Internal and External Growth Strategies

Growing a business is the process of of improving some measure of a comany’s success. A business can grow in terms of employees, customer base, international coverage, profits, but growth is most often determined in terms of revenues. There are different ways of growing a business. Igor Ansoff identfied four strategies for growth and summarized them in the so called Ansoff Matrix. The Ansoff Matrix (also known as the Product/Market Expansion Grid) allows managers to quickly summarize these potential growth strategies and compare them to the risk associated with each one. The idea is that each time you move into a new quadrant (horizontally or vertically), risk increases. The four strategies are:

  • Market Penetration: selling more of the company’s existing products to existing markets. To penetrate and grow the customer base in the existing market, a company may cut prices, improve its distribution network, invest more in marketing and increase existing production capacity
  • Market Development: selling more of the company’s existing products to new markets. This strategy is about reaching new customer segments or expanding internationally by targeting new geographic areas.
  • Product Development: developing and selling new products to existing markets Product development means making some modifications in the existing products to give increased value to the customers for their purchase or developing and launcing new products alongside a company’s existing offering.
  • Diversification: entering new markets with new products that are either related or completely unrelated to a company’s existing offering. Diversification in turn can be classified into three types of diversification strategies:
    • Concentric/Horizontal diversification (or related diversification): entering a new market with a new product that is somewhat related to a company’s existing product offering
    • Conglomerate diversification (or unrelated diversifcation): entering a new market with a new product that is completely unrelated to a company’s existing offering
    • Vertical diversification (or vertical integration): moving backward or forward in the value chain by taking control over activities that used to be outsourced to third parties like suppliers, OEMs or distributors

Ansoff Matrix

Figure 1: Ansoff Matrix

Generally speaking, business growth can be classified into internal growth and external growth. This article will discuss the various growth strategies and explain the differences between them.

Internal Growth

Internal growth (or organic growth) is when a business expands its own operations by relying on developing its own internal resources and capabilities. This can for example be done by assessing a company’s core competencies and by determining and exploiting the strenght of its current resources with the aid of the VRIO framework. Moreover, companies can decide to grow organically by expanding current operations and businesses or by starting new businesses from scratch (e.g. greenfield investment). Important to note here is that all growth is established without the aid of external resources or external parties. Internal growth has a few advantages compared to external growth strategies (such as alliances, mergers and acquisitions):

  • Knowledge improvement: organic growth strategies improve the company’s knowledge through direct involvement in a new market or technology, thus providing deeper first-hand knowledge that is likely to be internalized in the company
  • Investment spread: gradually growing internally helps to spread investment over time, which allows a reduction of upfront costs and commitments, making it easier to reverse or adjust a strategy if conditions in the market change
  • No availability constraints: the company is not dependent on the availability of suitable acquisition targets or potential alliance partners. Organic developers also do not have to wait for a perfectly matched acquisition target to come on to the market
  • Strategic independence: this means that a company does not need to make the same compromises as might be necessary in an alliance, for example, which is likely to involve constraints on certain activities and may limit future strategic choices
  • Culture management: organic growth allows new activities to be created in the existing cultural environment, which reduces the risk of culture clash—a common difficulty with mergers, acquisitions, and alliances

Internal growth strategies have a few disadvantages. For instance, developing internal capabilities can be slow and time-consuming, expensive, and risky if not managed well.

External Growth

External growth (or inorganic growth) strategies are about increasing output or business reach with the aid of resources and capabilities that are not internally developed by the company itself. Rather, these resources are obtained through the merger with/acquisition of or partnership with other companies. External growth strategies can therefore be divided between M&A (Mergers and Acquisitions) strategies and Strategic Alliance strategies (e.g. joint ventures).

Mergers and Acquisitions

M&A offers a number of advantages as a growth strategy that improves the competitive strength of the acquirer. They include:

  • Business extension: M&A can be used to extend the reach of a firm in terms of geography, products or market coverage.
  • Consolidation: M&A can be used to bring together two competitors to increase market power by reducing competition; to increase efficiency by reducing surplus capacity or sharing resources, for instance head-office facilities or distribution channels; and to increase production efficiency or increase bargaining power with suppliers, forcing them to reduce their prices.
  • Building capabilities: M&A may increase a company’s capabilities. Instead of researching a new technology from scratch, for instance, acquirers may wait for entrepreneurs to prove an idea and then take them over to incorporate the technological capability within their own portfolio.
  • Speed: M&A allows acquirers to act fast—and this may be an advantage in itself, wrong-footing competition and changing the industry landscape faster than competitors can evolve in response.
  • Financial efficiency: This may allow a company with a strong balance sheet to combine with another company with a weak balance sheet, enabling the latter to save on interest payments by using the stronger company’s assets to pay off its debt. The acquired firm could also access investment funds from the stronger company that were otherwise unavailable.
  • Tax efficiency: For example, profits or tax losses may be transferable within the combined company in order to benefit from different tax regimes between industries or countries, subject to legal restrictions.
  • Asset stripping or unbundling: Some companies are effective at spotting other companies whose underlying assets are worth more than the price of the company as a whole. This makes it possible to buy such companies and then rapidly sell off (unbundle) different business units to various buyers for a total price that is substantially in excess of what was originally paid for the whole. Although this is often dismissed as merely opportunistic profiteering (asset stripping), if the business units find better corporate parents through this unbundling process, there can be a real gain in economic effectiveness.

