Business growth requires both organic and inorganic growth. Each method carries its own set of advantages, challenges, and implications for the trajectory of a company. Whether you are a startup or established enterprise, understanding the dynamics of organic and inorganic growth is essential for making informed decisions that align with your business objectives and market conditions.
In this article, we discuss the differences between organic growth driven by internal forces such as innovation and market penetration, and contrasting it with the faster-paced inorganic growth fueled by mergers, acquisitions, and strategic alliances.
What is the Difference Between Organic and Inorganic Growth
In business, business growth strategies can be broadly categorized into two categories: organic and inorganic. Organic growth refers to the internal, gradual expansion of a company through increased sales, market penetration, and the development of new products or services. It is a natural progression driven by the organization’s own resources, innovations, and operational efficiencies. Organic growth is often considered a more sustainable and controlled form of expansion as it evolves from within the company’s existing framework without relying on external forces.
Conversely, inorganic growth involves external factors such as mergers, acquisitions, or partnerships that rapidly expand the business. This strategy allows companies to achieve substantial growth in a shorter timeframe, leveraging the strengths and resources of other established entities. Inorganic growth is characterized by the infusion of external capital, talent, or market presence. While it offers the advantage of quick market entry and enhanced scale, inorganic growth comes with challenges such as integration issues, cultural differences, and the need for effective strategic alignment to ensure long-term success.
The choice between organic and inorganic growth often depends on a company’s specific goals, athletic positioning, market conditions, and risk tolerance. Many businesses adopt a combination of both strategies to balance steady internal development and opportunistic external expansion.
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The Pros, Cons, and AN Investor’S Perspective
Every company loves to see growth. It’s a signifier of potential success and that things are “working” within the organization. However, not all growth is created equally. What are the benefits of organic and inorganic growth, and what type of growth do most investors prefer to see?
Pros of Organic Growth
Organic growth comes from expanding your organization’s output and by engaging in internal activities that increase revenue. It is typically considered a more sustainable, though slower, method of business growth. Here are some of the benefits of organic business growth:
- Management knows the company inside and out. Since organic growth occurs in a relatively tighter-knit organization, management knows the company strategies and operations more intimately than an organization that has recently undergone a merger or acquisition. This means the company is typically able to adapt to changes in the marketplace more quickly.
- Less integration challenges and restructuring. During a merger or acquisition, there’s typically restructuring of personnel and operations that occurs to manage the new volume of business. This can often mean layoffs, changes in the leadership team, and overall figuring out how to monitor more employees and assets. During organic growth, integration challenges or management/personnel changes are typically more gradual, which can feel more comfortable and natural for the internal culture.
- Stay true to your dream. Without mergers or acquisitions, entrepreneurs have more control over the direction the business is headed.
- It’s considered to be more sustainable. Sustainable growth is the ultimate goal of any company. Without organic growth, there’s no investor interest, little possibility of becoming an acquisition target, and virtually no chance that the company will become vibrant enough to sell. Bringing in consistent or growing revenues is a sign that things are working within an organization and is an important step in business success.
Cons of Organic Growth
- Growth can be significantly slower. Since there’s no infusion of market, product, assets, or resources, a company growing organically must do so at a sustainable pace. This means growth can’t overshoot the personnel, support, and resources available.
- May decrease your competitive edge. We all know that the best way to succeed in any industry is to out-play your competitors. If your competitors are growing quickly or if your industry has high M&A activity, then growing too slowly can mean you’ll be quickly overtaken by competitors.
- There is sometimes a glass ceiling. Businesses that rely on organic growth often find that they lack the resources to continue to grow in a way that allows them to achieve their goals. As business and customer needs grow, receivables and other cash-consuming items and resources grow as well.
- Competition drives the market. M&A activity is like dominoes—once companies in an industry begin merging, it puts the heat on all the other companies to grow more quickly than is organically possible, or they may be left behind. Competitors’ influx of resources and business may allow them to lower prices or employ other tactics to steal market share, making it more difficult for smaller companies in the industry to grow.
Pros of inorganic growth
Inorganic growth comes from mergers, acquisitions, and joint ventures. It is typically a much faster, more high-impact form of growth, but also requires more resources and dynamic management to be successful.
