Theme 3 · 3.1 Business growth · Microeconomics
Business growth
In 2022 the Canadian airline WestJet bought Sunwing Travel Group, an airline and package-holiday business, so that it could sell luxury flights and holidays to more destinations. Almost every idea in this topic is hiding inside that one deal: why buy a firm rather than build the capacity yourself, what happens to average costs as the combined firm gets bigger, and who ends up holding the market power that size brings.
The big picture
Growth questions look like questions about size. Underneath, they are questions about economies of scale, market power and risk, and the strongest answers treat them that way from the first sentence. A takeover is a bet that a bigger firm will have lower unit costs or a stronger grip on its market, and the bet can fail: plenty of takeovers end in the demerger that undoes them.
The exam consequence is blunt. Examiners reward one developed chain of reasoning, anchored in a named industry, with a cost diagram drawn and then explained in that context. An answer with no industry, or no diagram, stalls in the middle levels however fluent it is. So every idea on this page comes attached to a firm, and the long-run average cost diagram below is the compulsory picture for the whole topic. What you learn here feeds directly into business objectives: once a firm has grown, the question becomes what its managers are actually trying to maximise.
The theory
Sizes and types of firms
Private sector organisations are owned by individuals and shareholders rather than by the state; state-owned enterprises are owned and run by government, and often pursue social objectives rather than profit. Within the private sector, firms grow to gain economies of scale, to raise market share and market power, to spread risk across products and markets, to increase profit for owners, and because managers of large firms enjoy higher pay and status. Yet many firms stay small by choice: a niche market may be too thin to support scale, personal service may be the product, and owners may prefer control and a quiet life to the costs and risks of expansion.
The separation that occurs when a firm's owners (shareholders, the principals) no longer manage it day to day, so decisions are taken by managers (the agents) whose objectives may differ from the owners'. This is the principal-agent problem, and it shapes both how firms grow and what they maximise.
How firms grow
Growth from a firm's own resources: opening new sites, building capacity, developing products, hiring staff. Slower than a takeover, cheaper, and lower risk, because the firm expands only what it already understands.
The alternative is integration, combining with another firm by merger or takeover. Horizontal integration joins firms at the same stage of production, as when WestJet bought Sunwing to enter the luxury travel market. Vertical integration moves along the supply chain: backward towards suppliers (a fast-food chain buying a farm) and forward towards the customer (a car manufacturer buying showrooms). Conglomerate integration joins firms in unrelated markets, diversifying products and spreading risk. Each route buys something specific: horizontal integration buys market share and a quicker, less risky entry into a new market than organic growth; backward vertical integration buys control over inputs and can raise rivals' barriers to entry; forward vertical integration captures the retail margin; conglomerates buy revenue streams that do not all fall together.
Constraints, demergers and the limits of growth
Growth is constrained by finance (small firms borrow on worse terms), by the size of the market itself, by owner objectives, by regulation and competition authorities, and by the supply of managers able to run a bigger operation. When growth overshoots, firms demerge, splitting into separate companies: to shed diseconomies of scale, to let each business focus on its core market, to raise finance, or to satisfy regulators. A demerger can sharpen management and lift the value of both parts, though workers face restructuring and consumers may gain or lose depending on whether the split restores competition or removes scale economies.
Application
WestJet and Sunwing (2022) is the model horizontal case. The applied point that separates top answers from average ones is that buying Sunwing was a less risky way into the luxury holiday market than organic entry: WestJet acquired customers, aircraft and expertise in one move, rather than spending years building them against an incumbent. In an answer, that sentence does the work of a whole paragraph of generic "takeovers increase market share".
Apple's move into designing its own chips shows vertical integration earning its keep: bringing chip design in-house put Apple's average cost below what a third-party supplier would charge, a productive efficiency gain you can draw as one AC curve sitting below another. INEOS buying 25% of Manchester United for £1.3bn (2024) shows why ownership matters to growth analysis: a change in who owns the firm changes what the firm is for. And Meta's Reality Labs, which lost $47bn between 2021 and 2023, is the principal-agent problem with a price tag: managerial empire-building pursued at shareholders' expense, exactly the behaviour the divorce of ownership and control predicts. Use it whenever a question asks why growth might harm the owners it is supposed to serve.
Building the paragraph
Horizontal integration gave WestJet a faster and less risky route into the luxury travel market than organic growth, because buying Sunwing in 2022 bought its customers, capacity and expertise in a single move. A top-level paragraph then develops that one claim as an applied chain:
- WestJet and Sunwing operated at the same stage of production, so the takeover is horizontal integration, and it took WestJet straight into luxury flights and holidays it did not previously sell.
- Entering by acquisition avoids the years of route-building and marketing that organic entry against established holiday firms would need, so the risk of failed entry is lower.
- The combined airline's output rises, so purchasing, technical, financial and managerial economies of scale become available: aircraft, fuel contracts and head-office functions are spread over more passengers.
- On the LRAC diagram, output expands from Q towards the minimum efficient scale and average cost falls from C to C₁; the diagram is a step in the argument, drawn and then explained in WestJet's context.
- Duplication is removed, one marketing department where there were two, so costs fall further while the merged firm's share of the Canadian leisure market rises.
- Lower unit costs and greater market power mean higher margins or lower fares, so the takeover answers the question: it makes WestJet more profitable than organic growth would have, and sooner.
Evaluation
Evaluating this, the chain holds only if the price paid for Sunwing leaves room for the gains: takeovers are expensive, and an inflated purchase price can swallow years of cost savings before they arrive. The strongest counter-evidence is cultural, since merging two differently run airlines invites the culture clash and communication problems that turn scale economies into diseconomies, which is why so many takeovers end in demerger. Cross-examine the claim itself: WestJet already ran an airline, so the expertise gap was small and integration risk lower than in a conglomerate deal, which strengthens the case here without rescuing takeovers in general. On balance the takeover was the better route for WestJet precisely because the firms were so similar; the further a target sits from what the acquirer knows, the more the balance tips back towards organic growth.
Key terms
| Term | Precise definition | Where it earns marks |
|---|---|---|
| Organic growth | Growth from the firm's own resources, such as new sites, capacity or products, rather than by combining with another firm. | The AO1 anchor for any "takeover versus internal growth" comparison. |
| Horizontal integration | Combining with a firm at the same stage of production in the same industry. | Classifying the deal in the stem correctly, then linking it to market share and scale economies. |
| Backward vertical integration | Combining with a firm at an earlier stage of the supply chain, such as a supplier of inputs. | Chains about input costs, control over suppliers and raising rivals' barriers to entry. |
| Conglomerate integration | Combining with a firm in a different, unrelated market. | Risk-spreading analysis, and the evaluation point about entering markets the firm does not understand. |
| Demerger | The splitting of a firm into two or more separate companies. | Evaluation of takeovers, and questions on impacts for the business, workers and consumers. |
| Principal-agent problem | The conflict that arises when agents (managers) take decisions on behalf of principals (owners) but pursue their own objectives. | Explaining why growth may serve managers rather than shareholders. |
Towards the exam
Explain the likely benefits to a national coffee-shop chain of buying one of the plantations that grows its beans. Classify the integration, then build one developed chain through input costs and control of supply.
A UK supermarket group has announced it will demerge its clothing brand into a separately listed company. Evaluate the likely effects of the demerger on the business, its workers and its consumers. Aim for one developed chain per agent, and a judgement about who gains most.
Evaluate the view that taking over a rival is a better way to enter a new market than growing organically. Refer to an industry of your choice. Draw and explain the LRAC diagram inside your analysis, and let your evaluation turn on price, culture and expertise.