External Growth, this form of corporate growth can lead to rapid expansion of the business which might be vital in very competitive markets, or in industries that expand fast.
However, when two firms with potentially very different cultures form a new company through mergers, acquisitions and takeovers, or cooperate with one another through Joint Ventures (JV) or Strategic Alliances (SA), major problems occur, mainly due to management problems.
Advantages of External Growth
Advantages of External Growth include:
1. Much faster than Internal Growth. External Growth is a faster way to grow and evolve than Internal Growth. Buying the entire business enables for very fast expansion into new markets, industries and countries.
2. Achieving economies of scale. Reduction in costs results from the benefits of internal 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.
3. Quick way to eliminate competition. The company can eliminate a competitor quickly either in a friendly way (in case of mergers and acquisitions), or in a hostile way (in case of a takeover). However, such strategies can be prohibited by the national government because the lack of competition might not be in the best interest of the general public.
4. Gaining greater marker share immediately. External Growth gives the business an opportunity to increase market share fast as the business gains immediate access to all customers of the target company at once. Horizontal mergers, acquisitions and takeovers do not represent growth in the industry, but a larger market share leading to greater market power and dominance in the industry for the amalgamated business.
5. Acquiring know-how. Merging can be a very good way to access new technology, innovative products, patents or trademarks without wasting precious time on researching and developing them which may take many years. Working with other businesses in the same, or similar industry, means sharing of ideas, generating new skills and experiences.
6. Spreading risks. External Growth can help a firm to spread risks across several markets, industries and countries as partners share both risks and rewards in a Joint Venture (JV) or Strategic Alliance (SA). Hence, such firms can benefit from risk-bearing economies of scale.
7. Easier to obtain finance. Finance is necessary for business growth. Larger businesses have it easier 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 tangible assets as collateral.
Disadvantages of External Growth
Disadvantages of External Growth include:
1. Very expensive. External Growth involves much higher cost than what is needed for Internal Growth, especially when it comes to acquisitions and hostile takeover bids.
Example 1: Heinz acquired Kraft for USD$100 billion to form The Kraft Heinz Company.
Example 2: Exxon acquired Mobil for USD$77.2 billion to form Exxon Mobil.
Example 3: Microsoft acquired LinkedIn for USD$26.2 billion.
Example 4: Facebook acquired WhatsApp for USD$22 billion.
Example 5: Disney’s takeover of Pixar cost USD$7.4 billion.
Example 6: The Coca-Cola Company completed the acquisition of Costa Coffee for $4.9 billion from Whitbread.
2. Loss of control and ownership. External Growth can surely lead to a loss of control and ownership of the business. It is because takeovers are hostile business integrations in contrast to friendly acquisitions. When a company buys enough shares (more than 50%) in another target firm, it becomes the controlling owner of it. The new Board of Directors (BOD) will need to be restructured which may include managers who were not originally appointed by the owners.
3. Culture clashes. When growing inorganically, the business integrates with other businesses, therefore the previous work culture and past management styles cannot be maintained. The newly formed organization that will emerge, after the business integration, will have its new and unique corporate culture built upon the previous two corporate cultures. All of the current employees will need to adapt quickly to the desired culture, new methods of working and the firm’s updated vision statement and mission statement.
4. Incompatibility. External Growth means there will be problems related to conflicting management styles. Management styles and corporate cultures might be so different that the two teams do not blend well together. The business managers may have different styles of leadership that makes decision-making difficult. It will be especially visible during routine business activities such as business meetings, business presentations or during the production process.
5. Stakeholder conflicts. There might also be conflict between the two teams of managers who are used to working with different practices and systems in the past. The cultures may be quite difficult to match up, and conflict of cultures and business ethics will emerge.
6. Higher Gearing Ratio. Large amounts of long-term debt mean deteriorating gearing position. Businesses growing externally are at risk of having unhealthy gearing position as external debt is used to fund expansion. Higher debt will have negative effect on the company’s cash flow position, if a debt-to-equity ratio reaches over 50%. The borrowed capital needs to be repaid with interest on the top of the repayments. This may result in financial instability and insolvency of the firm. In the long-term, business integrations that rely on bringing huge external finance may suffer negative impacts on profitability.
7. Regulatory problems. The government and certain market watchdogs may be concerned with, and hence prevent a merger, acquisition or takeover from happening. Especially, if it may lead to a monopolistic position giving the amalgamated business too much market power.
Despite the risks of External Growth, shareholders may prefer more rapid methods of growth to boost their returns on investment.
