chapter 18 – expansion. what is ‘expansion’? expansion means ‘getting bigger’. it involves...

Chapter 18 – Expansion

What is ‘Expansion’? Expansion means ‘getting bigger’. It involves

Selling more products Entering new markets Obtaining more assets

One of the main aims of any business is to expand and increase profits.

eg.: Dunnes Stores has 150 Stores today compared with one when it started in 1944.

Reasons for Business Expansion

1. Profits and Sales More products = more sales = more

profit.Economies of Scale

A business might wish to expand (to sell more products in new places). If they sell more they have to produce in larger amounts.

A firm’s fixed costs are spread over a greater number of units.

This means that the cost of producing each unit decreases.

If a business grows, sales go up, costs per unit fall and profits will also rise

2. Safeguard Supplies If a business is very dependant

on certain raw materials, then it may make business sense to expand into production of these supplies

eg.: A butcher buys a small farm to rear and produce his own meat

3. Eliminate Competition A business might become bigger by taking over one

of its competitors. It can now sell its products to its competitor’s customers and therefore increase sales and profits.

Eliminates a threat from the market E.g.: Ryanair’s bid to takeover Aer Lingus

4. Asset Stripping This happens when a business

takes over another company and has no intention of running that company.

eg.: A property developer takes over a hotel. He demolishes it to build houses instead.

5. Increase product range If a firm is looking to add to its product

range, it may consider taking over a company with products similar to their own.

A business might takeover another business to get its hands on that business’s ideas, products, technology, staff, market, etc.

eg.: In 2006 Adidas took over Reebok for €3.1 billion. Adidas was not well known in the U.S. for sports equipment and clothing but Reebok was. By buying Reebok, Adidas now controls 20% of the US market.

Finance for Expansion The finance needed for business

expansion is mainly long-term finance.

There are 3 types of Finance1. Equity Capital2. Debt Capital3. Grants

1. Equity Capital It is money that is put into the business

by its owners. It does NOT have to be paid back

There are at least 4 sources of equity capital: Additional Owner’s Capital Issuing Shares Retained Earnings Venture Captial

2. Debt Capital The entrepreneur raises money to pay

for expansion by borrowing money from banks and finance companies.

This money has to be repaid with interest.

One long term loan available to companies is called a Debenture.

If the loan is not repaid the lenders can take a businesses assets (eg.: stock, machinery, vehicles, buildings, etc.)

3. Grants Non-repayable sums of money Obtain from the Government,

Enterprise Ireland Must obey/reach certain conditions. Grants can be used:

To train staff For R&D Purchase Fixed Assets Carry out feasibility studies

Choosing Finance for Expansion

1. Cost The manager should choose the cheapest

form of finance. This helps to lower cost and increase profits.

With equity finance, owners must pay dividends. They must decide on the size of the dividend. If profits are low they can pay a small or no dividend.

With debt finance, owners need to pay interest. Interest is fixed and must be repaid regardless of profits or losses being made.

2. Security No security is needed for equity

finance, so there is no risk of loosing assets.

Security is needed for debt finance, so there is a risk of loosing assets.

3. Tax Implications Interest on loan capital is tax

deductible and can save you money. 4. Control With equity capital, the owner looses

some control over their business. With debt capital they do not.

Methods of Expansion

1. Organic Growth Organic Growth is the growth of the

business from within. Organic Growth involves:

developing new products, opening new branches, etc.

Doesn’t build up big debts Ownership and control of the business

not affected Time Consuming

A business can expand internally by:

1. Increasing Sales Domestically Improve its product by promoting

and advertising. This also may involve opening

new branches. eg.: Meteor. It grew by keeping

its prices low and using ads to tell customers how low it’s prices were.

2. Exporting If domestic market is saturated As a member of the EU, Ireland

can trade freely with other EU countries.

Exporting outside EU is difficult because of language, transport, rules and regulations, etc.

3. Franchising A business may have an established name

and logo. Instead of opening up new branches of the

business themselves, management may decide to franchise out the name.

This allows another person to open an identical branch of the firm in exchange for a fee and a percentage of sales.

eg.: O’Briens Irish Sandwich Bars, McDonald’s

4. New Products/Services The firm may add to the range of

products/services it provides. R&D is very costly but customers are

always interested in buying new goods and services.

Eg: Aer Lingus’s expansion programme, it started long-haul flights to Dubai in 2006.

Inorganic Growth

Inorganic Growth is the expansion of the firm with the involvement of an outside company.

It is quicker. It requires a lot of finance. It increases the risk of it going

bankrupt.

There are 3 different types of Inorganic Growth:

1. Acquisition/Takeover2. Alliance/Joint Venture3. Merger/Amalgamation

1. Acquisition/Takeover This is where one company gets control of

another by buying it outright. Takeovers can be friendly. This is when the

company being taken over is welcome to it. Takeovers can be hostile. This is when the

management of the company doesn’t want it to be taken over by a firm.

Eg: Eircom’s purchase of Meteor for €420 million Growth takes place quickly by instantly

increasing the customer base.

2. Alliance/Joint Venture This is when two firms agree to

help each other on one project for the mutual benefit of both.

They share resources However, both firms remain

separate entities E.g.: McDonald’s and Disney

Benefit of Alliances include the following.

Both parties benefit through shared skills, marketing and sales, etc.

The alliance is a voluntary, temporary arrangement and so can be easily ended.

It increases the range of services that each firm has to offer,

Makes both businesses more competitive

3. Merger/Amalgamation A merger is when two separate

businesses join together A permanent move agreed

between both firms. Biggest reason is to cut costs –

provides economies of scale Eg: Irish Permanent and TSB

Implications of Expansion Finances Short Term The business may have to raise finance

to pay for the expansion. This may involve selling shares or borrowing.

Long Term As the business grows it will be easier to

obtain debt and equity capital in the future as investors have more confidence in the business.

ProfitsShort Term

The costs of expansion (paying for the new business, redundancy packages, etc.) may lead to a fall in profitsLong Term

Economies of scale and increased sales will mean profits will rise. These profits can be used as retained earnings

EmployeesShort Term

Uncertainty about the future may lead to poor morale and low productivity

As a business expands, it tries to cut costs which might lead to redundancies.Long Term

Bigger businesses provide better pay, more job security, better training and increased promotion prospects for employees.

This should mean that staff morale improves in the long term

Consumers Short Term Consumers can enjoy a bigger (and newer)

range of products giving consumers more choice.

Economies of scale mean the products can be bought at lower prices.

Long Term Consumers benefit from more goods at lower

prices but might be put off by the impersonal nature of big business

Importance of Irish Business Expansion in Domestic Markets

1. Irish expansion has a spin off effect on other Irish businesses such as suppliers and service providers.

2. Large firms employ more people and make more profits They contribute large amounts of tax revenue, which is re-invested in the country.

3. Exports increase. This leads to an improvement in Ireland’s Balance of Trade and Balance of Payments.

4. Expansion reduces unemployment levels.5. R&D increases. This improve the quality of

products and services.

Importance of Irish Business Expansion into Foreign Markets

Expansion abroad increases Sales Employment Cost of living Wealth, in Ireland

Expansion abroad increase the profile of Irish business and Ireland as a country. E.g. Kerry Group