Business growth is quite straightforward. Businesses can grow in two different ways, either through Internal Growth, also known as organic growth, or External Growth, also known as integration.
Businesses grow for a number of reasons including to take advantage of a gap in the market, to gain a competitive edge over rivals, to increase sales and maximize profitability or to win increased market share.
Internal Growth (or Organic Growth)
Although Internal Growth is often quite slow, it is considered safer. The business is using its own capabilities and resources, such as retained profits and employees, to expand. Therefore, it avoids some of the problems of External Growth such as overborrowing, overtrading and management problems.
Internal Growth occurs when a business expands by:
- Developing new products for its current customers;
- Finding new customers for its current products;
- Increasing production capacity to produce more goods, e.g. by buying more equipment, or replacing old machines with faster ones;
- Entering into new markets by opening more shops where it previously had none;
- Hiring more workers such as sales people, or new workers who are more productive.
- Providing better value for money products for customers.
External Growth (or Inorganic Growth)
External Growth occurs through dealings with outside organizations. It happens through integration such as mergers, acquisitions and takeovers, or forming agreements with other companies such Joint Ventures (JV) or Strategic Alliances (SA).
External Growth offers a faster way to grow, but is considered riskier as external funding is often needed to buy another business and cultural conflicts may emerge after merging with another business.
Mergers, Acquisitions and Takeovers
The process of integration takes place when a business merges with another business, acquires or takes over another firm in the same industry or different industry.
A merger is an agreement that unites two existing companies into one completely new company.
Acquisitions and takeovers are quite similar to each other. In both acquisitions and takeovers, the acquirer firm purchases the target firm and both firms will operate as one larger new unit.
An acquisition is quite similar to a takeover in that one company will purchase the other; however, usually on a preplanned and orderly manner in which both parties strongly agree, if beneficial to both firms.
A takeover is usually a hostile act, where the acquirer will surpass the target company’s Board of Directors (BOD) and will purchase more than 50% of the shares to obtain a controlling stake in the firm.
There are four main types of business integration:
1. Horizontal Integration. It brings together two firms in the same industry which are also at the same stage of production, e.g. two vegetable farms in the primary sector, two shoe manufacturers such as Nike and Adidas in the secondary sector or two banks such as Bank of America and Wells Fargo in the tertiary sector.
Primary sector business + Primary sector business
Secondary sector business + Secondary sector business
Tertiary sector business + Tertiary sector business
2. Vertical Integration Backward. It brings together two firms in the same industry, but which are at different stages of production. The company merges, acquires or takes over a business at the earlier stage of production (its supplier), e.g. an ice-cream manufacturer merges with, acquires or takes over a milk supplier.
Supplier <- Manufacturer
3. Vertical Integration Forward. It brings together two firms in the same industry, but which are at different stages of production. The company merges, acquires or takes over a business at the later stage of production (its customer), e.g. a shoe manufacturer merges with, acquires or takes over a shoe retailer.
Manufacturer -> Retailer
4. Conglomerate Integration. It brings together two businesses which are in completely different industries, e.g. a cosmetics manufacturer such as L’Oréal merges with, acquires or takes over an energy drink manufacturer Red Bull.
Business in Industry A <- Business in Industry B
Joint Ventures (JV) and Strategic Alliances (SA)
These are two forms of External Growth that do not involve complete integration or changes of ownership.
A Joint Venture (JV) happens when two businesses agree to work closely together on a particular project, and create a separate business entity to do so. For example, a German car manufacturer Audi starts a project in China together with a local distributor to produce German cars in Asia and sell them to the Chinese market using the local company’s distribution network. After the project is over, both companies split and continue operating separately from one another, meaning the Joint Venture (JV) is over.
A Strategic Alliance (SA) is an agreement between many firms, usually from the same industry, in which each agrees to commit resources to achieve an agreed objective. Those firms share the costs of product development, running business operations and doing marketing. A Strategic Alliance (SA) is similar to a Joint Venture (JV) in that businesses cooperate together for mutual benefits. However, the affiliated businesses remain independent organizations, and a separate business entity is not created. There are three popular alliances in the world between airlines including Star Alliance, One World and Sky Team.
To sum up, there are two ways for a business to grow which is either internally by using its own capabilities and resources (Internal Growth) or externally by using the outside resources (External Growth).
