Internal and External Growth in Business

Posted on Aug 18, 2024 in Economy

1. Introduction

There are two distinct yet compatible concepts we will define: aspects of a company and mergers. While some growth affects both the system and the company, this is not always the case.

Previously, we discussed two types of growth:

  1. Expansion of activities in traditional markets and products into new markets.
  2. Diversification, which can be vertical, horizontal, concentric, or conglomerate. Note that vertical and horizontal diversification are related, while concentric and conglomerate diversification are not.

2. Internal Growth and External Growth

Let’s compare these two forms of development.

Internal Growth

Internal growth occurs when a company expands its own structure. This can be achieved by:

  • Increasing the size of plants
  • Hiring more people
  • Investing in new technologies (tangible or intangible)

Internal growth, also called natural growth, focuses on acquiring new technologies. It’s a leap forward that doesn’t necessarily mean increasing the workforce. In fact, growth can sometimes be achieved by reducing the number of employees.

External Growth

External growth involves acquiring or merging with other companies or parts of their businesses. This can occur through:

  • Mergers
  • Acquisitions
  • Partnerships

External growth materializes by acquiring existing production capacities. While internal growth implies growth for both the company and the economic system, external growth only benefits the company. For the system to grow, sales and profits must increase.

When is external growth the right choice?

  • When the market is saturated, and it’s the only way to grow
  • To achieve economic efficiency by complementing technology, staffing, or facilities
  • When a company has surplus financial funds and wants to invest in another business
  • When management aims to lead a larger company
  • In a mature industry
  • For tax benefits

Advantages of External Growth

  • Faster growth
  • Reduced risk due to shorter implementation time
  • Increased market power (a larger company with a larger market share)
  • Increased funding opportunities
  • Potential tax benefits

Disadvantages of External Growth

  • Higher financial costs, including a premium paid for the acquisition
  • The need to accurately value the goodwill of the acquired company
  • Potential decrease in the acquiring company’s value

3. External Growth Rate: Integrations

Integration is the union of two or more companies, often resulting in the loss of identity for one or more entities. Let’s distinguish between two key concepts:

Fusion

  • Pure Fusion: Two or more companies combine to form a completely new entity. For example, Company A and Company B merge to create Company C. The original companies cease to exist, and a new one is born.
  • Absorption: One company takes over another. For example, Company A acquires Company B. Company B ceases to exist, and its assets are absorbed into Company A.
  • Fusion Contribution: A company merges with a branch or division of another company. For example, Company B merges with Branch 2 of Company A. The new company consists of Company B and Branch 2, while the rest of Company A remains unchanged.

Breakdown

Breakdown is an economic term, not to be confused with deconcentration, which is a political term. There are different types of breakdowns:

  • Cleavage: A company divides its capital and contributes it to several other companies. For example, Company A splits into three parts, each going to a different company (e.g., EON, ENEN, and ACTION).
  • Segregation: Part of a company’s assets are separated to form legally independent units. For example, Company A splits into three parts, creating three new, separate businesses.

Participation

Participation occurs when a company purchases a block of shares in another company. This can be:

  • Minority: Owning less than 20% of the company, typically with a seat on the board of directors.
  • Minority-Majority: Owning more than 20% but less than 50%, holding the largest share among other investors.
  • Majority: Owning 50% or more of the company. The company with the majority stake is the parent company, while the company whose shares are held is the affiliated company.

Cooperation

This topic will be discussed in the next section.

Problems of Company Integration

Integration can present three types of challenges:

Legal Issues

  • Complications with the legal merger process
  • Difficulties establishing a new legal entity and board of directors
  • Determining the fair value of each company involved in the merger
  • Addressing potential tax implications and asset transfers

Cultural Issues

  • Establishing a new organizational structure, hierarchy, and common culture
  • Managing the impact on employee motivation and productivity
  • Minimizing negative effects by planning common goals and defining management objectives

Economic Problems

: the main problem is the valuation.