Business Growth (AQA A-Level Business): Revision Notes
Organic growth
What is organic growth?
When a successful business experiences high demand for its products, it may choose to expand through organic growth. This type of growth is also known as internal growth because the business grows from within its existing operations rather than by joining with other companies.
Organic growth happens when a business develops its own strategies to sell more products, increase its market share, or expand into new markets. For example, a retailer might open new stores in different towns, or a manufacturer might develop new product lines to attract more customers. The key point is that the business is using its own resources and capabilities to expand gradually over time.
Unlike external growth (such as mergers or acquisitions), organic growth relies entirely on a business's internal capabilities and resources. This makes it a more controlled and predictable expansion method, though typically slower than external alternatives.
Key characteristics of organic growth
Organic growth has several important features that distinguish it from other growth strategies:
Financed through reinvested profits: Businesses growing organically typically finance their expansion by reinvesting profits back into the company. This means they use the money they've earned from sales to fund new premises, hire additional staff, purchase equipment, or develop new products. This approach means the business maintains greater control and doesn't rely heavily on external funding sources.
Easier in growing markets: Companies find organic growth most effective when operating in markets that are growing quickly. When demand is rising and more customers are entering the market, businesses can naturally capture a larger share. They're able to outperform their competitors and increase their market share more easily because there's more opportunity available.
Market conditions play a crucial role in organic growth success. In stagnant or declining markets, achieving significant organic growth becomes much more challenging, as businesses are essentially competing for a fixed or shrinking pool of customers.
Slower and more gradual: Compared to external growth methods like mergers and takeovers, organic growth is slower and more gradual. This steadier pace makes it easier for the company to adapt to changes as they happen. Management can make adjustments along the way without the shock of sudden, dramatic transformation.
Advantages of organic growth
Organic growth offers several benefits that make it attractive to many businesses:
Maintaining management style and culture: When a business grows organically, it can keep its current management style, culture, and ethos. This consistency is valuable because it preserves what made the business successful in the first place. Employees understand the company's values and way of working, which supports smooth operations.
Lower risk: Organic growth involves less risk compared to external methods. The business is simply expanding what it already does well, using proven strategies and products. It's usually financed using profits the company has already earned, which means there's less financial pressure compared to taking on large debts or making risky investments in mergers.
Easier to manage and control: It's straightforward for businesses to manage internal growth because they can control exactly how much and how quickly they expand. Management makes deliberate decisions about opening new locations, hiring staff, or launching products. This control allows for careful planning and reduces the chances of overextending the business.
The level of control in organic growth is particularly valuable for family-owned businesses or companies with strong brand identities. They can ensure that every new location or product line maintains the same standards and values that built their reputation.
Less disruptive to operations: Because organic growth happens gradually, changes are less disruptive to daily operations. Workers' efficiency, productivity, and morale can remain high because they're not dealing with the upheaval that comes from mergers or major restructuring. The business continues operating smoothly while it grows.
Disadvantages of organic growth
Despite its advantages, organic growth comes with certain limitations:
Time-consuming process: It can take a long time to grow a business internally, and this slow pace can make it difficult for the business to adapt to big changes in the market. If competitors are growing faster or market conditions shift quickly, the business might fall behind because it can't respond rapidly enough.
In fast-moving industries or highly competitive markets, the slow pace of organic growth can be a critical weakness. Competitors using external growth strategies may capture market share more rapidly, potentially leaving organically-growing businesses at a significant disadvantage.
Market size limitations: Market size isn't affected by organic growth. If the overall market isn't growing, the business faces restrictions on how much it can increase its market share. To continue expanding, it may need to find a new market to enter, which can be challenging and uncertain.
Missed opportunities: When businesses focus solely on internal growth, they might miss out on opportunities for more ambitious growth. External growth methods like acquisitions could allow them to enter new markets quickly, gain new technologies, or eliminate competitors. By growing only organically, these strategic possibilities remain out of reach.
