There are two categories of business growth such as Internal Growth and External Growth.
External Growth (or inorganic growth) occurs through dealings with other businesses outside the organization. It is usually achieved by merging with another firm, acquiring another business or taking over another company, either in the same industry or in a different industry.
Firstly, External Growth is often referred to as ‘integration’ as to some extent it involves bringing two or more businesses together. Mergers, acquisitions and takeovers are collectively known as the amalgamation of company that requires permanent change of ownership.
Secondly, External Growth also comes in the form of Joint Ventures (JV) and Strategic Alliances (SA) which are more like business partnerships with other firms that do not require permanent change of ownership.
Why do businesses join together in External Growth?
The main reason for growing externally is reduction in costs resulting from the benefits of economies of scale. By integrating with another firm, the combined business is able to spread the costs of many activities such as purchasing raw materials or advertising, thus reducing the unit cost of producing one product. In addition, the combined expertise of two companies may enhance the design, features and quality of the product.
Another reason for External Growth is to easier obtain finance necessary for growing the business. It is because financial institutions are more likely to consider favorably a request for finance from a very large business given the combined value of the assets including cash, inventory, land or buildings. The large business may simply be charged with a lower interest rate because of the extra security of having the real assets as collateral.
Some economists suggest that when the economy is booming and businesses are growing, there are more mergers, acquisitions and takeovers. And when the economy moves into a recession, the number of mergers, acquisitions and takeovers goes down significantly – businesses think about survival in tough times rather than expansion.
How to grow a business externally?
There are five ways of External Growth: Mergers, Acquisitions, Takeovers, Joint Ventures (JV) and Strategic Alliances (SA).
The first three forms of External Growth involve complete integration and change of ownership.
1. Mergers
A merger takes place when two firms agree to form a new company. Shareholders and managers of those two businesses bring both firms together under a common Board of Directors (BOD) with shareholders from both businesses owning shares in the newly merged business proportionally to their past holdings.
Example 1: In 1998, BP merged with Amoco.
Example 2: In 1998, Daimler Benz merged with Chrysler.
Example 3: In 2000, Glaxo Wellcome merged with SmithKline Beecham to create GlaxoSmithKline.
Example 4: In 2001, Hewlett-Packard merged with Compaq.
Example 5: In 2013, American Airlines merged with US Airways.
Example 6: In 2015, Dow Chemical merged with DuPont and then split the merged entity into three independent firms.
Example 7: In 2018, AT&T merged with Time Warner.
Example 8: in 2019, United Technologies merged with Raytheon to create Raytheon Technologies.
2. Acquisitions
An acquisition happens when a company buys enough shares (more than 50%) in another target firm and becomes the controlling owner of it. An acquisition is quite similar to a takeover, in that, one company will purchase a majority stake in the other. However, it is usually on a pre-planned, friendly and orderly manner in which both parties strongly agree as it is beneficial to both firms. In an acquisition, the company that acquires the target company will be entitled to all the target company’s assets such as cash, land, buildings, equipment, patents, trademarks, etc., as well as liabilities such as bank loans, etc.
Example 9. Heineken, the Dutch beer company established in 1864, acquired many of its local competitors to dominate the Dutch brewing industry.
Example 10: In 2006, Google acquired YouTube for USD$1.65 billion to enlarge revenues from global advertising services.
Example 11: In 2010, Cadbury was bought out by Kraft Foods, Inc. for approximately USD$18 billion to gain access to a huge chocolate market as people spend around USD$9.4 million on chocolate per hour.
3. Takeovers
Takeovers are hostile. In contrast to an acquisition, a takeover occurs when a company purchases enough shares (more than 50%) in another target firm and becomes the controlling owner of it. However, the purchase is done without the permission of the company or its Board of Directors (BOD). To encourage shareholders of the target company to sell their shares, the offer price will most likely to be well above the value of the shares as quoted on the stock market.
Example 12: In 1999, Vodafone acquired Mannesmann AG for around USD$202 after the Mannesmann’s largest investor pleaded with the Board of Directors to finally accept Vodafone’s offer.
Example 13: In 2010, Sanofi took over a biotechnology company Genzyme by offering higher price per share triggering a sell out that resulted in purchasing over 90% of its target company.
The second two forms of External Growth do not involve complete integration, nor permanent change of ownership.
4. Joint Ventures (JV)
A Joint Venture (JV) happens when two businesses agree to work closely together on a particular project. They create a new legal entity (a new company) to do so. Sometimes, it benefits two businesses to work closely together on a new business opportunity which they would not be able to pursue individually. Those two companies in the Joint Venture (JV) will do a 50:50 split of the costs, risks, control, responsibilities and profits or losses in a business project.
Example 14: The Swedish telecommunications company Ericsson created a Joint Venture (JV) with the Japanese consumer electronics company Sony Corporation. The new company called Sony Ericsson was created in order to produce mobile phones. It brought together Sony's consumer electronics expertise with Ericsson's technological leadership in the communications sector.
Example 15: In 2007, The Virgin Group announced a Joint Venture (JV) with The Tata Group in India. This Joint Venture (JV) combined the large network and customer base of Tata Tele Business Services with Virgin Mobile which committed to use its marketing expertise to target the youth of India. It enabled The Virgin Group to enter into a very profitable and the fastest growing mobile phone market in the world at the time.
Example 16: The Coca-Cola Company has created a Joint Venture (JV) with San Miguel by shared ownership of Coca-Cola’s bottling plant in the Philippines.
Example 17: BMW has created a Joint Venture (JV) with Brilliance Auto Group in sharing paint facilities in China.
5. Strategic Alliances (SA)
Strategic Alliances (SA) are agreements between many firms in which each business agrees to commit resources to achieve a set of objectives. A Strategic Alliance (SA) is similar to a Joint Venture (JV) in that many businesses cooperate in a business venture for mutual benefit. The firms in the Strategic Alliance (SA) share the costs of product development, operations and marketing. However, unlike a Joint Venture (JV), forming a Strategic Alliance (SA) means that the affiliated businesses remain independent organizations.
Example 18: In 2000, four different airlines with half-empty aircrafts decided to collaborate by using a single full airplane to cut staff and fuel costs, and split the profits for mutual benefit. The airlines in this Strategic Alliance (SA) called SkyTeam managed to benefit from economies of scale by operating on a larger scale. Their customers gained added value services such as the convenience of access to wider channels of distribution. These days, SkyTeam encompasses 20-member airlines traveling to over 1,000 destination airports in almost 180 countries.
To sum up:
A merger is when two firms combine with one another to form one large business in an attempt to enhance profitability, productivity and market position.
An acquisition is when one business takes control of a major part of another business in a friendly and agreeable way for the same reasons.
A takeover is when one business gains control of a major part of another business in a hostile way.
A Joint Venture (JV) occurs when two businesses agree to form a new company to work closely together on a particular project.
A Strategic Alliance (SA) occurs when many businesses agree, without forming a new company, to commit resources to achieve a set of objectives which would not be possible otherwise.
