Mind Your Business - 9 October 2008
Business Ownership
Case Study: Philip Green and Arcadia
The essential reasons for a business being placed in a specific type of ownership are likely to be pretty much the same regardless of the size of the owner!These reasons are likely to include:
Economies of Scale
Economies of Scale are the advantages of large-scale production that result in lower cost per unit produced.
The important thing about this concept is the term 'scale'. This is not just about a firm expanding by selling more; it is referring to the implications of a change in scale. When Philip Green bought the businesses in the Arcadia Group, there was a change of scale. Mr Green in effect purchased the 2,000 stores that make up the group. Each store in itself is one representation of a scale of production with its own cost structure, both fixed and variable. When you add all these stores together the scale of operations is clearly significantly different to that which would be the case if there were only 500 stores.
This very large scale of operations means that there are a range of advantages that Philip Green can gain that lead to a lower unit cost. Note that the total costs are going to be significantly higher - 2,000 stores cost a good deal more to run than 500 stores! However, the average cost per item might well be lower as a result of these advantages.
You can get more detail about economies of scale through following our presentation on this concept here.
The reason for this is that Mr Green can use a range of tactics that increase output/sales at a greater rate than the increase in the costs. For example, within the group there might be people employed specifically for their skills in buying new stock. Their expertise in understanding the market, the fashion industry, knowing where to look for new supplies, what fabrics and styles will sell and what will not, might be crucial in the success of a season's sales.
Hiring this sort of expertise might not come cheap. Let's assume that Mr Green pays his buyer for Topshop £150,000 a year. Not a bad salary. The economies of scale will arise if the contribution that this person makes to the output/sales of the business is worth far more than the salary costs. The cost per unit, found by dividing total cost by the number of units of output, will fall as a result.
Mr Green might also gain other benefits by being able to negotiate with suppliers around the world on prices. It's not just 'bulk buying' but the relationship that large firms are able to build with their suppliers that helps and leads to lower average costs.
Diversification
There is an old saying - don't put all your eggs into one basket! For a business, relying on one area of the market can be dangerous. If that market slows down for any reason, for example as a result of a slowdown in the economy, then it could mean financial difficulties. This might particularly affect businesses in very competitive industries where the margins they are working with are slim. The margin can be thought of as the difference between the price and the cost of production for each unit.
Once sales decline, rival firms might decide to compete by reducing price. This trims margins even further; some firms will suffer and may have to close down stores or even sell off the business. Allsports, a high street sports clothing chain with 177 stores, was bought by JD Sports in 2007 after being in administration, blaming a price war as the reason for its demise.
Diversification, therefore, might be a way of a business getting involved in different activities. In so doing, the hope might be that if one section of the business is doing worse than expected, other parts of the business might compensate for this and keep the group as a whole on an even keel.
Synergies
2 + 2 = 6. It sounds ridiculous but in business terms this is what synergy is all about. Synergy occurs where the whole is greater than the sum of the parts. For example, Mr Green's Arcadia Group consists of seven brands. Individually, they might all be perfectly good businesses but together they form a powerful retail presence on the high street. They can also secure cost savings for the group as a whole, share information and knowledge from within and outside the business all of which can serve to make it good business sense to have each of these different businesses under one ownership.
Branding
Branding is about achieving recognition and identity for your products or services. A brand is not just a name; a brand has to be recognised by customers and invariably associated with something. It has to have an identity and that identity reflects what the customer might be looking for out of the product.
There is a common perception amongst exam candidates that a brand has to be a luxury product, such as Prada, Armani and so on. This is not the case. Matalan, Primark and Poundstretcher are all brands but they are not associated with high priced products. Instead they would hope to be seen as good quality, reasonably priced (the word 'cheap' might not be what they would naturally choose) products that are within the range of many ordinary customers. Parents might harbour a desire to dress their three children in Armani clothes but on a combined income of £500 per week this is unlikely to be the case. Making sure their children have clothes that are functional, have some respect for fashion but which are affordable is what brands like Matalan are trying to do.
Primark - a brand which is associated with low-priced, functional but fashionable clothing - not exactly Armani though!
Copyright: Biz/ed images.
This sort of market is a big one and such firms will rely on selling in volume rather than having high margins on each item but selling less. That, by contrast, is what the high fashion brands do. They will certainly not sell large quantities (by comparison) of shirts at £300 a time, but the margin they make on each item is much larger. The whole intention is to retain an air of exclusivity and having a high price does this effectively by squeezing out a large part of the potential market. After all, what is the point of having Armani clothes if everyone has got them? It would defeat the whole point of telling your friends you have bought an Armani suit! Armani would want to be associated with exclusivity, quality and the style that boasts of high incomes.
For Philip Green, therefore, the benefits of having a variety of different stores under different ownership means that different market segments can be targeted that wish to be associated with that brand. Tammy, for example, is associated with young girls' fashion - between the ages of probably 9-14; Evans is associated with fashions for the 'fuller figure' and Topshop might be targeted at the 18-25 age groups primarily.