What it is: Business growth is part of a management target. By growing, companies can make more money for their shareholders.
Growth is also essential for competitiveness. In competition, larger businesses are one step ahead of smaller companies. They have better resources and capabilities to seize market opportunities and dominate the market.
Not all growth strategy options are suitable for companies. Each has its advantages and disadvantages. To grow, management will look at various rational options.
What is business growth
Business growth refers to increasing the scale of a company’s operations. You can use the following indicators to show that the company is growing:
- Production – the firm produces more output due to an increase in production capacity.
- Sales and profits – the company sells more goods, contributes positively to increased revenue and profit.
- Number of employees – as the company grows, they need more workers.
- Number of customers – if the number of customers increases, the company can sell more products and encourage them to increase production.
- Firm value – for public companies, growing companies see their share price go up, thereby increasing market capitalization.
Why is business growth important
Several reasons explain why a business wants to grow. Growing a business is part of management goals. They want to expand the company’s business into new markets to increase shareholder value.
Value is created when growth increases profits and returns to shareholders, reflected in larger dividends and higher share prices.
To increase profits, companies try to dominate the market. Apart from benefiting from a larger market share, being a market leader also improves bargaining power with suppliers and customers. Large companies also have more influence on market prices.
Also, with more extensive operations, companies enjoy economies of scale. They can spread costs across a large number of outputs, driving lower unit costs. That allows the company to have a lower cost structure than competitors.
Growth is not only aimed at increasing profits but also securing future profits. Companies can diversify their business or products into different segments. Running multiple different businesses reduces the risk of failure in one business.
How to grow a business
There are two options for growing a business, namely:
- Internal growth – relying on internal resources and capabilities.
- External growth – combines internal and external resources and capabilities.
Internal growth
Another term for internal growth is organic growth. Companies expand the business from within, relying on their own inner resources and capabilities.
Using internal capital, companies can grow their business by:
- Increasing the number of workers
- Increasing production capacity
- Opening a new outlet or branch office
- Increasing the number of items sold through aggressive advertising
- Offering new variants of existing products to the existing market
- Expanding market segments
- Expanding into new markets, for example, international markets
The advantage of internal growth is a lower risk of failure than a merger or acquisition. Expansion can fail and result in losses due to the inability to synergize resources and capabilities.
By growing organically, companies also do not lose control of business operations. This strategy does not involve outsiders. Companies can empower employees to foster new ideas. This can motivate them to work because they feel involved and contribute to business success.
But, internal growth is also relatively slow, and shareholders may not like it. It may be wasted if the industry has reached a mature phase where growth will start to decline.
Lack of internal resources and capabilities is another weakness. Internal capital, a lack of innovative ideas, and liquidity problems often arise when companies want to grow organically.
External growth
In external growth, companies combine resources and capabilities, both internal and external. In other words, the company involves outsiders (other companies) to grow.
Some of the options a company might choose are:
- Business integration (mergers and acquisitions)
- Joint ventures
- Strategic alliance
Business integration
Business integration involves two options: mergers and acquisitions. A merger is a business consolidation of two companies into one larger entity. Before the merger, the two companies operated independently. And, after the merger, only one company survived, and the others cease to exist.
Meanwhile, the acquisition involves the purchase of another company (target), but each is still operating independently. After the acquisition, the target is to become a subsidiary of the acquirer.
The two types of acquisitions are friendly acquisitions and hostile takeovers. A friendly acquisition occurs when the target company’s management and shareholders agree to be acquired. Meanwhile, if they disagree, we call it a hostile acquisition.
The three types of business integration are:
- Horizontal integration
- Vertical integration
- Conglomerate integration
Horizontal integration
Horizontal integration involves two companies in one line of business. In other words, before integration, the two companies competed with each other. As an example:
- Heinz and Kraft in the food business
- Marriott International and Starwood hotels in the hospitality industry
- The Walt Disney Company and 21st Century Fox in the entertainment industry
Horizontal integration offers several advantages, including:
Increased economies of scale – the production capacity of a company increases as it combines two similar production facilities.
