0264 · 1.3.3Why some businesses grow and others remain small

Reasons businesses grow

0:00Sunrise Bakery has loyal customers, busy mornings and an owner considering another branch. Expansion could bring higher profit, but it would also require more money and management. Across the street, a successful repair shop plans to stay small. By the end of this video, you will understand why both decisions can make sense and how different methods of growth work. Business growth is an increase in the size of a business over time.

0:23It can involve more employees, greater production capacity or higher sales revenue. Revenue is the income a business receives from selling goods or services, while profit is total revenue minus total costs. Owners must therefore consider the extra expenses that expansion brings. Start with the opportunity facing Sunrise Bakery. Its existing ovens and employees can serve only a limited number of customers each morning. A larger operation could meet more demand and increase sales revenue.

0:51If the additional revenue exceeds the additional costs, expansion increases profit. That potential reward gives the owner a financial reason to grow. Some owners also value the status and prestige associated with running a larger organisation. A recognised regional business may bring its owner greater respect and influence within the industry. Market share is a business’s sales revenue as a percentage of the total sales revenue of the whole market.

1:16Other owners want a larger market share. Winning more customers strengthens the business’s position against competitors. Economies of scale are the factors that lower average costs as a business increases in size. Growth can also bring these cost advantages. Larger flour orders may allow Sunrise Bakery to negotiate a discount. Its greater importance as a customer also increases its influence over suppliers. You will explore these cost advantages further in the video on economies and diseconomies of scale.

1:45Selling in more markets can reduce a business’s dependence on demand in one location. For example, a hotel business serving several regions has income from different customer groups. A decline in visitors to one region may leave demand elsewhere unchanged. This spreads risk, although its effectiveness depends on whether those markets face different conditions.

Internal growth methods

2:05Internal growth, also called organic growth, occurs when a business expands its own operations. Sunrise Bakery could add ovens, recruit employees or open another branch. Each change develops the organisation that already exists. The owner builds additional capacity and attracts customers through the business’s own activities. Developing new products gives existing customers more reasons to buy. Sunrise Bakery could introduce savoury lunches alongside its bread and cakes. Employees would need suitable equipment, ingredients and training before those products could be sold reliably.

2:38If customers buy the lunches, the bakery gains an additional source of sales revenue. Developing new markets means finding additional groups of customers for the business’s products. A furniture maker could sell in another region or reach customers through an online shop. Exporting to customers abroad is also possible, although it brings additional challenges. New branches can also bring an existing product closer to customers who were previously beyond the business’s reach.

3:03Internal growth gives owners greater control over the pace of expansion. Sunrise Bakery could open a branch, establish reliable working practices and then consider another location. Existing managers can teach new employees the service standards customers expect. This helps preserve the business’s culture, which is its shared values and ways of working. For the business, gradual expansion usually involves less financial risk than purchasing another organisation outright. Retained profit is the profit kept in the business after the owners have taken their share.

3:34Using this money allows expansion without necessarily taking on additional borrowing. Owners also avoid the purchase price associated with acquiring an established business, although new premises and equipment still require finance. The main disadvantage for the business is speed. Building premises, recruiting employees and attracting customers can take considerable time. A competitor might establish itself in the target market before Sunrise Bakery opens its branch. Developing products also carries risk because customers may buy fewer than expected, so the investment produces insufficient revenue.

External and horizontal growth

4:09External growth occurs when a business expands by combining with another existing business. It can happen through a merger or a takeover. A merger occurs when two businesses agree to join together to form one business. For example, two regional delivery businesses could combine their vehicles, employees and customer relationships within a single organisation. A takeover occurs when one business buys control of another business. For a company, this often involves buying more than half its shares.

4:35Shares are units of ownership in a company. A takeover can be agreed, or it can go ahead against the wishes of the target business’s managers. The buyer gains control over operations that are already established. External growth gives the expanding business rapid access to employees, premises, equipment and customers. A delivery business could acquire an existing network instead of building routes gradually. However, the purchase can require substantial finance, and combining operations creates further expenses.

5:03Managers must also reconcile different working practices, so a fast increase in size can bring difficult organisational changes. Horizontal integration joins businesses in the same industry at the same stage of production. Sunrise Bakery taking over Meadow Bakery would qualify because both manufacture bread. This classification describes the relationship between their activities. Either a merger or a takeover can produce horizontal integration, depending on how the businesses come together. The combined business gains Meadow Bakery’s customers, which can increase its market share.

5:37It also faces fewer independent competitors because the two bakeries now operate under common control. Larger ingredient orders may secure discounts, so the business benefits from lower average costs. Customers could benefit if those savings allow lower prices. However, the business may inherit branches serving similar locations, so maintaining every site could waste money. Combining overlapping activities can remove duplicated jobs, and affected employees may face redundancy. Customers may also have fewer independent businesses to choose between.

6:09The owners therefore need to weigh potential savings against disruption and the consequences for other groups.

Vertical integration

6:16Vertical integration joins businesses at different stages of production in the same industry. In backward vertical integration, a business joins with one operating at an earlier stage of production. Sunrise Bakery taking over Hilltop Mill moves towards its flour supplier. The direction follows the production chain from the bakery’s position. Owning Hilltop Mill gives Sunrise Bakery greater control over flour quality and delivery schedules. Reliable supplies reduce the risk of production stopping because ingredients arrive late.

6:45The combined business also keeps the profit previously earned by the independent supplier. These advantages depend on managing the mill efficiently and keeping its costs under control. The disadvantage for Sunrise Bakery is the need to manage an unfamiliar activity. Producing flour requires different equipment and expertise from baking bread. Buying the mill also commits money that could have funded additional bakery branches. Ownership can reduce flexibility because switching to another supplier leaves the business with its own mill to support.

