What you should know about external growth

M&A are a growth accelerator that allows a company to expand more rapidly, for example geographically or technologically.

External growth, as opposed to internal or organic growth – is conceived as a strategic combination of companies whose development should in principle, be accelerated. A company may consider this type of development to achieve significant time savings and long-term synergies.

How is external growth defined?

External growth is defined as a merger between two companies with the aim of improving performance in the medium and long term, increasing their turnover and profitability, and making the whole more than the sum of the parts, i.e. generating synergies.

However, the main objectives differ depending on the nature of the integration:

• Vertical integration offers the possibility to rationalise supply chains or to secure opportunities.
• Horizontal integration allows companies to diversify their range of products or services.

Increasing the size of the acquiring company also allows for economies of scale and can provide additional visibility that strengthens its bargaining power.

What are the differences between internal and external growth?

Unlike external growth, internal growth, also known as organic growth, consists of a company developing, and therefore increasing its revenues, by mobilising its resources, whether through investment to increase production or productivity capacities, by recruiting new talent or by spending on R&D.

When should you opt for external growth?

This strategy is of particular interest in mature, highly competitive sectors, with a high dependency on technology or which require specific administrative authorisations (e.g. the use of the Internet: ICPE) where, in short, barriers to entry make it difficult for a company to set up or expand its business. Acquisitions or joint ventures of companies allow for faster development in this type of market.

This type of operation can be used to compensate for a delay in innovation or a strategic shift that should have been made at a given moment in the company’s history. Development is then ensured by the integration of expertise that was previously absent within the company. This is one reason why large groups acquire start-ups. In the banking sector, for example, several institutions have recently absorbed companies with strong potential for innovation, in order to reduce their competitive weakness in online banking.

Finally, external growth can prove to be a sound way to develop international activities because it allows the buyer, through the company it is taking over, to understand its new markets better and more quickly.

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What are the different strategies for external growth?

Traditionally, we distinguish three types of external growth:

1. Horizontal concentration is the acquisition of companies operating in the same market segment. This type of growth is most often motivated by the elimination of competition, by the relative reduction of costs due to economies of scale, or by the desire to expand geographically while remaining focused on the same type of products or services.
2. Vertical concentration, is designed to increase a company’s control over the value chain. This may involve, for example, the integration of suppliers or distributors into the company.
3. Conglomerate growth allows the business to diversify in order to reduce risk and benefit from different sources of revenue.

External growth, when it takes the form of a horizontal merger and thus the acquisition of a competitor, is in theory a rapid way of expanding market share. A vertical merger also allows for the rationalisation of supplies or outlets. However, it is essential to analyse the relevance of this type of strategy and the risk/return ratio, which may involve additional costs, particularly during the integration phase.

Nord France Invest is the economic development agency of the Hauts-de-France region. We support the development project of companies in Hauts-de-France in complete confidentiality. We work in close collaboration with advisors specialised in M&A.

To conclude

External growth is a merger between two companies with the aim of generating time savings and synergies to develop the business. The nature of the integration will be either vertical or horizontal, depending on the objectives pursued. This strategy is particularly interesting for penetrating markets where barriers to entry hinder the growth of the business.

Other articles about mergers & acquisitions that you may find interesting:

• What is a takeover in business
• Everything you need to know about Leveraged buyout (LBO)
• The main steps in the m&a process
• business valuation: methods & steps
• Advantages and Disadvantages on merger through absorption