Eliminating competition – one company disappears from the market (in case of a merger) or under the control of an acquirer. The intensity of competition is reduced in the market because there are fewer firms.
Higher bargaining power – greater market power allows the company to have a better bargaining position with suppliers and customers. Companies also have more power to influence market prices.
Easier to manage – because both companies share the same market, risk profile, and core business. This strategy also reduces the risk of failure after integration.
But, horizontal integration also contains several drawbacks, such as:
Higher market power leads to monopoly – regulators monitor such integration. Regulators will seek to prevent anti-competitive and monopolistic behavior.
Cultural conflicts and managerial problems – as companies get more prominent, it is difficult to manage the business and lead to business failure. Also, problems arise due to cultural clashes.
Reduced employee morale – integration often involves downsizing excess work. Companies may choose to retire some employees to support downsizing.
Vertical integration
Vertical integration involves two companies in different stages of the production chain, but in the same industry. One company may be a supplier or distributor of another company.
Variations of vertical integration are backward vertical integration and forward vertical integration. For example, if a car manufacturer acquires a distributor company, we call this forward vertical integration. Whereas, if a car maker takes over a supplier (say a steel company), it is backward vertical integration.
Advantages: Vertical integration allows companies to reap value in their supply chains. After integration, the company controls the profit margins previously enjoyed by the supplier or distributor. Also, forward vertical integration offers greater control over product promotions and pricing. Meanwhile, backward vertical integration contributes to greater control over the quality, price, and delivery time of inputs.
Weaknesses: Lack of experience in upstream or downstream businesses can lead to integration failure. Business management has also become more complex as companies have to focus on operations that are not their core competencies.
The benefits of economies of scale are also lower. Because it involves two different businesses, it is difficult for companies to achieve higher economies of scale, such as horizontal integration. As a result, it may be cheaper to buy from independent suppliers than internal suppliers.
Conglomerate integration
We also call it a diversification strategy because it unites two businesses in different industries, such as car manufacturers and electronics manufacturers. We call companies that have multiple businesses a conglomerate, which brings together different types of businesses under one control.
The main advantage of conglomerate integration is that it reduces the risk of loss in one business. Profits in one business compensate for losses in another. Apart from that, conglomerates can also transfer skills and knowledge from one market to another.
Weaknesses: Conglomerate integration strategies also carry a higher risk of failure than vertical or horizontal integration. Much more complex management and lack of experience in new markets can lead to business failure.
Joint ventures
In a joint venture, the two companies agree to work closely together on a project or build a new business. A joint venture is a short term relationship based on a business project. Examples are Google and NASA developing Google Earth, and Toyota and Panasonic setting up an EV battery joint venture.
Joint ventures provide companies with opportunities to acquire new capacity and expertise. Companies have access to new technology and more significant resources. Also, they can share risks with business partners.
But, failure of business partners will put the joint project at risk. Moreover, collaboration can lead to failure because the two have very different management styles and cultures.
Strategic alliance
A strategic alliance is an agreement between two or more companies to share resources to carry out a specific project and mutually benefit. Each party remains independent of each other.
For example, clothing retailers work with specific clothing manufacturers to ensure consistent quality and size. Or, bookstore companies partnered with coffee shops to offer complementary products.
A strategic alliance differs from a joint venture. The latter are separate legal entities, whereas strategic alliances are not.
Strategic alliances are relatively flexible than joint ventures. Neither party needs to combine capital and can remain independent of each other. However, differences in business styles can lead to conflict and lead to the failure of the alliance.
Factor of consideration
In the early phase, companies usually grow organically and collect income from the core business. After having sufficient resources and capabilities, they will pursue inorganic growth, complementing existing organic growth.
The advantages and disadvantages, of course, are the primary considerations when choosing a growth strategy. The other three factors are:
- Resources and capabilities – what the company wants to have to support its strategic competitiveness in the future.
- Timing – whether growing fast is essential for maintaining competitiveness or not
- Goals – which is better for supporting the long-term target of the company: whether it is growing externally or internally
