Growth is a major concern
for most businesses. In today's environments, business leaders that cannot continue to sustain reasonable growth levels
are considered ineffective and removed from their leadership positions. Most business leaders at some point in their
careers are faced with key strategic decisions on how to sustain and improve the growth of their businesses. Most (if
not all) businesses reach an inflection point at which they must begin to undertake expansion efforts. The ultimate
question becomes whether to expand organically (through internal investment) or inorganically (through acquisition,
joint venture or alliance).
The expansion could be one of several
options:
- Expand into a new market (consumer or geographic)
with a new product
- Expand into a new market with an existing
product
- Expand into a new segment in an existing market with
a new product
There are a several questions
that must be answered as a company begins to consider expansion:
Are their significant barriers (i.e. significant upfront cost, required body of knowledge and experience,
regulation) to entering the new market or consumer segment?
Barriers
to entry can cause organic expansion to be an expensive and time-consuming project. If there are significant barriers
to entry, but you find that the market is still attractive, then it may be better to enter the market inorganically.
Is the market or segment growing? How is market share divided among existing
firms? How have those firms competed with one another (price vs. differentiation)?
If there is significant rivalry among existing firms in the market, the response from competitors
could be significant, upon your entry. You may be better served reviewing the strengths and weaknesses of the existing
players and evaluating an inorganic transaction. Regardless, include the effects from the competitive response in your
financial model. It should affect your revenue forecast.
Are
there significant substitutes or complements in the new market or segment?
Cheap and effective substitutes can make a market very unattractive, while powerful complements can make it
attractive. Evaluate the effects of these items as you forecast the revenues received from the expansion.
Do suppliers or consumers hold significant pricing leverage?
The pricing leverage from suppliers will impact your Cost of Goods Sold (COGS).
You should make reasonable assumptions for COGS so you don't overestimate operating profits. Pricing leverage from consumers
will impact your revenues as it could result in a lower price per unit. If supplies (inputs) are scarce and manufacturing
knowledge of those supplies are limited, it may makes sense to acquire a supplier (backwards integrate).
Does your internal forecast predict a positive Net Present Value (NPV) for
this project? Is this NPV higher or lower than the NPV predicted from an acquisition?
If your NPV for internal development is positive and exceeds the NPV projected from in organic expansion,
then you should strongly consider internal investment / development. If the NPV for inorganic expansion is positive
and exceeds the NPV for internal development, then you should in organic expansion.
Does internal development or acquisition allow for any project flexibility (i.e. phasing / staging
of development)?
As you complete your financial model
and determine your organic and inorganic NPVs, be sure to include any inherent flexibility in the project. For example,
instead of acquiring a company or launching an internal project in the 1st year, you may be able to establish a
strategic alliance for 1 - 2 years to get as better understanding of the market or segment. This will allow you to have
better and more refined assumptions in Year 2 and make a more informed decision on whether to develop the project internally
or externally.
Expansion efforts are usually costly and complicated
processes. Make sure you make a well-informed decision as you determine how and where to allocate resources.
