Business Growth and Integration
- Reasons why businesses want to grow
- Types of business growth
- Internal growth methods
- External growth methods
- Business integration
Some startups are survival successes. They grow to be more mature with higher sales. Their operations have become more significant with increases in production scale.
Business growth is about increasing the company’s size or operation scale. That’s important to support a stronger market position and higher profits. When companies grow faster than their competitors, they can dominate the market.
Growth allows companies to make more money. On the one hand, they can earn more revenue by selling more products. On the other hand, they can lower costs through higher economies of scale.
Reasons why businesses want to grow
Several reasons explain why a business wants growth.
- Increase profits. Companies sell more products at lower costs.
- Reduce costs. Increasing output leads to higher economies of scale, allowing the cost per unit to decrease.
- Reduce risk. Relying on old products has the potential to fail because the business environment changes (consumer tastes and competitors’ competitiveness changes), forcing companies to introduce new products.
- Dominate the market. The company wants to be a market leader because it allows it to have the power to set market prices and higher bargaining power with stakeholders.
- Diversify business. Companies reduce their risk exposure in one market by expanding into other unrelated markets, enabling them to benefit from diversification.
- Security and survival. Large companies have more resilience than small businesses when facing more established competitors. They have more resources to compete with.
Types of business growth
There are two types of business growth:
- Internal growth
- External growth
The difference between the two lies in whether the company relies on its own resources or combines external resources to increase its operating scale and sales revenue.
Internal growth, also known as organic growth, relies on internal resources and competencies. For example, a company opens a new factory, spends more on advertising and promotion, or establishes a subsidiary.
Internal growth has less risk than external growth. However, for most businesses, this strategy tends to be slow.
Internal growth offers several advantages, such as:
- Less risky than taking over another company
- Allows businesses to grow at a more reasonable rate
- Requires relatively smaller resources than the acquisition
- Can be financed through internal funds such as retained earnings
- Leverage core competencies and internal strengths to grow
- Have more control because outsiders are not involved
- Increase employee engagement to support growth
- Encouraging staff to think broader to bring new ideas
However, internal growth also comes with some drawbacks, including:
- Relatively slow growth
- Disliked by shareholders as they may prefer faster growth
- More difficult to achieve if the business is already a market leader
- Limited growth if the market is mature
- Depends on the market size
- Intensifies competition than if acquiring or merging with a competitor
External growth – also known as inorganic growth – combines external and internal resources and competencies to increase business size. It can be through acquisitions, mergers, and joint ventures.
Although riskier, external growth is a faster way to scale operations than internal growth. In addition, external growth offers other advantages, such as:
- Reducing competition by taking over or merging with competitors
- Preferred by shareholders because it provides fast growth
- Integrate external resources and competencies to complement each other
- Not adding new supply to the market (as in acquisitions and mergers); therefore, market profitability is unchanged
However, external growth also comes with drawbacks, including:
- Riskier because management lacks the experience to deal with other businesses.
- Expensive – as in acquisitions – than building a new plant or increasing promotions
- Conflict because it involves two organizations with different corporate cultures
- Gain market share immediately by combining customers (acquisitions and mergers)
- Spreading risk, such as through joint ventures and strategic alliances
- Regulatory issues if an acquisition or merger leads to an increase in market power
Internal growth methods
The company grows business internally by:
- Launching a new product
- Increasing production
- Finding new markets
- Opening new distribution channels
- Increasing advertising and promotion
Launching a new product. For example, a company introduces a new product to complement its existing product and targets the same market segment. It may bundle with a current product and offer lower prices to attract more sales.
In addition, new products may target different market segments. In this case, the company serves different consumers. For example, Unilever introduced beauty and personal care products to diversify revenue from its previous focus on food and beverage products.
Increasing production. For example, a company may hire new employees to push operations closer to full capacity. Thus, in addition to increasing output, costs also decrease because fixed costs, such as machines, are spread over more output.
When operations have reached maximum capacity, the company may purchase new machinery and equipment to increase production. Or it invests by opening a new production facility.
Finding new markets. The company has two alternatives. First, they offer existing products to new markets. For example, they sell existing products to foreign markets or domestic markets but in different geographic locations.
Second, the company develops new products and sells them to new markets. This alternative is riskier than the first.
Opening new distribution channels. For example, a company adds retail outlets to sell products. Or they expand their network by encouraging more cooperation with wholesalers and retailers.
Another way is to enter the online channel. For example, the company may launch a new website to serve customers or rely on existing e-commerce.
