all the profit, not just a percentage.

2. Risk that a careless franchisee could damage the name: The reputation of the whole business could be affected by the actions of one franchisee , e.g. through poor quality standards or staff problems,

3. Control is lost over the day-to-day management of the franchise businesses. Strict guideline on all aspects of the business would need to be drawn up, implemented and monitored. However, even this will not give you the same level of control as running the company yourself would.


Drawbacks

• For the Franchisee• Cost: Bears the capital investment of setting up the

business and risk of failure. They must pay an annual fee to the franchiser each year. E.g. a percentage of the profits.

• They have little independence in the running of the business: The franchiser imposes restrictions and conditions on the running of the business. This leaves little room for individual flair and puts the entrepreneur under pressure to perform to a high standard.


Organic: Exporting & Licensing• New Markets: Exporting to foreign

markets can be very profitable and does not affect the ownership or control of the company. In 2007, Ireland exported some US$125 billion worth of goods led by machinery and equipment, computers, chemicals, pharmaceuticals, live animals and animal products. Topping the list of customers for Irish exports were the United States (18.7% of total exports), the United Kingdom (17.9%), Belgium (14.4%), Germany (7.8%), France (5.8%) and Italy (4.2%).

• Licensing: means allowing other firms to use or sell an invention or design in return for payment of a license fee or royalty.

• Licensing can be a fast, low cost and low risk expansion method for the firm selling the license.

• However, it does result in some loss of control and profits.

• For the firm acquiring the license it is low risk but the fee must be paid.

• E.g. Man. Utd. Earns millions from licensing the name and logo to different products.

In 2013 they were asked to evaluate two different methods of business expansion. Only one internal method was accepted in the marking. Franchise is typically the best

one to discuss.


INORGANIC GROWTH• Strategic Alliance/ Joint

Venture: this occurs when two or more firms agree to cooperate in the establishment of a project or business together. They remain separate companies but share skills and resources to maximise possibility of success, e.g. Swatch and Mercedes made the SMART car. Google have worked with Hyundai to integrate Google Maps into new car models.


Strategic Alliance/Joint Venture• Benefits• A comparatively cheap way of

expanding, as costs are shared.• The opportunity to expand

even if you lack a critical resource, providing your partner has it.

• Access to new skills, technology and markets.

• Either party can end the agreement relatively easily if they need to.

• Drawbacks• Control must be shared. • Profits must be shared.• There may be a clash of

company cultures.


Mergers

• A merger is when two companies voluntarily agree to join together permanently into one larger business, for their mutual benefit. Mutual consent is needed.

• E.g. Avonmore Plc and Waterford Plc merged to form Glanbia.

• A single new legal entity is formed once it is approved by shareholders.


Mergers• Benefits• It is a defensive strategy as the

merger may involve diversification into new product areas, which reduces the risk of the firm ‘having all its eggs in the on basket’.

• It is a quick form of business expansion, unlike the organic growth. Firms can access new technology and new markets quickly

• Costs will be reduced: economies of scale will result as they will be a bigger company. Resources will also now be pooled together which may lead to greater efficiencies.

• Drawbacks• Usually very expensive• Redundancies may result in some

employees losing their job to avoid duplication.

• Redundancies may lead to poor industrial relations.

• Good management is need to integrate the two companies.


• The biggest merger to date in U.S. history was that of Internet service provider America Online and media giant Time Warner. The merger was worth a reported $162 billion in January, 2001. Unfortunately, the arrangement never quite worked out as either company had hoped.

• Described as “one of the biggest failures in merger history” – arguably a fair assessment, even in light of the tech crash that forced AOL Time Warner to take a $99 billion loss in 2002. Today, the two companies are separate entities once again.


Takeover

• A takeover (acquisition) is when one company (Holding Company) takes control of another company (Subsidiary Company) by buying more than 50% of its shares.

• It can be hostile or friendly.• It is a quick form of

expansion. Firms can access new technology and markets very quickly.

• The acquiring company absorbs the other company, which loses its identity.

• E.g. Eircom bought Meteor in 2006 for €420 million.

• Google bought Motorola Mobility for €12.5 billion.


