What you'll learn

• How firms grow through internal growth and external growth.
• The difference between horizontal, vertical and conglomerate integration.
• Why growth can reduce costs, increase revenue and strengthen market power.
• How to evaluate the possible benefits and costs of mergers for firms, consumers and the wider economy.

What does “growth of firms” mean?

A firm grows when it increases its scale or size over time. This could mean higher output, higher sales revenue, more employees, more stores, a larger asset base, or a bigger share of the market.

Be careful: one measure can rise while another falls. For example, a firm’s sales revenue might increase because prices rose, even if it sold fewer units.

A useful calculation is percentage change:

$$Percentage\; change=\frac{new\; value-old\; value}{old\; value}\times 100$$

The two main ways firms grow

Firms can grow internally or externally.

The main routes are shown below: internal growth happens inside the firm, while external growth happens through integration, mergers or takeovers.

Internal growth

Internal growth is usually steadier and lower-risk. For example, Greggs opening more UK stores, expanding delivery options, or investing in production capacity would be internal growth.

Common methods include:

• reinvesting retained profit into new machinery, stores or technology
• hiring and training more workers
• launching new products
• increasing advertising and brand awareness
• expanding into new regions or online markets

The benefit is that the firm keeps more control over its culture and strategy. The drawback is that it can be slow, especially if rivals are expanding quickly through acquisitions.

External growth

External growth is often faster because the firm gains another firm’s customers, assets, staff, brand or technology immediately.

A merger happens when two firms agree to combine. A takeover, also called an acquisition, happens when one firm buys control of another firm. Integration means firms joining together under common ownership.

External growth can bring quick access to new markets, but it can be expensive and difficult to manage.

Types of integration and mergers

Horizontal integration

Horizontal integration happens when two firms in the same industry and at the same stage of production combine.

For example, if two supermarket chains merged, that would be horizontal integration. In the UK, the Competition and Markets Authority, or CMA, blocked the proposed Sainsbury’s-Asda merger in 2019 because of concerns about reduced competition and possible higher prices.

Potential benefits include:

• larger market share
• economies of scale
• reduced duplication, such as fewer head offices or warehouses
• greater bargaining power with suppliers

Potential costs include:

• less competition and choice for consumers
• job losses from closing duplicated stores or departments
• investigation or blocking by competition regulators

Vertical integration

Vertical integration happens when firms at different stages of the same production process combine.

There are two directions:

• Backward vertical integration: a firm buys or merges with a supplier. For example, a bakery buying a flour mill.
• Forward vertical integration: a firm buys or merges with a distributor or retailer closer to the consumer. For example, a manufacturer opening its own retail stores.

Vertical integration can help a firm control quality, secure supplies and reduce uncertainty. This became especially relevant after global supply-chain shocks, when some firms wanted more control over inputs and delivery.

Conglomerate integration

Conglomerate integration happens when firms in unrelated industries combine.

For example, a technology firm buying a food delivery business would be conglomerate integration if the two firms operate in clearly different markets.

The main reason is usually diversification, which means spreading risk across different markets. If one market performs badly, another may perform better.

Why do firms want to grow?

The basic aim is often higher profit, but the route to profit can vary. A firm may want lower costs, higher revenue, stronger market power, reduced risk, or greater long-run survival.

Growth and economies of scale

Average cost means cost per unit:

$$AC=\frac{TC}{Q}$$

where AC is average cost, TC is total cost and Q is output.

This links growth directly to the “costs, revenues and profits” part of the course. If growth lowers average cost while price stays the same, profit per unit rises.

Economies of scale can come from:

• Purchasing economies: buying inputs in bulk at lower prices.
• Technical economies: using larger, more efficient machinery.
• Managerial economies: employing specialist managers.
• Financial economies: borrowing at lower interest rates because lenders see the firm as less risky.
• Marketing economies: spreading advertising costs across more units.

Growth and market power

A larger firm may gain more market power. This can let it charge higher prices, negotiate better deals with suppliers, or spend more on advertising. However, from society’s viewpoint, this can be a problem if consumers face higher prices, lower quality or less choice.

Possible benefits of growth and mergers

For the firm, growth may lead to:

• lower average costs through economies of scale
• higher sales revenue and profit
• greater brand recognition
• more bargaining power with suppliers
• access to new technology, skilled workers or intellectual property
• easier entry into new markets, including international markets
• risk spreading through diversification
• improved survival against large global competitors

For consumers, growth can be beneficial if cost savings are passed on as lower prices or better products. For example, a larger firm might be able to invest more in research and development, improving product quality.

For the wider economy, successful growing firms can increase employment, investment and exports. This matters for UK firms trying to compete internationally after Brexit-related trade frictions and during periods of high global competition.

Possible costs of growth and mergers

Growth can also create problems.

The key internal risk is diseconomies of scale, which are increases in long-run average cost as a firm becomes too large. Communication may become slower, managers may lose control, workers may feel less valued, and decision-making may become bureaucratic.

Mergers can also fail because of integration problems. Different IT systems, workplace cultures and management styles may clash. The expected synergy, meaning the extra benefit from combining firms, may not appear.

External growth can be expensive too. If a takeover is funded by borrowing, higher interest rates, such as those seen during the Bank of England’s tightening after the inflation surge, can make debt repayments more costly.

For consumers, the biggest concern is reduced competition. A horizontal merger may create a firm with enough market power to raise prices or reduce quality. For workers, mergers can mean redundancies if duplicated roles are removed.

How to evaluate whether growth is worthwhile

In essays, avoid saying “growth is good” or “mergers are bad” too quickly. The judgement depends on context.

Growth is more likely to be beneficial when:

• the industry has large economies of scale
• management can integrate the businesses effectively
• demand is growing, so extra output can be sold
• cost savings are passed on to consumers
• competition remains strong enough to limit price rises

Growth is more likely to be harmful when:

• the firm becomes too complex to manage
• the merger mainly creates market power rather than efficiency
• workers and consumers lose out
• the firm takes on too much debt
• regulators block or restrict the deal