How and why firms grow

Organic and inorganic growth, horizontal, vertical and conglomerate integration on one supply-chain map, demergers and why many firms stay small.

The world’s biggest ice cream maker went its own way.

In December 2025 Unilever, the company behind Dove soap, completed the demerger of its ice cream business. The Magnum Ice Cream Company began trading on the Amsterdam, London and New York stock exchanges as a separate firm, with about €7.9 billion of sales and brands including Magnum, Wall’s, Ben & Jerry’s and Cornetto. Its chief executive said that, as an independent company, it would be quicker and more focused.

Why did ice cream and soap ever sit inside the same firm? And why separate them now?

Sources: FoodNavigator (8 December 2025); The Magnum Ice Cream Company, demerger information.

Why and how firms grow.

Firms grow for four main reasons: to gain economies of scale (lower long-run average cost), to gain market power (a bigger share and fewer rivals, so more control over price), to spread risk across different products, and because managers may want to run a bigger firm for its pay and status (the principal–agent problem).

Organic (internal) growth means expanding from within: more output, new shops, new products, paid for from profit or borrowing. It is slower but lower risk. Inorganic (external) growth means joining with another firm: a merger, where two firms agree to combine, or a takeover (acquisition), where one buys a controlling share in the other. It is faster, but the two firms have to be made to work as one.

Which firm to join with depends on where it sits in the supply chain.

Think first

A large company splits off one of its biggest divisions into a separate company.

The division is profitable and well known.

Which is the most likely reason?

Firms do not only grow. A demerger can make sense when a business has grown too big to manage well, or when two parts need different skills and investment. The new firms are more focused, and their owners can value each part separately. The last option would be illegal collusion.

Step by step

1. Start with one supply chain. A makes ice cream. Its milk comes from a dairy farm, the raw materials stage, and it sells through a supermarket, the retail stage. Each stage adds value on the way to the consumer.

2. Horizontal integration joins two firms at the same stage of the same industry: A buys its rival, B. The merged firm has a bigger market share and fewer rivals.

   Check: Ice cream maker A buys rival ice cream maker B. This is:

   Same industry, same stage of production. A and B were competitors.

3. Backward vertical integration joins with a firm at an earlier stage: A buys the dairy farm that supplies it. It now controls its own supply.

   Teacher tip: Before you name the type, say which way along the chain the firm is moving. Towards raw materials is backward; towards the consumer is forward. Students who learn the names without the direction swap them.

   Check: Now A buys the supermarket chain it sells its ice cream through. What type of integration is this?

   The supermarket is at a later stage of the same supply chain, closer to the consumer, so this is forward vertical integration.

4. Forward vertical integration joins with a firm at a later stage, closer to the consumer: A buys the retailer it sells through. It controls how its product is sold and gets the retailer’s margin.

5. Conglomerate integration joins firms in unrelated industries: ice cream and shampoo. There is no shared stage of production, so the main gain is diversification: if ice cream sales fall in a cold summer, shampoo still sells.

   Check: Why might a firm making a seasonal product buy a firm in an unrelated industry?

   If one product sells mainly in summer, owning another that sells all year makes revenue steadier. That is diversification, the main reason for conglomerate integration.

6. A demerger reverses integration: one firm splits into two. Firms demerge when the parts would be worth more apart, when diseconomies of scale make the whole hard to manage, or when one part needs investment the other cannot justify.

   Check: A firm’s directors push for a takeover that raises their pay but adds little to profits. This is an example of:

   The shareholders (principals) own the firm, but the directors (agents) run it and can pursue their own goals, such as pay and status, instead of profit.

7. And most firms stay small. A niche market may only be big enough for a small firm; the owner may prefer control and a manageable business; a small firm may not be able to raise the finance to grow; and a small firm can offer a personal service that large rivals cannot. Growth is a choice, not an obligation.

   Check: Which of these is a reason a firm might choose to stay small?

   If the market for its product is small, there is no room to grow, so a small firm can serve it well without expanding.

A common mistake

The arrow from A up to the dairy farm points to an earlier stage, towards raw materials. That is backward vertical integration. Forward goes towards the consumer.

Exam question

Explain the difference between horizontal and vertical integration, and one reason a firm might choose each.

Model answer

Horizontal integration is when two firms at the same stage of production in the same industry join together, for example two ice cream makers. A firm might choose it to gain economies of scale: producing more lets it spread fixed costs and buy inputs in bulk, so long-run average cost falls. It also removes a rival, so the firm gains market share and more power over price.

Vertical integration is when firms at different stages of the same supply chain join. Backward vertical integration joins with a supplier, such as an ice cream maker buying a dairy farm. It secures the supply and quality of inputs and removes the supplier’s profit margin, which can lower costs. Forward vertical integration joins with a firm closer to the consumer, such as a retailer, guaranteeing an outlet for the product.

**Evaluation:** the gains are not automatic. A bigger firm can suffer diseconomies of scale as it becomes harder to manage, and running a supplier or a retailer needs different skills. A horizontal merger that creates a large market share may also be investigated by the CMA, and blocked or allowed only with conditions.