Recent exam questions• 2013 • Q6 (B) ‘For a business to survive it needs to grow and expand.’• Evaluate two methods of business expansion. (20 marks)• 2012• Q7 (C) Read the information supplied below and answer the question

which follows. (20 marks)• SuperToys Ltd, a large retail chain with 45 shops throughout Ireland, had

sales of €100 million in 2011. It has just commissioned a firm to design and manufacture a new range of soft toys for babies. These will be available for sale in its shops from Summer 2013. SuperToys Ltd plans to open its first shop in the UK in 2014.

• Discuss the possible reasons for business expansion and growth at SuperToys Ltd.


Recent Exam Questions• 2011 (25 marks)• Q6 (A) (i) Illustrate the difference between a merger and a takeover as

methods of business expansion.(ii) Discuss the benefits and risks of a merger as a method of expansion.

• 2010 Q6 A• Read the information supplied below and answer the questions which follow. • Marie Nolan is the owner of ‘Marie’s Pizzas’ a successful pizza restaurant

with a home- delivery service. Demand for take-aways has increased, as more people are eating at home due to the economic downturn. Marie is planning to expand her business through franchising and her accountant recommends that a business plan should be prepared before going ahead.

• (A) Evaluate franchising (benefits and risks) as a method of expansion for the Pizza business.

• (20 marks)


Recent Exam Questions• 2009 (20 marks)• Q5 (A) (i) Explain the term ‘business alliance’ • (ii) Illustrate the advantages of an alliance as a form of business expansion.

2006Paula and Thomas have recently returned to Ireland having worked with transnational companies for ten years. They wish to set up in business together in Ireland manufacturing a range of new organic breakfast cereals. Paula has particular expertise in production and finance and Thomas in marketing and human resources.

(B) In time, Paula and Thomas intend to expand the business into the EU market. (i) Describe the implications for the business of expansion. (don’t do this one yet)(ii) Explain two methods of expansion you would advise them to consider. (20 marks)


Sources of Finance for Expansion

Grants

Equity Capital

Debt Capital

Sale & Leaseback

Retained Earnings


Finance• Grants• A source of finance given to a

business by the Government or the EU, which does not have to be repaid, providing all the conditions of the grant are met.

• No loss of ownership or control of the business.

• No dividends, interest or repayments to be made (unless conditions are broken).

• Main sources of grants: County Enterprise Boards, Enterprise Ireland, IDA Ireland, EU.

• Equity• The entrepreneur

raises the money for expansion by selling shares in his company.

• Loss of ownership and control.

• Dividends have to be paid.

• 1 share = 1 vote.


Enterprise Ireland

• Enterprise Ireland has moved away from just giving grants and now opts for buying shares in these businesses (equity finance). If the company is successful, they can sell the shares at a later date and reinvest the money in another company.

• E.g. Enterprise Ireland invested made a profit of €11 million after selling shares they had invested in for Kingspan.


Finance

• Debt • Debentures are a long term

fixed interest loan secured on a valuable asset.

• No loss of control or ownership.

• Security needed. • E.g. When Largo Foods

bought Tayto this takeover was financed by debentures.

• Sale and Leaseback• A contract to raise cash by

selling a piece of property and simultaneously leasing it back on a long term lease.

• Loss of ownership.• Use of asset as before.• Used if the company seriously

needs a cash injection or to spread the cost of an asset.

• E.g. Celtic Helicopters sold an aircraft hangar to a Russian company and leased it back.


Finance

• Retained Earnings• The profits the business

has saved up. It can use these profits to pay for expansion.

• No interest.• E.g. Ryanair used some

of its retained earnings to buy a large number of shares in Aer Lingus.


Choosing Finance – Factors to Consider Cost – shop around.

Security – collateral needed?

Tax Implications Control

Grant No repayments

No security required

n/a No loss of ownership

Equity Pay dividends – co. decides how much

No security required

Dividends not tax deductible expense

Loss of control.1 share=1 vote

Debt Interest repayments – bank sets rate

Collateral required.

Tax deductible expense i.e. you pay less tax.

No loss of control

Sale & Leaseback

Rent payments. But big cash inflow.

n/a Rent is a tax deductible expense.

Loss of the asset e.g. building. No loss of shares.

