Because the costs of External Growth are considerably high, it means that Internal Growth is the only suitable method of growth for many firms on the market.
The main advantage of Internal Growth is that the business is able to maintain a healthy gearing position. Because it is not building up external debts, which require interest regular repayments, the business is better placed to maintain solvent growth for years. In addition, ownership and control of the business are more likely to be retained by the existing shareholders.
The main disadvantage of such approach is that it takes a very long time to grow the firm, and in the meantime, competitors may be expanding and gaining competitive advantage.
Advantages of Internal Growth
Advantages of Internal Growth include:
- Relatively inexpensive. Lower investment is often required as growth may be possible simply from using the existing investments in capacity. The main source of organic growth mainly comes from retained profits. There might also be a need to raise interest-bearing capital from bank loans or debentures, but there is much less risk connected with Internal Growth as the amount of capital required is relatively lower.
- Less risky. Internal Growth is the easiest and least risky method of growth and evolution for most businesses. The business is being built over the years step by step relying on the strengths of the firm, e.g. its brand reputation, best-selling products, loyal employees, a few major customers, etc. The company mainly concentrates on growing sales of products it knows very well and which have been proved to sell well in the past.
- Easier to control and coordinate. It is often easier to grow internally than to rely on external businesses. In this way, the firm’s owners and managers maintain total control of its business operations without any unknown factors that would need to be considered after merging with, acquiring or taking over another business.
- Maintains corporate culture. When growing organically, the business does not integrate with any other business, therefore the work culture and management style is maintained. Internal Growth means there are no problems related to culture clashes and conflicting management styles.
- Maintains healthy gearing position. Internal growth is often funded from equity – either retained profits generated in previous years or issuing shares to investors. These two methods do not have any negative effect on the company’s cash flow position. The capital does not need to be repaid as there is no external debt, neither there is any interest on top of the repayments. This provides financial stability and solvency of the firm.
- Ensures continuity. Business continuity brings the benefit of consistent productivity of the entire team of workers following company’s pre-established policies. Everyone in the business is consistently on the same page working together to offer the same quality of goods and services on regular basis to customers. Only then people can become loyal customers as they experience little or no change in whatever products they buy.
Disadvantages of Internal Growth
Disadvantages of Internal Growth include:
- Slow. Internal Growth is slower than External Growth as it takes time to generate profits and retain them as cash for future growth of the business. Hiring employees and developing new products also takes a considerable amount of effort and time. On the top of that, growth may be slow particularly, if the business operates in saturated, mature or declining markets.
- Divorce between ownership and control. If a firm grows by changing its legal status, e.g. from a private limited company to become a public limited company, then the few original owners will have to share decision-making with the new owners. The number of shareholders will increase. With more owners, decision-making is prolonged and there is more likely to be much conflict of interests between those different shareholders. In addition, there will most likely be a divorce between ownership hold by the shareholders and control of the business which lies in the hands of The Board of Directors.
- A need to restructure. Although sole traders or partners in the partnership can control and coordinate daily tasks quite easily, if they grow their businesses into a large-size firm, then the organizational structure has to be changed. A private limited company or even a public limited company will be created. But, restructuring the business organization requires time, expertise, effort and money. It may require training and updating of skills of the current management, or even specialist managers will have to be hired as the firm and its workforce grows over time.
- Diseconomies of scale. Higher unit costs of production arise as the businesses increase in size a lot. With more managers and workers employed, hierarchical structures will need to be established. These will most likely cause communication problems resulting from longer chains of command and slower decision-making due to increased bureaucracy as the business grows resulting in internal diseconomies of scale in the end.
- Reluctant to explore new things. The business may become over reliant on its current sales revenue and profits generated from a small number of familiar markets, well-established products and loyal customers it knows very well. This will cause neglecting all range of possibilities that may be ventured into with External Growth, such as entering into new markets or doing business in additional sectors of the economy.
Although internal growth is often quite slow, it is considered much safer. Therefore, it avoids some of the problems of External Growth such as growing excessively fast that may lead to overborrowing, overtrading and various management problems.
