Organic Growth (Edexcel A-Level Business): Revision Notes
Organic growth
Organic growth is a business expansion strategy that many entrepreneurs choose, particularly in the early stages of their business development. Understanding this approach, along with its benefits and limitations, is essential for evaluating business growth strategies.
What is organic growth?
Organic growth (also called internal growth) happens when a business expands gradually by selling more of its output using its own resources. This contrasts with growing through mergers or takeovers.
Real-World Example: Co-wheels Car Club
Co-wheels is a national car club operating as a social enterprise across the UK. Members can access vehicles on a 'pay by the hour' basis using a smartcard system. The company has expanded organically since its establishment and by 2015 had over 350 vehicles with a turnover of $2 million.
The business grew by:
- Adding new locations
- Increasing its fleet size
- Diversifying into electric bike hire
- Adding wheelchair accessible vehicles
All of this was achieved without acquiring other companies, demonstrating pure organic growth.
Organic growth vs inorganic growth
Inorganic growth (also called external growth) involves two or more businesses joining together through mergers or takeovers to form a much larger organisation. This can potentially double the size of a business almost immediately.
Contrasting Growth Strategies
Inorganic Growth - Finsbury Food Group: When Finsbury Food Group acquired Fletchers Group for $56 million in 2014, sales were expected to increase from $175 million to $300 million—an immediate, dramatic expansion.
Organic Growth - Fog Creek Software: Fog Creek Software, a US company developing project management tools, has grown organically since 2000 by gradually gaining more customers and consultancy work. By 2014, it employed over 40 people and generated substantial income through steady, measured growth.
Key differences
Critical Distinctions Between Growth Strategies
Speed of growth: Inorganic growth is significantly faster. A merger or takeover can instantly double a company's size, whereas organic growth takes time as the business develops using its own resources. Building customer bases, developing new products, and expanding operations gradually is inherently slower.
Risk levels: Organic growth is generally considered safer. Owners expand by developing their current expertise and often grow by 'doing more of the same'. In contrast, inorganic growth carries integration risks, including potential culture clashes between organisations, which can result in conflict, delays and instability.
Typical Timing Pattern
In the early stages of business development, most owners pursue organic growth strategies. Entrepreneurs tend to be cautious initially, perhaps selling more products to existing customers or attracting new ones. Once they have built confidence and generated cash reserves, they may consider accelerating growth through acquisitions.
Methods of growing organically
Organic growth typically involves building on existing strengths to increase sales, but businesses can take several different approaches.
Attracting new customers
Perhaps the most straightforward method is driving sales from existing activities. A food processing company supplying local shops might gradually increase production to serve more customers. When the factory reaches full capacity, the business can continue growing by building an extension or relocating to larger premises.
Businesses can also find new customers by exploiting different distribution channels. For example, the food processor might begin supplying supermarkets instead of just local shops. This approach usually requires investment in marketing to expand the customer base.
Developing new products
Some businesses grow through innovation and product development. They may be highly innovative with strong commitment to research and development. For instance, a software company designing computer games can grow by creating new games.
Alternatively, businesses might identify customers with slightly different needs and adapt existing products to meet these requirements. This approach typically requires reinvesting profit into product development activities.
Entering new markets
Businesses can grow organically by finding new markets for their products, sometimes called geographic expansion. A hairdresser could open another salon in a different location, replicating the assets, systems and working practices that proved successful in the original salon.
Geographic Expansion: New Look in China
UK fashion retailer New Look planned to expand to China in 2014, initially opening two stores with hopes of establishing 15-20 stores in Beijing and Shanghai. This demonstrates organic growth through geographic expansion, though it carries more risk due to unfamiliarity with foreign markets.
Adopting a new business model
Technological developments or social changes may enable businesses to grow by adopting new business models. A retailer selling children's toys might start an online operation, potentially growing very quickly because the potential market could become considerably larger—possibly even global.
Franchising
To accelerate organic growth, businesses might establish franchising operations. This allows other entrepreneurs to trade under the original business name.
Franchising Success: SUBWAY
SUBWAY fast-food outlets exemplify this method of expansion, enabling rapid growth while maintaining the organic growth classification. Franchising allows the brand to expand quickly without the company directly investing in every new location.
Advantages of organic growth
Organic growth offers numerous benefits. Entrepreneurs typically know their business thoroughly and can grow by exploiting its strengths and expertise. They can adapt quickly to market changes and experience satisfaction from seeing their business develop. They also control the pace of growth, choosing a rate comfortable for their circumstances.
