Business Expansion: Definition, Importance, Types, Advantages, Disadvantages

By | Januari 10, 2022

What it is: Expansion of business (business expansion) is the company’s efforts to grow the size of its business. It aims to increase the scale of operations. Thus, the company can generate more money for the company’s shareholders. 

Expansion can be through internal growth such as:

  • Building a new production facility 
  • Targeting new markets
  • Developing new products
  • Establishing a subsidiary

Alternatively, it could be through external growth, such as:

  • Acquire another company
  • Merger with other company
  • Forming a joint venture
  • Building strategic alliances

Let’s discuss it in more detail.

The importance of business expansion

Expansion is a way to grow the business and make more money for the company’s shareholders. Several reasons explain why expansion is important for a company, including:

  • Make more money by selling more products to more customers
  • Increase competitiveness by building more resources
  • Dominate the market by controlling a higher market share 
  • Increase bargaining power with stakeholders, including bargaining power with suppliers, customers, distributors and suppliers
  • Gain market leadership to better influence market prices
  • Increase economies of scale and can spread costs over more output, lowering unit costs
  • Increase shareholder value in line with positive expectations for company growth and profits

Shareholder value increases as profits increase. Shareholders have the potential to earn higher dividends, which are part of net income. In addition, they also expect the company’s share price to rise, increasing the potential for capital gains. 

Measuring business growth

How can we show that a company is growing? 

As I explained earlier, growing a business is all about scaling operations. To measure whether the company is growing or not, you can use the following indicators:

  • Assets – the company has more resources (assets) both through internal and external growth.
  • Number of employees   – companies need more employees to operate various jobs in the business.
  • Total output – the firm produces more product as it increases production capacity.
  • Number of customers   – firms sell higher output to more customers, both in domestic and overseas markets. 
  • Revenue – by selling more products, the company generates more revenue
  • Profit – increased revenue should be supported by increased profits through a number of cost savings and economies of scale 
  • Market capitalization   – stock market investors like growth and profitability, expecting stock prices to rise.

Types of business expansion

In general, we can divide business expansion strategies into two categories. It is based on how growth is carried out, whether by developing internal resources or combining external resources.

  1. Internal growth – companies rely on internal resources and capabilities to increase business size.
  2. External growth – the company combines internal and external resources and capabilities.

The two growth strategies are not all suitable for the company. Each has advantages and disadvantages. For example, internal growth may be a rational option for small companies, where they have more limited resources.

Internal growth

We call this strategy organic growth. Companies grow existing resources and capabilities. It is possible via:

  • Increase production capacity by buying new machines or building new factories.
  • Opening new outlets or branch offices to reach consumers more broadly.
  • Increase advertising spending to increase sales by persuading consumers to buy. 
  • Offer new variants of existing products to existing markets.
  • Expanding market segments, for example by reaching other segments related to the current segment.
  • Expanding to new markets, for example by selling products overseas.

External growth

External growth involves external parties to grow. That is by combining the resources and capabilities of other companies. We also call it inorganic growth.

It can be run via:

  • Merger
  • Acquisition
  • Joint ventures
  • Strategic Alliance

A merger consolidates two companies into a single, larger entity. After the merger, only one company survived.

Meanwhile, an acquisition involves the takeover and control of another company. After the acquisition, the target company becomes a subsidiary of the acquirer and each still operates independently.

Acquisitions can be amicable or hostile. A friendly acquisition is when the management of the target company agrees to be taken over. On the other hand, if they don’t agree, we call it a hostile acquisition.

Furthermore, under the joint venture, the two companies agreed to work together to establish a new business. This strategy gives companies the opportunity to combine complementary capacities, expertise, technology and resources. Companies share risks with business partners.

Lastly, a strategic alliance involves an agreement between two or more companies to share resources to carry out a particular project. Each remains independent of the other.

Advantages and disadvantages of business expansion strategy

Internal growth advantages and disadvantages

Internal growth offers a number of advantages. 

First , the risk of failure is relatively lower than when the company acquires or merges with other companies. Mergers or acquisitions have a higher risk of failure because they must synergize different resources and capabilities to generate value. And, that is often difficult to do.

Second , the company has full control over operations because there is less outside interference. Companies can develop new ideas by empowering current employees.

Third , employees are more motivated. Management engages them to grow the business. They feel involved and contribute to the company’s success.

However, internal growth also contains a number of drawbacks. 

First , this strategy is slower to grow the business. Companies must rely on existing resources, which are more limited. 

Second , the internal capacity is more limited. Lack of innovative ideas and liquidity problems often create problems when companies grow organically.

Third , internal growth is futile. Since it is slower, it will be useless if the market has reached a mature phase where growth will start to decline.

Advantages and disadvantages of external growth

Inorganic growth has a number of advantages over organic growth. Here are some of them:

First , faster growth. In mergers and acquisitions, companies combine two different production facilities to increase economies of scale and operating capacity more quickly. Likewise, the company also adds customers and target markets.

Second , the intensity of competition decreases. The number of players decreased after the merger. Likewise, when acquiring, the company controls competitors under its control.

Third , the bargaining power of the company becomes more significant. Firms have greater market power. It makes it to have a better bargaining position with suppliers and customers. 

Fourth , higher profits. Companies can capture value in the supply chain by acquiring suppliers or distributors. They can earn profit margins previously enjoyed by suppliers or distributors. They also have control over inputs or products, especially in terms of price, quality and delivery time.

However, internal growth also contains a number of drawbacks. 

First , government supervision is more stringent. As competition decreases and the company’s market power is higher, it often gives rise to anti-competitive behavior. This is often to the detriment of consumers. So, the government will prevent it. 

Second , cultural conflicts and managerial problems often arise. Two companies often have different cultures and resources. Therefore, the company is more difficult to control.

Third , synergizing resources and capabilities failed. Ideally, companies can create value by acquiring or merging with other companies. But, it is a difficult task. And, oftentimes, companies incur costs that outweigh the benefits.

Fourth , employee morale decreases. Mergers are often followed by downsizing of excess work. Workers may lose job security due to rationalization, making them less motivated.

Fifth , companies lose focus on core competencies. Company operations are becoming more complex. Management has to focus on different businesses, which is often not accompanied by experience in operating them. 

Sixth , negative consumer perceptions emerge. They may suspect uncompetitive activity and react negatively.

Business expansion risk

Indeed, expansion has the potential to generate more money. Companies can market their products to more customers. Selling to more people allows the company to achieve higher economies of scale, allowing unit costs to fall. Eventually, it leads to higher profits.

However, expansion also comes with a number of risks, including:

  • Financial loss
  • Ineffective management
  • Instability
  • Reluctance to change
  • Political risk

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