Growing your own | Royal Bank of Scotland

Growing your own | Royal Bank of Scotland

It is often said that, in business, if you are not constantly moving ahead you are effectively falling behind. But should you grow your business organically or go down the acquisition trail?

Small business owners with an eye on rapid expansion will usually consider one of two approaches – either growing the business organically or accelerating its expansion by acquiring or merging with another enterprise – each of which comes with merits and shortcomings.

The acquisitive approach creates a larger entity that can benefit from economies of scale, increased assets and potentially more favourable credit arrangements because of its greater value. There is also the potential for deriving value from the expertise of the management of the acquired business.

The downsides of ‘inorganic’ growth include the need to expand management resources to deal with a greater number of employees and a wider range of assets. There is also the risk that the market focus of the acquired company diverts attention from the core strategy of the business, while, if the funding required to finance the deal is predicated on forecasted revenue from the merged entity, any shortfall in income will make it harder to service this debt.

The upside of expanding a business organically is that management understand every facet of the business and can use that intimate knowledge to react rapidly to opportunities and changing market conditions. The absence of additional financing for acquisition reduces the pressure on the business to increase its income rapidly and can also make it easier to sell if a suitable opportunity arises.

But the absence of that finance can also limit growth potential, especially in markets where scale becomes an issue at a certain point.

Appetite for risk

According to David Caddle, area director of Pera Consulting, the question of whether an acquisitive or organic growth strategy is most appropriate will be largely determined by the business’s appetite for risk.

“The most obvious advantage of an acquisitive approach is that the business can accelerate its growth exponentially,” he says. “The downside is that it will need to have the management skills to conduct the acquisition. Organic growth puts less pressure on the business than growth that comes about through acquisition, and one of the major issues to resolve with the latter approach is the cultural fit with the acquired business.”

Licensing and franchising are other options for businesses seeking an alternative to acquisitions while also looking to boost their rate of growth. However, Caddle observes that the suitability of these options varies widely depending on the nature of the business.

“Small, family-owned business like to have control (certainly within the manufacturing sector) and are reluctant to get involved with licensing or franchising. However, in other sectors – such as retail – there is more appetite for this approach.”

Costs and time considerations

Regardless of the strategy adopted, there are a number of factors that need to be carefully considered by any ambitious SME. Chris Bond, principal at SBCA Chartered Accountants, observes that in order to grow a business effectively it is necessary to plan ahead, which requires an understanding of the levels of spare capacity in the existing workforce.

If staff are not operating at full capacity, there may be an opportunity to grow the business modestly without investing in additional personnel. However, if the business has more ambitious growth targets, staff numbers may have to increase. In addition, growth may require larger premises and additional IT infrastructure, which means higher running costs and a requirement for increased cash flow in order to maintain profitability.

On the financial side, the business will need to determine the additional capital expenditure required, explains Bond. These extra expenses include staff costs and operating costs such as stock, utilities and premises.

Time is another consideration. Management must have the requisite time to manage the process of expanding the firm – if they are tied up with managing important clients, for example, the expansion will not go to plan, as key people will not have time to focus properly on the growth of the firm.

According to The Exact Small Business Efficiency Index, compiled by the Centre for Enterprise and Economic Development Research for business software firm Exact, one in three of the SMEs surveyed reported being so busy with day-to-day activity that they did not have time to focus on a plan for growth. A similar number did not have time to research routes for funding and general advice for growth.

Operational efficiency

The research suggested that operational efficiency was a key factor separating businesses that see profits and growth and those that don’t. More than two thirds (70%) of companies that classed themselves as having at least industry-average operational efficiency reported a profit last year, compared with 50% that classified their efficiency as below average.

Meanwhile, Leadership and Management Skills in SMEs, a research paper by Professor James Hayton of Warwick Business School on behalf of the Department for Business, Innovation and Skills, found that “under-developed L&M skills and a widespread failure to adopt management best practices are constraining the performance and growth of a large number of English SMEs”.

Market forces should also be taken into account when planning to implement a growth strategy, says Bond. A business will need to consider where the additional sales will come from, and draw up a marketing plan detailing how it will go about attracting new sales, as well as the repeat customers required to generate the cashflow needed to expand the business.

under-developed L&M skills and a widespread failure to adopt management best practices are constraining the performance and growth of a large number of English SMEs
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