- Growth is much, much faster. Many businesses nearly double or triple their client list with a business merger. Since this growth occurs through a transaction, this inorganic growth is much faster than is possible for organic growth.
- Gain an immediate increase in market share. One of the greatest benefits of a merger or acquisition is the increase in market share. Through inorganic growth, you are gaining the benefits of an entire company’s prior sales and relationships, which means you’re immediately gaining markets and clients that you otherwise may not have had access to.
- Increases knowledge and experience. By combining your company’s forces with those resources of another company, you are gaining the knowledge and expertise of their key players. This increased knowledge and experience means you have a stronger roundtable in making strategic decisions moving forward.
- Create a stronger line of credit. It can be easier to take on debt financing after a merger or acquisition as some inorganic growth results in a stronger line of credit with the combined value of the two businesses.
- Gain a competitive edge in the market. Your newfound resources, assets, and market share, means—if the implementation goes well—you will be a force to be reckoned with in your industry. You’re setting a new pace for growth that can push you ahead of competitors and give you a strategic advantage in pricing, purchasing, volume, and overall reach.
Cons of inorganic growth
- Significant upfront cost. Funding a merger or acquisition usually means a sizable upfront cost. If your company doesn’t have cash on hand, you’ll likely have to rely on taking on debt, which can make the merger or acquisition riskier and less attractive to investors. If the integration doesn’t go well, this could also mean significant debt that may be more difficult to pay off.
- Management challenges. The sudden growth from a merger or acquisition generates complexities associated with properly scaling operations such as systems, sales, and support. Without proper management of growth, a merger or acquisition’s roots won’t be able to take hold and the integration will ultimately be unsuccessful.
- Financial systems sustainment. There are plenty of operational aspects that an organization can fumble through inorganic growth. Since finances support all company actions and is a key for all future growth, not having systems in place that can sustain the new growth is a huge (and unfortunately common) mistake.
- Less control over the direction of the company. Combining forces with another organization means you often have less control over the ongoing company vision. It can also mean you grow in directions you didn’t necessarily anticipate.
- Integration, restructuring, and culture differences. In the end, mergers or acquisitions rely on the buy-in of both parties for a successful implementation. If cultures are too different or operations don’t adapt to manage the influx of employees, resources, or sales, then the merger or acquisition will likely become unsuccessful.
What Type of Growth do Investors Like to See?
As is commonly the case, it’s not a simple equation of growth equaling good and more growth equaling better. If a company is showing slow (yet strong) organic growth, then that organization may still be more attractive than a company that saw significant growth due to an acquisition, especially if that company took on significant debt to acquire a company that had less than favorable growth.
A common misconception is that inorganic growth will repair the currently declining growth of a company. It is typically more prudent to fix your company’s internal problems before taking on more customers and business. Remember the phrase, “Can’t get out from under a sky that is falling.” Your organization’s shortcomings and struggles will follow you regardless of growth, so make sure you’re in a stable position to take on more weight.
The ultimate question an investor is answering is how strong is the company’s story, and do they have the forecast, proof, and track record to back it up?
The key is formulating the best strategy for your organization and designing a strong business case around that strategy.
Whether you choose to grow your organization organically or inorganically, your greatest focus should be on doing so in the most strategic way possible. Formulate the best strategy based on your company’s current health, competition, industry trends, and financial capacity, then design a strong business case around that strategy by projecting short- and long-term financial forecasts. Having this level of detail for whichever strategy you commit to will give you a detailed blueprint to make the most intelligent decisions to support and sustain growth.
For more information about organic or inorganic growth or for personalized insights into your business, schedule a no-obligation consultation with one of our expert CFOs today.
This article is meant for educational purposes only and does not constitute financial advice. For personalized information, insights, or recommendations, reach out to your financial advisor or speak directly with a CFO.
This article was originally published March 2, 2020 and has since been edited for information, references, accuracy, and completeness.
About the Author
Jerry Vance is the founder and managing partner of Preferred CFO. With over 16 years of experience providing CFO consulting services to over 300 organizations, and 30 years in the financial industry, Jerry is one of the most experienced outsourced CFOs in the United States.
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