Increasing advertising and promotion. Companies increase advertising spending to attract new customers. Or they aim to stimulate repeat purchases from existing customers. Increased advertising spending may also be directed at stealing customers from competitors by highlighting products.
External growth methods
The external growth method may involve the following:
- Joint venture
- Strategic alliance
A merger occurs when two companies are combined into one. As a result, there is only one surviving entity, which may be a new entity or one of two merged companies.
Mergers are different from acquisitions. Under the acquisition, the two companies still survive and operate independently. One company acts as the parent company, while the other acts as a subsidiary.
Reasons for the merger
- Higher profits due to combining two companies
- Synergizing core competencies and resources
- Strengthening market position by combining two market shares
- Reduced competition because only one entity survives
- Higher economies of scale by combining two operations into one
Mergers offer several advantages, including:
- More product lines
- Higher economies of scale
- Increase in market share
- Reducing competition
- More profit
- Avoid duplication as in acquisitions
However, mergers also have drawbacks, such as:
- Conflict due to differences in culture and management style
- Duplicated jobs and business functions
- Downsizing employees to eliminate duplication
- Declining employee morale
- Internal opposition because the position is threatened
An acquisition occurs when a company buys a controlling stake in another company. After this corporate action, the target company becomes a subsidiary and continues to operate independently, unlike a merger.
There are two types of acquisitions, namely:
- Friendly acquisition
- Unfriendly acquisition
Under the friendly acquisition, the target company’s management approves the proposal and, possibly, helps implement it. Thus, the acquisition was carried out without difficulty.
In contrast, under the unfriendly acquisition, the target company’s management opposed it. They develop anti-takeover strategies to thwart this corporate action, including through:
- Pac-Man defense
- Macaroni defense
- Poison pills
An unfriendly acquisition is also known as a hostile acquisition or hostile takeover. In addition, the term takeover is often identified with this term.
Advantages of acquisition:
- Faster to grow a business, perhaps with complementary businesses
- Without having to unite different resources and competencies because each can operate independently
- Increase in market share if the target operates in the same market
- Revenue growth by consolidating revenue from target companies
- Increase market power by acquiring competitors
- Overcoming barriers to entry, for example, by not having to build brand loyalty and a distribution network from scratch
- Avoid retaliation from existing companies for not adding new supply to the market
Disadvantages of acquisition:
- Expensive, and often the acquirer pays a higher price than the fair price (premium)
- Duplicated resources or business functions
- Culture clash between acquirer and target
- Failed to synergize due to bad identification or inexperience of acquirer management
- Brand damage as the target company’s reputation deteriorates
A joint venture refers to an agreement between two or more companies to work together on a particular project or business for the common good. It is a formal strategic alliance in which the companies involved set up a new, separate entity.
Joint ventures have several advantages, including:
- Access to greater resources and expertise
- Enabling companies to have access to new technologies
- Share risks and profits with partners
But, joint ventures also have drawbacks, including:
- Clash due to differences in management style and culture
- Poor communication between partners
- Low commitment and support in the early stages
- Unequal contribution to capital and resources
- Risk due to partner’s business failure
A strategic alliance is a cooperation between two or more parties without establishing a new separate entity. Each party shares resources and expertise to achieve common goals.
Different from joint ventures, cooperation in strategic alliances are less permanent. In addition, partners usually have low involvement.
Strategic alliances have advantages, including:
- Complementary resources and knowledge
- Low initial investment
- Low risk, less significant than joint ventures
Meanwhile, strategic alliances also contain weaknesses such as:
- Shorter life cycle because it is less permanent
- Communication barriers and cultural conflicts
- Risk due to partners’ mistakes, resulting in damage to reputation and goodwill
- Can be challenging to manage, especially when there are changes
Franchising offers rapid growth without having to get involved in running day-to-day activities. It is when a company (called the franchisor) grants rights to another party (called the franchisee) to use its name, reputation, and skills in a specific location or area. In return, the company obtains royalties or fees.
Franchisors often provide franchisees technical expertise, startup capital, and inventory assistance. Meanwhile, franchisees agree to abide by strict rules on how to do business.
Growing through franchising offers several advantages, such as:
- Fast way to earn more revenue
- Efficient growth when expanding in unfamiliar territory
- More resources to grow the business
- Spreading the business risk among different franchisees
- No need to be involved with operations and business management in other regions
However, franchising also comes with risks, including:
- Inconsistent quality by franchisees
- Reputation damage due to mismanagement by the franchisees
- Low control over franchised business operations
- Conflicts and increased potential for legal disputes
- Low direct contact with customers
Licensing involves a company (licensor) granting another party (licensee) the right to use a technology, manufacturing process, or patented design in a particular market or geographic area. The licensee then uses it to make money. As compensation, the company receives fees and royalties.