Strategic Alliances

Mergers and acquisitions bring together companies through complete changes in ownership. However, companies can also share resources and activities to pursue a common strategy without sharing in the ownership of the parent companies. There are two main kinds of strategic alliance: equity and non-equity alliances.

  • Equity alliances involve the creation of a new entity that is owned separately by the partners involved. The most common form of equity alliance is the joint venture, where two companies remain independent but set up a new company that is jointly owned by the parents. Alliances can also be formed with several partners, and these are termed a consortium alliance.
  • Non-equity alliances are typically looser, and do not involve the commitment implied by ownership. Non-equity alliances are often based on contracts. One common form of contractual alliance is franchising, where one company (the franchisor) gives another company (the franchisee) the right to sell the franchisor’s products or services in a particular location in return for a fee or royalty. McDonald’s restaurants and Subway are examples of franchising. Licensing is a similar kind of contractual alliance, allowing partners to use intellectual property, such as patents or brands, in return for a fee. Long-term subcontracting agreements are another form of loose non-equity alliance, common in automobile supply.

Types of Strategic Alliances

Strategic alliances allow a company to rapidly extend its strategic advantage and generally require less commitment than other forms of expansion. A key motivator is sharing resources or activities, although there may be less obvious reasons as well. There are four types of alliance: scale, access, complementary, and collusive.

  • Scale alliances involve companies combining to achieve necessary scale. The capabilities of each partner may be quite similar, but together they can achieve advantages that they could not easily achieve on their own. Thus, combining together can provide economies of scale in the production of outputs (products or services). Combining might also provide economies of scale in terms of inputs—for example by reducing purchasing costs of raw materials or services.
  • Access alliances involve a company allying in order to access the capabilities of another company that are required to produce or sell its own products and services. For example, in countries such as Mexico a Western company might need to partner with a local distributor to access effectively the national market for its products and services. The local company is critical to the international company’s ability to sell. Access alliances can also work in the opposite direction, with a local company seeking a licensing alliance to access inputs from an international company—for example technologies or brands.
  • Complementary alliances involve companies at similar points in the value network combining their distinctive but complementary resources so that each partner is bolstered where it has particular gaps or weaknesses. The Renault-Nissan Alliance is a great example of two companies combining their strenghts to overcome their individual weaknesses.
  • Collusive alliances involve companies colluding secretly to increase their market power. By combining into cartels, they reduce competition in the marketplace, enabling them to extract higher prices from customers or lower prices from suppliers. Such collusive cartels among for-profit businesses are discouraged by regulators. For instance, mobile phone and energy companies are often accused of collusive behavior.

There are many potential advantages of external growth through acquisitions and alliances. Down below there is a list of some of these advantages compared to internal growth depeding on the nature of the acquisition/alliance. For a more systematic way of choosing between acquisitions and alliances themselves, you may want to read more about the Acquisition-Alliance Framework.

  • Faster speed of access to new product or market areas
  • Instant market share / increased market power
  • Economies of scale (perhaps by combining production capacity)
  • Secure better distribution channels
  • Increased control of supplies
  • Decreased competition (by taking them over or partnering with them)
  • Acquire intangible assets (brands, patents, trademarks)
  • Overcome barriers to entry to target new markets
  • To take advantage of deregulation in an industry / market

Acquisition or Alliance Framework

Figure 2: External Growth Framework from the article ‘Acquisitions or Alliances?

In sum, growing a company can be done in many different ways. The most used ways are internal growth or external growth through acquisitions and alliances. The Ansoff Matrix is a great tool to map out a company’s options and to use as starting point to compare growth strategies based on criteria such as speed, uncertainty and strategic importance.

Further reading:

  • Ansoff, I. (1957). Strategies for Diversification. Harvard Business Review.
  • Dyer, J.H., Kale, P. and Singh, H. (2004). When to ally and when to acquire. Harvard Business Review.