Article by Knogle
There are two forms of growth – internal growth and external growth. Internal growth can be done by investment in new servers, new branch offices, etcetera. External growth (integration of amalgamation) can be done though expansion (through mergers with other companies/firms), mergers (mutually agreed partnership), and acquisitions/takeovers (hostile buy-over of the majority (at least 51% of a firm’s shares by another firm)).
External growth exists in 4 different forms, which will be elaborated below.
Firstly, there’s horizontal integration. This involves the mergers or acquisitions of firms in the same stage of production in the same industry. In this case, an example would be UnitedHosting merging with HTTPme. This is usually done for two reasons. Firstly, to exploit the potential economies of scale reaped from a larger scale of production (EOS comes in various forms including technical and managerial EOS. I could give you a thousand word essay on it but it’s a whole new ball game. Secondly, to achieve monopoly power in order to capture market share. However I don’t think the second reason applies here in a saturated market with relatively elastic demand.
The second form of external growth is vertical integration. This involves the integration of firms engaging in different stages of production within the same industry. There are two types of vertical integration — backward integration and forward integration. Backward integration is the acquiring of firms engaged in the previous stage of production (e.g. UnitedHosting buying EV1Servers). Forward integration is the acquiring of firms in the next stage of production (e.g. EV1Servers buying UnitedHosting). Vertical integration is done for 4 main reasons. Firstly, to achieve greater control and stability in the supply of inputs through backward integration (e.g. If UH could control all of EV1′s servers, they could ensure optimal uptime and put greater focus on their own servers). Secondly, it is to restrict the supply of inputs to competitors through backward integration. This is pretty self explanatory — with backward integration, you can make your competitors suffer and deny them access to your servers, which they require to run their business. The third reason is to obtain greater control of the demand for your products through forward integration (e.g. EV1Servers could market their services adequately to different markets with different packages if they bought out UnitedHosting). The fourth reason would be to penetrate and capture new markets through forward integration. Again, taking the example of EV1 and UH. EV1 would be able to appeal to the lower end users who consume fewer resources if they bought UH.
The third form of external growth is lateral integration. This involves the integration of firms engaged in the same stage of production in related industries (e.g. UH buying out DemoDemo). Again, this is done for 4 reasons. Firstly, to diversify and spread risks. If one of their businesses went bust, they have another one to fall back on, in a relatively different market. Secondly, to achieve economies of scope from R&D and marketing. Products can be marketed together, and this saves advertising cots. Thirdly, to develop greater compatibility and dependency between products so as to make the demand more inelastic (e.g. UH could put up a promotional offer like “If you buy 10 tutorials from DemoDemo, you get plan 2 at a 50% discount!”. The fourth reason is to penetrate related markets in order to jointly market products; this has been explained earlier on already.
Finally, the fourth type of external growth is conglomerate integration. This is the integration of firms in completely unrelated industries (also known as ‘diversifying’ integration). An example would be UH buying out a local chicken farm. This is done for 2 main reasons. Firstly, to acquire and strip the assets of sunset firms for the purpose of converting its real assets (land and capital) into more productive alternative uses. For example, UH could eventually use the chicken farm’s land as a site for a future datacenter that it’s about to build. The second reason is to diversify into different non-related markets in order to spread risks and exploit potential infant markets.
About the Author
Knogle has been closely involved in the webhosting industry for over 4 years. HeÃÂ
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