Table of Contents
- Importance of business expansion
- Measure business growth
- Types of business expansion
- Advantages and disadvantages of a business expansion strategy
- Risks of business expansion
What’s it: Business expansion is the attempt of a company to grow the size of its business. It aims to increase the scale of operations. Thus, the company can generate more money.
Expansion can be through internal growth such as:
- Build new production facilities
- Target new markets
- Develop new products
- Establish a subsidiary
Alternatively, it could be through external growth, such as:
- Acquired another company
- Merger with other companies
- Establish a joint venture
- Build strategic alliances
Let’s discuss it in more detail.
Importance of business expansion
Expansion becomes a way to grow the business and generate more money for the company’s shareholders. Several reasons explain why expansion is essential to companies, including:
- Make more money by selling more output to more customers
- Increase competitiveness by building more enormous resources
- Dominate the market by controlling a higher market share
- Increase bargaining power with stakeholders, including bargaining power with suppliers, customers, distributors, and suppliers
- Achieve market leadership to further influence market prices.
- Increases economies of scale and can spread costs across more outputs, lowering unit costs
- Increase shareholder value in line with positive expectations for company growth and profits
Shareholder value increases as profit increases. Shareholders have the potential to get a higher dividend, which is taken from the net profit. Also, they expect the company’s share price to rise, increasing the potential for capital gains.
Measure business growth
How can we show that a company is growing?
As I explained earlier, growing a business is about increasing the scale of operations. To measure whether a company is growing or not, you can use the following indicators:
- Assets – the company has more resources (assets) either through internal or external growth.
- Number of employees – companies need more employees to operate various jobs in the business.
- Total output – the firm produces more product as it increases production capacity.
- Number of customers – the company sells higher output to more customers, both in the domestic and foreign markets.
- Revenue – by selling more products, the company generates more revenue.
- Profits – income increases should be supported by increased profits through several cost savings and economies of scale.
- Market capitalization – Stock market investors love growth and profitability, expecting stock prices to go up.
Types of business expansion
In general, we can divide business expansion strategies into two categories. It is based on how growth is carried out, whether by developing internal resources or by combining external resources.
- Internal growth – the company relies on internal resources and capabilities to increase the size of the business.
- External growth – the company combines internal and external resources and capabilities.
The two growth strategies are not all suitable for the company. Each has advantages and disadvantages. For example, internal growth may be a rational option for small firms, where they have more limited resources.
We call this strategy organic growth. The company grows its existing resources and capabilities. It may be through:
- Increase production capacity by buying new machines or building new factories.
- Opening new outlets or branch offices to reach a broader range of consumers.
- Increase advertising spending to increase sales by persuading consumers to buy.
- Offers new variants of existing products to existing markets
- Expanding market segments, for example, by reaching other segments related to the current segment.
- Expanding into new markets, for example, by selling products abroad
External growth involves external parties to grow. That is by combining the resources and capabilities of other companies. We also call it inorganic growth.
It can be run via:
- Joint ventures
- Strategic alliance
The merger consolidates the two companies into a single, larger entity. After the merger, only one company survived.
Meanwhile, an acquisition involves the takeover and control of another company. After the acquisition, the target companies became subsidiaries of the acquirers, and each of them is still operating independently.
Acquisitions can be either friendly or hostile. A friendly acquisition is when the target company’s management agrees to take over. Conversely, if they disagree, we call it an unfriendly acquisition or hostile acquisition.
Furthermore, under the joint venture, the two companies agreed to build a new business. This strategy allows companies to combine complementary capacities, expertise, technology, and resources. Companies share risks with business partners.
Lastly, a strategic alliance involves an agreement between two or more companies to share resources to carry out a specific project. Each of them remains independent of the other.
Advantages and disadvantages of a business expansion strategy
Internal growth advantages and disadvantages
Internal growth offers several advantages.
First, the risk of failure is relatively lower than when the company acquired or merged with another company. Mergers or acquisitions have a higher risk of failure because they have to synergize different resources and capabilities to produce value. And, that’s often difficult to do.
Second, the company has full control over operations due to less outside interference. Companies can develop new ideas by empowering current employees.
Third, employees are more motivated. Management engages them to grow the business. They feel involved and contribute to the company’s success.
However, internal growth also has some disadvantages.
First, this strategy is slower to grow a business. Companies must rely on existing resources, which are more limited.
Second, the internal capacity is more limited. Lack of innovative ideas often creates problems when companies are growing organically.
Third, internal growth is futile. Because it is slower, it will be useless if the market has reached a mature phase where growth will start to decline.
Advantages and disadvantages of external growth
Inorganic growth has some advantages over organic growth. Here are some of them:
First, growth is faster. In mergers and acquisitions, companies combine two different production facilities to increase scale and operating capacity more rapidly. Likewise, the company also added customers and target markets.
Second, the intensity of competition decreases. The number of players decreased after the merger. Likewise, when acquiring, the company controls competitors under its control.
Third, the bargaining power of the company becomes more significant. Companies have more market power. That makes it have a better bargaining position with suppliers and customers.
Fourth, profits are higher. Companies can capture value in the supply chain by acquiring suppliers or distributors. They can obtain the profit margins previously enjoyed by the supplier or distributor. They also have control over inputs or products, especially in price, quality, and delivery time.
However, internal growth also has several disadvantages.
First, government oversight is tighter. As competition decreases and the firm’s market power is higher, it often gives rise to anti-competitive behavior. It is often detrimental to consumers. So, the government will prevent it.
Second, cultural conflicts and managerial problems often arise. Two companies often have different cultures and resources. Therefore, companies are more difficult to control.
Third, synergizing resources and capabilities failed. Ideally, the company could create value by acquiring or merging with another company. But, it is a difficult task. And, often, costs outweigh the benefits.
Fourth, employee morale has decreased. Mergers are often followed by downsizing excess work. Workers may lose job security due to rationalization, making them less motivated.
Fifth, the company loses focus on core competencies. The company’s operations are becoming more complex. Management must focus on various different businesses, which often lack experience in operating them.
Sixth, negative consumer perceptions emerge. They may suspect uncompetitive activity and react negatively.
Risks of business expansion
Indeed, expansion has the potential to generate more money. Companies can market their products to more customers. Selling to more people allows the company to achieve higher economies of scale, allowing unit costs to fall. Ultimately, it leads to higher profits.
However, the expansion also comes with several risks, including:
- Financial loss
- Ineffective management
- Reluctance to change
- Political risk