Definition, How It Arises, Methods, and Example
What Is Inorganic Growth?
Inorganic growth arises from mergers or takeovers rather than an increase in the company’s own business activity. Firms that choose to grow inorganically can gain access to new markets through successful mergers and acquisitions. Inorganic growth is considered a faster way for a company to grow compared to organic growth.
Key Takeaways
- Inorganic growth is growth from buying other businesses or opening new locations.
- Meanwhile, organic growth is internal growth the company sees from its operations, often measured by same-store or comparable sales.
- Acquisitions can help immediately boost a company’s earnings and increase market share.
- The downside of inorganic growth via acquisitions is that implementation of technology or integration of the new employees can take time.
- Inorganic growth involving the opening of new stores can capitalize on high-traffic areas, but it can also cannibalize existing stores.
How Is Inorganic Growth Achieved?
Firms can choose to grow inorganically in several ways including engaging in mergers and acquisitions and, in the case of retail or branch organizations, opening new stores or branches.
Mergers are challenging from an integration perspective. Acquisitions can be accretive to earnings, but the implementation of the technology or knowledge acquired can take time. In other words, pulling the value out of mergers and acquisitions is more complex than taking credit for sales. Costs in the form of restructuring charges can greatly increase expenses. The purchase price of the acquisition can also be prohibitive for some firms.
By opening new stores in profitable locations, businesses can take advantage of the higher growth rates associated with new stores. However, when new stores are placed in locations that cannibalize sales and/or do not have enough traffic to support those stores, they can be a drag on sales.
Inorganic Growth vs. Organic Growth
Which is best, inorganic or organic growth? Inorganic growth, such as a boost from acquisitions, can provide a short-term boost. However, steady and slow organic growth can be viewed as superior, as it shows the company has the ability to make money regardless of the economic backdrop. Plus, there’s the downside of potentially using debt to fund inorganic growth. On the flipside, inorganic growth might not fully repair declining organic growth or internal issues.
One of the most important measures of performance for fundamental analysts is growth, particularly in sales. Sales growth can be the result of promotional efforts, new product lines and improved customer service, which are internal, or organic, measures.
Growth in organic sales is often described in terms of comparable sales or same-store-sales when referring to retail outlets. In other words, these sales occur naturally and not through the acquisition of another company or the opening of new stores. Some analysts consider organic sales to be a better indicator of company performance. A company may have positive sales growth due to acquisitions while same-store-sales growth may decline due to a decrease in foot traffic. Analysts research organic sales by analyzing inorganic sales growth.
Advantages and Disadvantages of Inorganic Growth
If a company merges with another in pursuit of inorganic growth, that company’s market share and assets become larger. This offers immediate benefits such as the additional skills and expertise of new staff and a greater likelihood of obtaining capital when needed. As well, it allows a company to grow much faster and almost immediately increase its market share.
However, there are disadvantages in that additional management is required, the direction of the business may go in an unanticipated direction, there may be additional debt or a company could grow too quickly incurring substantial risk. The downsides to inorganic growth is the large upfront costs and management challenges with integrating acquisitions.
What Is an Example of Inorganic Growth?
Consider that Company A is looking to leverage an inorganic growth strategy. Company A acquires a software startup that provides a new technology that its competitors don’t yet provide. In doing so, Company A now offers its customers new technologies and gains access to new markets that were established by the acquired company.
Is M&A Inorganic Growth?
Yes, mergers & acquisitions are a form of inorganic growth as the company takes external measures to grow the company by combining with another firm.
What Is Balanced Growth?
In short, balanced growth involves using organic growth to build the company as well as inorganic growth in acquiring other companies to help boost growth. Acquisitions can lead to faster sales growth and quicker cashflow, but may be unpredictable. Organic growth is advantageous because it is familiar and inherent to the company, although sales may not be as robust.
Do Companies With More Organic Growth Outperform Those With Higher Inorganic Growth?
According to a study from McKinsey, S&P 500 companies that had higher organic growth tended to outperform companies with the least organic growth when assessed at comparable growth levels.
What are Common Forms of Inorganic Growth?
Based on a survey of 1,300 CEOs by PwC, 40% said they were planning on targeting a joint venture to boost revenues, 37% were considering a merger or acquisition, 32% were planning on working with startups, and 14% were planning on selling a business.