Evaluating a business: continue, grow, diversify or close
Every few months, an owner should check the business. Look at sales, profit, cash, customer feedback and the market.
- Continue: things are fine and the market is stable. Keep going, fix small problems.
- Grow: demand is rising and there is money or a way to raise it. Sell more of the same, or in new places.
- Diversify: add new products or enter new markets to spread risk.
- Close or sell: losses keep coming and there is no fix. Closing early saves money.
Why grow at all? Bigger firms can buy in bulk (economies of scale), get a bigger market share, earn more profit and survive bad times better.
Organic (internal) growth
Organic growth means growing from inside, using the firm's own profit or loans. Examples: a new branch, a bigger factory, more staff, new products, selling online.
- Plus: the owner keeps full control; growth is steady; the culture stays the same.
- Minus: slow; limited by the money the firm earns.
Inorganic (external) growth means growing by working with or joining other firms: franchising, joint ventures, mergers and acquisitions. It is faster but more risky.
Franchising: types, pros and cons
In franchising, the franchisor (brand owner) gives a franchisee the right to use its name, products and way of working. The franchisee pays a starting fee and a royalty (a share of sales, often 4–8%).
Types of franchising
- Product (distribution) franchise: the franchisee sells the brand's products, like a car dealer or a fuel pump.
- Business format franchise: the whole system is copied: name, menu, shop design, training. Fast-food chains and tutoring centres work like this.
- Manufacturing franchise: the franchisee makes the product under licence, like a soft-drink bottler.
- Master franchise: one person gets the right for a whole region and can sell sub-franchises.
Pros and cons
- For the franchisor: fast growth with other people's money; local owners work hard. But less control; one bad franchisee can hurt the brand.
- For the franchisee: a known brand, tested system and training, so lower risk. But fees and royalties cut profit; strict rules; less freedom.
Mergers and acquisitions: types and reasons
A merger is when two firms agree to join and form one firm. An acquisition or takeover is when one firm buys control of another, usually by buying more than 50% of its shares. A takeover can be friendly or hostile (against the wishes of the target's managers).
Types
- Horizontal: firms at the same stage in the same industry (two banks, two phone makers).
- Vertical backward: joining with a supplier (a chocolate maker buys a cocoa farm).
- Vertical forward: joining with a buyer or seller nearer the customer (a maker buys a chain of shops).
- Conglomerate: unrelated businesses (a steel firm buys a hotel chain).
Reasons
- Grow quickly and gain market share.
- Economies of scale: lower cost per unit.
- Get new skills, technology, brands or customers.
- Control supply or sales outlets (vertical).
- Spread risk (conglomerate).
- Remove a competitor.
Problems
Clash of cultures, job losses, high cost of buying, and a firm that is too big to manage. Many mergers fail to give the hoped-for benefits.
Try it
Choose a shop near your home. Write which of the four roads (continue, grow, diversify, close) fits it now and why. Then, in the 3D free play, tap each growth route and note its speed, cost and risk. Which route would you pick for this shop?
Key formulas and definitions
- Organic growth: grow with own profit; slow, full control.
- Inorganic growth: grow by joining or working with other firms; fast, more risk.
- Franchisor = brand owner; franchisee = person who runs a copy of the business.
- Royalty = agreed % of the franchisee's sales paid to the franchisor.
- Merger: two firms agree to become one. Acquisition: one firm buys control (> 50% of shares).
- Horizontal = same stage; vertical = supplier or seller in the chain; conglomerate = unrelated.
- Economies of scale: cost per unit falls as the firm grows.
Worked examples
1. A franchisee's sales are ₹40,00,000 in a year and the royalty is 5%. How much royalty is paid?
Royalty = 5% of ₹40,00,000 = 0.05 × 40,00,000 = ₹2,00,000.
2. A tyre maker buys a rubber plantation. What type of integration is this and why might it do it?
Vertical backward integration, because it joins with a supplier of its raw material. It secures rubber supply, controls quality and removes the supplier's profit margin.
3. A juice brand wants 50 outlets in 3 years but has little cash. Suggest a growth strategy.
Business-format franchising. Franchisees pay to open outlets, so the brand grows fast with other people's money, while the brand earns fees and royalties.
4. Firm A (value ₹60 crore) buys 55% of Firm B's shares. Is this a merger or an acquisition? Who controls B?
An acquisition (takeover). Owning more than 50% gives A control of B. B may keep its name, but A decides its policy.
Common mistakes
- Calling every takeover a merger. A merger is by agreement and forms one firm; an acquisition is one firm buying control.
- Mixing up franchisor and franchisee. The franchisor owns the brand; the franchisee pays to use it.
- Thinking vertical integration means two rivals joining. Rivals at the same stage = horizontal.
- Believing growth is always good. Too fast growth can cause cash shortage and loss of control.