Problems that arise from growing in size
As businesses grow larger through organic expansion, they encounter various challenges that can threaten their success:
Diseconomies of scale
Large companies can experience diseconomies of scale, where further growth actually causes them to lose money rather than become more efficient. When a business becomes too large, coordination becomes difficult, communication breaks down, and bureaucracy slows decision-making. If this happens, the only solution may be retrenchment — reducing the size of the business to restore efficiency.
Diseconomies of scale are the opposite of economies of scale. While small to medium-sized growth often reduces per-unit costs, excessively large organizations can experience increased costs per unit due to management inefficiencies, communication breakdowns, and loss of motivation among workers who feel disconnected from the organization.
Cash flow management difficulties
Growing companies find it increasingly difficult to manage cash flow effectively. They need to invest in infrastructure and purchase assets, but these large expenses use up cash that isn't immediately available for the day-to-day expenses of running the business. This creates a timing problem where the company has money tied up in long-term investments but struggles to pay immediate bills.
Overtrading risks
Fast growth significantly increases the risk of overtrading. This occurs when a business has increased demand but needs to buy more raw materials and employ more people to meet orders. These purchases reduce the amount of working capital available to pay bills and manage daily operations. The business faces the dangerous possibility of going bust before customers actually pay for their orders, even though sales are strong.
Warning: Overtrading Can Sink Successful Businesses
Overtrading is one of the most dangerous situations for a growing business. Even with strong sales and customer demand, a company can fail if it runs out of working capital before receiving payment from customers. This is why cash flow management is just as important as generating sales.
Changing from Ltd to PLC
When a company grows substantially, it often changes from a private limited company (Ltd) to a public limited company (PLC). This transition makes running the company more complicated in several ways:
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Loss of control: The original owners lose some control to new shareholders who buy shares in the company. These shareholders can influence strategy and direction, which may not align with the founders' vision.
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Pressure for short-term returns: Becoming a PLC can make managers more short-termist in their thinking. Shareholders often want a quick return on their investment through dividend payments, which pressures management to focus on immediate profits rather than long-term sustainable growth.
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Vulnerability to takeover: Once a company becomes a PLC, it's more exposed to being taken over. Anyone with sufficient money could buy enough shares to gain a controlling interest in the business, potentially removing the original leadership entirely.
Market dominance concerns
Businesses must be careful not to grow so large that they dominate their market and become a monopoly. The Competition and Markets Authority (CMA) can penalise companies that gain too much market power, as this can damage competition and harm consumers through higher prices or reduced choice.
Reasons business owners restrict growth
Sometimes business owners deliberately choose to restrict growth or retrench for strategic reasons:
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Maintaining company culture: They may want to maintain the culture and intimate atmosphere of a small business, where everyone knows each other and shares common values.
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Managing complexity: The business becomes more complicated to manage as it expands. Owners might prefer to keep operations at a manageable scale rather than deal with the bureaucracy and coordination challenges of a large organisation.
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Securing funding: Growth requires businesses to secure additional financial resources, which can be complicated and time-consuming. Owners may decide the effort isn't worth the potential benefits.
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Protecting cash flow: Business owners might not want to put too much strain on their cash flow position. Rapid expansion requires significant investment, and they may prefer financial stability over aggressive growth.
Greiner's model of growth
Greiner's Model is a framework that describes how businesses typically progress through different phases of growth over time. The key insight is that each phase of growth is followed by a crisis that the business must resolve before it can move to the next phase.
Greiner's Model is based on the principle that organizational growth is not smooth and continuous, but rather proceeds through distinct stages. Each stage is characterized by a particular management style and organizational structure, and each eventually becomes inadequate, leading to a crisis that forces evolution to the next stage.
Phase 1: Creativity → Leadership crisis
When a business first starts up, it's often very creative with everyone able to share ideas easily. The organisation is small and informal, allowing for rapid innovation and quick decision-making. However, once the business reaches a certain size, this informal approach becomes problematic. There's a need for strong leadership to give the company clear direction and structure. Without this, the business faces a leadership crisis where nobody is coordinating efforts effectively.