7:14Forward vertical integration joins a business with one operating at a later stage of production. Sunrise Bakery could take over Corner Bread, a retailer that sells bread to final customers. The bakery would gain an outlet for its products. It could also control displays, customer service and the way its bread reaches shoppers. The combined business keeps the retailer’s profit, although it also takes responsibility for running the shops. Rent, employees and unsold products become costs that managers must control.

7:43Retail management requires skills that the bakery’s production team may lack. For customers, better coordination could improve availability, but disruption during the takeover could temporarily weaken service. Classify integration by identifying what each business does and where it sits in the production chain. Two bakeries joining gives horizontal integration, while a bakery joining its flour supplier gives backward vertical integration. When a bakery joins a bread retailer, it moves towards final customers, so this is forward vertical integration.

8:13Always identify the business whose growth you are describing before deciding the direction.

Growth challenges and staying small

8:18Growth creates control and coordination problems because more activities must work together. A manager overseeing several branches has less time to check each location personally. Sunrise Bakery could appoint branch managers with clear responsibilities and agreed standards. Delegation is giving a subordinate the authority to carry out particular tasks; the manager remains responsible. It allows routine decisions to be made closer to each branch. Communication can also become slower as information travels through a larger organisation.

8:49An incorrect delivery instruction might leave one branch short of ingredients while another receives too much. Clear reporting arrangements and shared information systems help employees receive accurate instructions promptly. Regular contact between branch managers also helps coordinate orders and production. Cash-flow problems arise when expansion requires payments before the additional customer receipts arrive. A new branch needs equipment, ingredients and wages before it develops reliable sales. The business can reduce this pressure by arranging suitable finance before expansion and checking when payments fall due.

9:22Opening branches gradually also spreads the demand for cash over time. After a merger, employees may find that the other organisation uses unfamiliar rules and working methods. Managers can reduce these clashes by explaining changes and agreeing consistent procedures. Low morale can arise when employees feel overlooked or worry about duplicated jobs. Consultation, clear information and suitable training help employees understand their responsibilities within the enlarged business. Some businesses remain small because of the owner’s objectives.

9:54Lena’s Salon may provide enough income while allowing its owner a manageable workload. Additional branches would create more responsibilities and reduce time spent with regular customers. Keeping direct control and limiting stress may matter more to that owner than the possibility of higher profit. The type of industry also matters because personal services often depend on individual attention and trust. Customers of a repair shop may value speaking directly with the person who fixes their equipment.

10:20Expansion could make that relationship harder to maintain. A small business can preserve this service by limiting the number of customers it accepts. Some businesses serve a niche market, which is a small, specialised section of a larger market. Cedar Crafts makes replacement parts for unusual musical instruments. Demand may be sufficient to support a workshop but too limited to justify a large factory. Remaining small keeps its capacity better matched to the number of potential customers.

10:48Limited finance can also prevent an owner from pursuing expansion. A young business may have little retained profit and find borrowing difficult to obtain. Without enough money for equipment, premises and additional employees, growth plans must wait. This explains why some businesses remain small through choice, while others face constraints despite an ambition to expand.

Choosing a growth method

11:09Consider Willow Café, a business with one café and eight employees. Its owner has sixty thousand dollars available for expansion. The aim is to reach more local customers while preserving personal service. Opening another branch would cost fifty thousand dollars, while taking over an established café would cost one hundred and forty thousand dollars. Begin by identifying what each route gives Willow Café. A new branch is internal growth because the business would expand its own operations.

11:35Taking over the other café is external growth through horizontal integration, and it provides established customers immediately. Next, compare the financial requirements with the available money, and connect each route to the owner’s service objective. The takeover costs one hundred and forty thousand dollars, and the owner has sixty thousand dollars. One hundred and forty thousand minus sixty thousand leaves a gap of eighty thousand dollars. That additional finance must be obtained before the purchase can proceed.

12:02A new branch costs fifty thousand dollars, so ten thousand dollars remains for everyday payments such as wages and ingredients. An exam-style question could ask you to justify which method of growth Willow Café should choose. To justify, support a case with evidence or argument. A strong response uses the business’s finance and aims, explains the consequences, and considers the alternative. Here is a model answer that follows those steps.

12:27Willow Café should choose internal growth through a new branch. The fifty thousand dollar opening cost fits its budget and leaves ten thousand dollars for everyday payments. Training new employees in existing service standards supports its aim of preserving personal service. A takeover offers immediate customers, but it needs eighty thousand dollars of extra finance, and that café’s employees may follow different service standards. Internal growth therefore better matches Willow Café’s money and its aim.

12:56In Paper One Short Answer and Data Response and Paper Two Case Study, use the stimulus information to explain business consequences. When asked to explain an advantage, connect the method to a relevant outcome for the business or another affected group. Keep revenue, profit and cash distinct when judging expansion. Also identify integration from production stages, and explain both the opportunities and the practical demands of growth. Internal growth occurs when a business expands its own operations.

13:24External growth can come through a merger, which occurs when two businesses agree to join together to form one business. In a takeover, one business buys control of another business. These routes offer different combinations of speed, control, cost and risk. Horizontal integration joins businesses in the same industry at the same stage of production. When businesses at different stages of production in the same industry join, the result is vertical integration.

13:49Owners may pursue profit, prestige, influence, lower average costs or reduced dependence on one market. The best choice depends on demand, finance, management capacity and personal objectives, so remaining small can be a sound business decision.