Licensing provides benefits for companies, including:
- Earn income without additional costs
- Costs nothing to manufacture, promote or sell products
- Utilize the licensee’s knowledge and competence to generate revenue
- An easy way to enter foreign markets
However, growing through licensing also carries risks, such as:
- Theft or duplication by the licensee
- Unintentional competition when licensees and companies target the same market
- Damage to reputation due to unethical business practices by licensees
Business integration is a strategy or action by a company to unite or combine various businesses to be under control. For example, a company takes over a controlling stake in its supplier and makes it a subsidiary.
Integration can be through acquisitions or mergers. And the goal is to maximize synergy.
Integration can involve:
- Horizontal integration
- Vertical integration
- Conglomerate integration
Horizontal integration involves combining one business with another at the same stage in its current supply chain. For example, the company can merge with its competitors, making its operation bigger. Or, the company acquires a competitor and makes it a subsidiary and under control.
Horizontal integration has several advantages, including:
- Reducing failures due to having the same market and product knowledge
- Enjoying higher economies of scale by integrating the operations of two companies
- Eliminating competition by reducing the number of competitors
- Improving market position by having more customer base
- Greater bargaining power over suppliers due to larger purchase sizes
- Easy to manage compared to conglomerate integration as they have similar business models
However, horizontal integration also has disadvantages, such as:
- Conflict when two different cultures are combined
- Managerial problems when the business becomes very large
- Concentrated market power (and leading to monopoly) and, therefore, closely monitored by regulators
Vertical integration involves two businesses in the same supply chain at different stages. Companies can acquire other companies and establish subsidiaries or joint ventures.
Two types of vertical integration are
- Backward vertical integration
- Forward vertical integration
Backward vertical integration involves the company going into the upstream business. For example, a car company acquires a tire manufacturer.
Backward vertical integration aims to gain control over inputs such as raw materials and components. Thus, the company can secure input supply, price, and quality.
Companies gain through backward vertical integration, including:
- Securing supply because it prioritizes the company over competitors
- More restrictive supply and alternatives for competitors if the upstream business has a dominant position
- Guarantee the input quality because it is under the company’s control
- Cutting out the intermediaries leads to increased profits
- Capture added value and profits in the upstream business
- Create entry barriers for potential competitors by forcing them to have integrated businesses to be profitable
However, backward vertical integration also has disadvantages, such as:
- A higher price than if the upstream business operated independently
- Lack of experience in managing the business in the upstream sector
- Potentially unfocused as resources and expertise need to be shared
- Low flexibility because the size becomes large, but the business is different
- Synergy failure when upstream business is integrated
- Huge capital requirements to grow current and upstream businesses
Forward vertical integration combines other businesses downstream in the current supply chain. For example, a car company takes over a car distributor.
Forward vertical integration aims to increase control over distribution and retail. In addition, the company is also closer to the customer.
Forward vertical integration offers several advantages, such as:
- Ensure goods reach customers at the right location and time
- Capture the value created and profits in downstream businesses
- Cutting out the middleman which leads to reduced costs
- Greater control over promotions and selling prices
- Closer to the customer, the source for the following product innovation
- Create entry barriers for potential competitors
- Gain insight from downstream businesses on what items are selling best
But, forward vertical integration also contains some disadvantages, such as:
- Not focused because they have to manage two different businesses
- Synergy failure, leading to increased costs
- Difficulties in managing as the bureaucracy increased and the size became too big
- Onerous capital expenditure requirements to acquire targets and integrate resources and operations
- Losing focus on core business and main goals
Under conglomerate integration, companies combine unrelated businesses under one control. In other words, the company enters another business outside its current supply chain.
Conglomerate integration aims to diversify and reduce concentration risk. Thus, the company can compensate for losses in one business from profits in other businesses.
There is also lateral integration. It involves integrating several companies where they sell related goods or services but do not compete directly with each other.
For example, a cinema company acquires a restaurant. After the acquisition, the company operated restaurants in its cinema network.
Another example is a hairdresser’s business acquiring a beauty therapist’s business. The two operate in different supply chains and are not in competition with each other but are linked.
Growing through conglomerate integration offers several advantages, such as:
- Diversify income streams
- Spreading the risk by operating in an unrelated business
- Not subject to monopoly laws
However, conglomerate integration also has drawbacks, such as:
- Not focused on the core business
- No knowledge of different business
- Differences in business models, resulting in complexity in management
- Does not benefit from supply chain synergies
- Low economies of scale because business is unrelated