Lower risk
Risk Reduction Through Familiarity
Organic growth is generally less risky than alternative strategies. Growth can be achieved by extending well-known and understood practices, helping prevent errors since the culture, norms and practices are already established and effective. This approach avoids complications that might arise when integrating with another organisation.
Cost effectiveness
Growing organically is often relatively cheaper than other methods. Organic growth can be financed from retained profit, likely the cheapest source of finance. While there is an opportunity cost, the financial cost can be minimal.
Businesses growing inorganically often must borrow money or raise fresh capital, adding to growth costs. Organic growth also avoids the premium prices often paid when acquiring other businesses.
Greater control
Businesses retain more control when growing organically. Owners or senior management have complete control of the growth process without outsiders having controlling interests.
For example, if a retail chain opens a new store every six months, it likely has an experienced team who can recruit and train staff, ensuring stores run according to proven successful methods. This approach means full control and easier organisation compared to joining with another business where some control would inevitably be shared.
Better financial position
Protecting Financial Stability
The financial position may be better protected with organic growth. Since growth is gradual, there is less strain on financial resources, resulting in stronger cash flow and better liquidity. Inorganic growth often requires enormous outlays—for instance, Three's purchase of O2 reportedly cost $10.5 billion. Such high expenditure creates significant financial pressure.
Fewer diseconomies of scale
Businesses growing organically are less likely to encounter diseconomies of scale. Sharp increases in unit costs are unlikely if growth is steady and measured. It becomes easier to spot potential difficulties from scale increases in advance, helping keep costs under control.
Disadvantages of organic growth
Despite its advantages, organic growth may prevent businesses from reaching full potential. Companies might miss lucrative opportunities and fall behind in the market.
Pace too slow for stakeholders
Shareholder Expectations
The pace of organic growth may be too slow for some stakeholders. Shareholders in a plc may want quicker returns on investments than organic growth can deliver. If shareholders become unhappy with the growth rate, they may sell shares, causing the share price to fall and potentially making the company vulnerable to takeover.
Missing out on resources
Organic growth may prevent businesses from accessing resources owned by other companies, causing them to miss profitable developments.
Resource Access Trade-off: Construction Firm Example
A construction firm wanting to develop expertise in energy-saving technology for houses with solar panels could gradually develop its own expertise. However, acquiring a company with a proven track record in these fields might be preferable to building expertise from scratch, as specialists provide established knowledge and experience.
Getting left behind
Growing slowly may mean businesses fall behind in the market. If competitors grow through mergers and acquisitions, the business may seem small in comparison, losing its ability to compete effectively. For instance, it may struggle to match the advertising budgets of larger rivals.
Delayed economies of scale
As businesses grow, they can exploit economies of scale. However, organic growth may delay full exploitation of these economies, meaning businesses operate with higher costs for longer periods. This could lower profit margins and reduce competitiveness.
Additionally, some industries like shipbuilding require investment in large-scale production before trading can begin, potentially preventing organically growing businesses from entering such sectors.
Inappropriate for rapid markets
If a market is growing rapidly, organic growth may not be appropriate. When mobile telephones were first introduced, the market expanded very quickly. Businesses making the best progress grew through mergers or acquisitions.
Rapid Market Growth: Mobile Telephone Industry
The three firms remaining in the UK mobile market all resulted from multiple takeovers and mergers. This demonstrates how organic growth can be insufficient in rapidly expanding markets where speed is critical to capturing market share.
Combining strategies
Flexibility in Growth Approaches
Remember that companies may use organic and inorganic growth strategies together. It doesn't have to be a straight choice between one or the other. For example, a supermarket chain might grow organically by opening new stores in new locations while simultaneously growing inorganically by acquiring another chain.
Key Takeaways: Organic Growth
Core Definitions:
- Organic growth means expanding gradually using the business's own resources, while inorganic growth involves mergers or takeovers to rapidly increase size
Five Methods of Organic Growth:
- Attracting new customers
- Developing new products
- Entering new markets
- Adopting new business models
- Franchising
Main Advantages:
- Lower risk - extending known practices
- Cost effective - using retained profit
- Greater control - no outside interference
- Better financial position - less strain on resources
- Fewer diseconomies of scale - gradual, manageable growth
Main Disadvantages:
- Too slow for some stakeholders
- Missing out on other businesses' resources
- Risk of falling behind competitors
- Delayed economies of scale
- Inappropriate for rapidly growing markets
Critical Distinction: Speed and risk are the key differences between organic and inorganic growth—organic is slower but safer