Which is best: Internal Expansion or Acquisition?
We had covered this debate topic in a recent Nobel Mantrich strategy workshop.
I find this to be a little bit of a dilemma, but internal expansion or what is termed as organic growth tends to be seen as a slower process than acquisition. From my experience I see that both of them have their pros and cons. Internal expansion may be slower because you need to recruit staff from scratch, set up plant and equipment from scratch and grow into the market right from day one. However, I have also found acquisition to also be littered with its own set of problems. Acquisitions may be fast to get into the market on face value, however, integrating the culture of two organisations may at times take longer than setting up an enterprise from scratch. One cannot underestimate the cultural implications of acquisitions nor the time required to set up an enterprise from scratch.
Clearly, each individual case would require its own profile; the profile of success is based on the market situation and a general guide to systemising the potential factors involved. Once the factors have been identified an attempt can be made to rank them. Briefly, the rationale for each entry above is as follows. The purchase price is only incurred when an acquisition is made; the alternative is to invest in additional resources. Because of the need to hire new workers when expanding internally, the learning effects will lead to higher costs; on the other hand, the potential for scale economies is probably greater from internal expansion. The costs of carving out a higher market share are incurred when expanding internally, involving price reductions and/or additional marketing expenditure, and this is probably where the greatest element of risk is involved. Finally, the costs of integrating two management structures, making different accounting and control systems consistent, and dealing with different company cultures can be significant when making an acquisition.
The two items to watch out for are risk and the impact of the two strategies on competitive pressure. In this case, internal expansion is associated with the higher degree of risk because of the unknown outcome of the marketing strategy. While there are risks associated with acquisition, such as the possibility that the acquired management might not fit with the existing structure, none of the risks associated with acquisition seem to contain the seeds of complete disaster to the same extent as the potential failure of the internal expansion marketing strategy. By definition, the acquisition of a competitor will reduce the degree of competition in the industry, which may itself reduce the risks associated with an acquisition.
A lot depends on the options open to a company which wishes to expand by increasing the sales of an existing product (or products); a different approach to expansion involves increasing the number of products, i.e. enlarging the product portfolio. The entries in the comparative analysis would be different in this case. For example, a company can have the option of investing in the development of a new product itself, or acquiring a company which already has a product of the type desired.
There is no simple answer to the choice between internal and external expansion, and there have been many studies carried out which attempt to identify when acquisitions are likely to be successful, and the steps a company should undertake after acquisition to promote success. The outcome of these studies is inconclusive, as might be expected from a process which is highly complex and where different factors are important in different situations. The important issue to bear in mind is that different courses of action have different implications for future expected net cash flows, and the relative impacts of the various factors involved should be at least estimated and related to the relative risks. The type of analytical structure demonstrated by the comparative profile of relative cash flows is a useful starting point for tackling individual cases.