Growth and subsidizing in a company group

University essay from Blekinge Tekniska Högskola/Sektionen för management

Author: Nicklas Bylund; [2012]

Keywords: finance; Dupont; Higgins equation; growth; profit; NPV; ROCE;


This thesis is about growth, and the factors influencing growth in a positive or in a negative way. Particularly this thesis elaborates on growth of a profitable brand that is part of a group; i.e. growth within an internal capital market. A company being profitable does not equate growth; short-term profit is actually higher if the growth is held limited. This since growth implies a need for more assets, profit is traded for growth. However to keep market share a division needs to identify and pursue projects with positive net present value (NPV), otherwise competitors can find these same market opportunities and take the chance to grow stronger. The data for this thesis has been gathered from annual reports and from interviews with managers having influence of decisions affecting growth and profit. Text books and published research papers have been used for the theory building. The gathered data has been analyzed using the theory and conclusions have been drawn. The DuPont identity, relating the profit margin, asset turnover and leverage to the return on equity is used for analysis. The concept of external finance needed (EFN) has also been elaborated on i.e. that it takes money to make money. Finally Higgins equation for sustainable growth ratio (SGR) based on EFN, describing the relationship between growth and profit is the cornerstone of the theory used. A company operates under several stringent restraints leading to a trade of between growth and profitability. The group studied in this thesis consists of several divisions of which some consist of several brands. While the group as a whole has a relationship between growth and profitability in line with Higgins equation the individual brand in focus has the potential to grow faster. It seems that positive NPV’s need to be left out due to a subsidizing of weaker parts of the group by better performing parts. Capital allocation within a heterogeneous company is complex; a trade off between diversification to attenuate risk and a concentration of resources where profitability is highest is made. The brand in focus of this study has a tradition of preferring high profitability before growth. Trading that high profitability to a higher growth is challenging the mindset both at group, division and brand level. Another reason for turning down positive NPV project may be the payback method being used extensively to make investment decisions, resulting in a project having a long payback period being ruled out despite having a high NPV. A way of increasing revenue growth without affecting profitability can be to providing service in conjunction with the hardware offer. Service offers can be made without heavy investments in production machinery, piggybacking on existing investments. The somewhat opaque structure of the studied group decreases the external market scrutiny and increases the likelihood of the above mentioned capital allocation behavior including subsidizing. Recent changes at group level addresses this, by forming new divisions that are more specialized within each product area.

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