Phase 2: Direction → Autonomy crisis
Leaders respond to the leadership crisis by establishing a formal organisational structure with clearly defined departments and roles. This brings order and clarity to operations. However, as employees become more experienced in their jobs, they naturally want more say in decisions affecting their work. The business becomes too big for senior managers to manage everything on their own. Employees need more autonomy through delegation of decision-making authority, otherwise frustration builds and creates an autonomy crisis.
Phase 3: Delegation → Control crisis
To resolve the autonomy crisis, more power and responsibility is delegated down to middle managers. The organisational structure may become decentralised, giving different departments or divisions greater independence. However, this can lead leaders to worry about losing oversight. They may try to regain some control to ensure they maintain a coordinated business that optimises its use of resources. This tension creates a control crisis.
Phase 4: Coordination → Red tape crisis
As control is regained by senior managers, decisions become more centralised again and new procedures are implemented to coordinate different areas of the business. However, this can result in too many procedures, which decrease efficiency. People spend too much time waiting for decisions to be made and navigating bureaucratic processes rather than actually doing productive work. This excessive bureaucracy is known as red tape and creates the red tape crisis.
The Red Tape Crisis
This is often the most frustrating stage for employees and managers alike. Excessive procedures and bureaucracy slow down decision-making and innovation. The very systems designed to maintain control and coordination end up strangling the business's ability to operate effectively.
Phase 5: Collaboration → Growth crisis
To break through the red tape crisis, some formal procedures are replaced by collaboration between departments and teams. There's more focus on communication and information management to ensure everyone works together effectively. At this point, the company might struggle to grow internally using organic methods alone. It may need to consider external growth strategies like mergers or acquisitions to continue expanding.
Franchising as an organic growth method
Franchising allows established businesses to grow quickly by licensing their business model to independent operators. This is considered organic growth because the business is expanding its brand presence and market reach through its own business concept.
How franchising works
A franchise is an agreement (contract) that allows a new business to use the business idea, name, and reputation of an established business. The franchisor is the established business that's willing to sell or license its proven concept. The franchisee is the new business owner who buys into the franchise opportunity. They typically pay the franchisor an initial fee plus ongoing payments — usually a percentage of their profit.
Benefits of franchising
Franchising allows the franchisor to grow quickly because most of the costs and risks are taken on by the franchisee. The franchisee invests their own money to set up and run the location, while the franchisor receives payment and expands their brand presence.
Worked Example: SUBWAY's Franchise Growth
Through franchising, SUBWAY increased the number of its fast-food restaurants in the UK and Ireland from 100 in 2002 to over 2000 by 2015.
This represents a growth rate of:
- Absolute increase: 2000 - 100 = 1,900 restaurants
- Percentage increase: growth over 13 years
- Average per year: approximately 146 new restaurants annually
This demonstrates how franchising can accelerate growth far beyond what would be possible through traditional organic expansion, where the company would need to fund and manage each location directly.
Risks of franchising
However, franchising carries some risks for the franchisor. If just one or a few franchisees have poor standards and develop a bad reputation, this negative perception can affect the reputation and profits of the entire franchise network. Customers don't always distinguish between company-owned locations and franchises, so one bad experience can damage the brand.
Brand Reputation Risk
A franchisor's biggest vulnerability is that their brand reputation is in the hands of independent franchisees. One poorly-run franchise location can damage the entire brand's reputation, affecting all other franchisees and the franchisor's ability to attract new customers and franchise partners.
Key Points to Remember:
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Organic growth means growing from within by increasing sales, market share, or expanding into new markets using the business's own resources and capabilities.
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Businesses growing organically typically finance expansion through reinvested profits, making it lower risk but slower than external growth methods.
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Advantages include maintaining culture and control, lower risk, easier management, and less disruption to operations.
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Disadvantages include slow pace, market size limitations, and potential to miss opportunities for ambitious growth.
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Growing in size creates challenges like diseconomies of scale, cash flow problems, overtrading risks, and complications when changing from Ltd to PLC status.
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Greiner's Model shows that growth happens in phases (creativity, direction, delegation, coordination, collaboration), with each phase followed by a crisis that must be resolved.
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Franchising allows established businesses to grow quickly by licensing their business model to independent operators who take on most costs and risks, though this comes with brand reputation risks.