Retained Earnings

Money has been put by – no interest

None. N/a No loss


Contrast Equity & Debt• Equity• Amount: potentially large amounts are

available if business is attractive to investors.

• Cost: dividends can be reduced during bad years. Company sets rate. There is no obligation to ordinary shareholders. However, if dividends are routinely small or not paid, this may adversely affect share price.

• Control: The issue of shares may dilute control of the business.

• Risk: low risk. The business is lowly geared. The business has no long-term debt and no interest repayments. Business less likely to become bankrupt, as fewer creditors.

• Permanent source of finance.• No security• Not tax deductible

• Debt• Potentially large amounts are available if

business is low risk.• Cost: Interest rates set by bank. Fixed

Interest repayments must be made e.g. Debentures Fixed Dividends e.g. 8% Preference Shares

• No loss of control: Debt capital used to finance the business will not impact on control of the business.

• High risk. Loan and interest must be repaid regardless of profit. Highly geared. Increased risk of bankruptcy – more creditors, who may seek to have business wound up and assets liquidated to pay debts.

• Must be repaid by a certain date. • Security must be provided.• Interest repayments are tax deductible


Implications of Business ExpansionFor Implications

Share Price Should increase as investors want shares in big successful companies.

Products Bigger range of products. More money for R&D. Marketing may become more complex.

Management/Org. Structure

New organisation structure needed. Greater delegation needed.

Finances Finance needs to be raised for expansion. As it succeeds it will be easier to raise more.

Supplies Quantity discounts available for bigger companies.

Profits Short term: costs involved in expansion e.g. redundancies. Long term: economies of scale.

Employees Mergers, takeovers often lead to redundancies. However, in the long term bigger successful companies can lead to secure, well paid jobs.

Customers Bigger range of products at a lower price. Impersonal?

Legal May need to change to a PLC.


Why do some businesses stay small?

• Easier to manage and keep control over a small business. Extra growth can mean extra work and responsibility.

• Less stress.• Communications easier.• Easier to keep staff motivated. Sense of team spirit.• A better personal service for customers.• Niche market offers a way of being very profitable

without needing to benefit from economies of scale.


Importance of Business Expansion• Expanding In Ireland• Bigger business tend to earn bigger

profits. This leads to more tax for the Government.

• Expansion leads to more direct employment. People must be hired for the extra jobs. This is crucial for the Irish economy at the moment.

• Expansion has a spin off effect for other Irish businesses . The company is buying more supplies and so creating indirect employment.

• Lower price for consumers as a result of economies of scale.

• Expanding Abroad• Increased exports leads to more

jobs in Ireland, both directly and indirectly.

• Improves Balance of Payments. It brings money into the country.

• Brings foreign currency into Ireland. This can be used to pay for imports.

• Improves international relations. Trade results in countries needing each other and promotes peace.


Recent Exam Questions• 2013 (20 marks)• Discuss the short-term and long term implications of business expansion

using the following headings:• Organisation Structure; Product Mix; Profitability; Employment.• 2012 (10 marks)• Distinguish between a merger and a franchise as methods of expansion.• 2011 (15 marks)• Distinguish between debt capital and equity capital as sources of finance

for the expansion of a business.• 2009 (20 marks)• Evaluate Debt and Equity Capital as sources of finance for business

expansion.

For the 2013 Q it helps to think of a particular type of expansion and discuss the

implications of this


Recent Exam Questions2006 (20 marks)

Paula and Thomas have recently returned to Ireland having worked with transnational companies for ten years. They wish to set up in business together in Ireland manufacturing a range of new organic breakfast cereals. Paula has particular expertise in production and finance and Thomas in marketing and human resources. In time, Paula and Thomas intend to expand the business into the EU market.

(i) Describe the implications for the business of expansion.(ii) Explain two methods of expansion you would advise them to consider. (you

should have this part done earlier)2005 Q5 (20 marks) + (20 marks)B) Discuss, using examples, the factors a manager should consider when

selecting sources of finance for expansion.C) Describe three reasons for business expansion other than to increase profit

ms. marshall 6th year business unit 51 1. reasons for expansion 2. methods of expansion 3. financing...

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