By Eduardo Berdegué and Roy Graham
Achieving growth stands out as the objective most commonly pursued by executives whether by design or by default. Yet, as exciting and personally rewarding as growth may be, growth for growth’s sake does not necessarily equate to better performance, much less success. Many executives have seen, and some may have actually experienced, situations where a substantial increase in revenues from one year to another was accompanied by unexpected, sometimes devastating decreases in profits.
As with all other strategic business objectives, the aim of pursuing growth should be to maximize long-term value which results when shareholders, as well as other stakeholders, including customers, employees, suppliers, and others, are considered. Moreover, the adoption of growth as a strategic objective should result not from instinctive execution, but from a review of the alternative strategies, and the types and pace of growth options available in light of the company’s own management, culture, and market characteristics.
Organic growth refers to growth achieved by a company “on its own.” Managers can pursue market share or efficiency-seeking measures to achieve this type of growth. Market-oriented tactics may involve improving product mix to attract additional customers and/or increasing profitability from existing ones, or expanding into new geographic markets. Efficiency-related measures involve the adoption of management systems, technology, productivity incentives, improvements along the supply chain, and others. Proponents of organic growth emphasize the importance of keeping a company focused on its core competencies and on the skills of existing management. A notable example is Bigcommerce.com, a 4-year old e-commerce company in Austin with over 35,000 clients paying $25 a month each for its software-as-a-service platform (the company recently received $40 million in equity investment from former AOL chief Steve Case for a total $75 million raised in two years). Observers point out that there is naturally an inverse relationship between size of business and rate of organic growth: the larger the business, the slower the rate of organic growth.
Inorganic growth or growth through acquisitions, on the other hand, implies the gain of revenues, markets, technology, talent, capital or otherwise strategic assets via the acquisition of a company possessing those assets. Whether friendly or hostile, the acquisition of a business can be as complex a process as it can be rewarding in terms of the immediacy with which growth objectives can be achieved both in terms of revenues and bottom line through synergies achieved with the acquired business. Another important advantage of inorganic growth is that it practically eliminates entry barriers for an acquirer seeking to integrate vertically and own most or all aspects of the value chain, or to expand geographically. Such is the case of Austin-based Whole Foods, which owes a great deal of its present footprint to the acquisition during the past three decades of food-store chains across the U.S., as well as in Canada and the UK. Disadvantages are mainly related to integration issues, which, if not accounted for early in the process, may have disastrous consequences for all parties involved.
Finally, growth can also be achieved by leveraging resources through strategic alliances. These arrangements allow partnering companies to gain access to opportunities otherwise costly or altogether unavailable to each of them individually. Examples include the alliance between Starbucks and Barnes & Noble to sell coffee at B&N’s bookstores in the 80s. Another current example is the alliance between Eagle Ford Trucking of San Antonio with HTC Express of Roff, Oklahoma, by which Eagle Ford will be offering its clients a larger fleet for the hauling of frac sand, while HTC expands their presence in Texas. Strategic alliances may be temporary, project-specific, or permanent and are usually done through the creation (by the alliance partners) of a third company responsible for carrying out the agreed plan. While this approach can bring about rapid growth at a fraction of the cost of achieving similar results organically or through acquisitions, the limited control over execution and, more importantly, selecting the right partners, are key areas of concern.
What’s the Rate of Return?
It is important to note these growth strategies are not mutually exclusive. A company may choose to increase market share of an existing product line by organic means, while it chooses to expand geographically through an acquisition or strategic alliance. A number of factors will come to play in a manager’s choice of a course of action – among them the company’s strategic objectives, which need to be clearly defined, well founded, and widely communicated internally. In addition, the corporate culture and management skills have to be compatible with the selected strategy – the availability of resources, financial and other, will also be a critical factor in the decision. Finally, an analysis of the internal rate of return of each option under consideration will offer an objective way to measure the efficiency of the invested capital in each case. This commonly utilized management tool evaluates the desirability of an investment or project by ranking it against cost of capital. The premise being an investment whose internal rate of return exceeds its cost of capital is profitable and adds value to the company.
Normally, companies in the lower middle-market tend to rely on organic growth to reach maturity before they will venture into the rapid and more sizeable growth available to them through acquisitions. This is in part due to some misconceptions that exist around the adoption of an M&A strategy. Key among them is the belief that financial resources are harder to come by to buy a company than to fund modest and less demanding traditional growth. This is not necessarily true, as the financial benefits of a substantial and sudden increase in size (revenues, profits, assets) is rarely overlooked by lenders or investors, especially when acquirers have a solid plan and possess the management skills to execute it. A common way to fund acquisitions is through additional equity contributions made by a growth-recapitalization partner such as a private equity group with industry-specific interests. In fact, these partnerships usually add an important synergistic component by bringing to the table their existing industry-relationships. Another commonly held belief is that acquisitions are only for larger companies. Evidence increasingly points in the opposite direction as a growing number of business owners approach retirement age and become willing sellers to competitors of similar or even smaller size. Finally, there is the notion that acquisitions are riskier by their very nature, when in fact their riskiness, as that of any growth strategy adopted, can be managed with proper planning. Execution of an acquisition strategy can indeed be more demanding, but it can also be more rewarding.
As desirable as corporate growth may be, managers have the obligation to frame it within the long-term strategic objectives of the company taking into account the full range of stakeholders involved. Shareholders must demand from managers that their decision to pursue one growth strategy instead of others produce clear and tangible benefits beyond increased revenues. The sustainability of most businesses in today’s complex and highly interconnected corporate environment is less related to the pursuit of growth, and more related to the reasons behind the strategic decision to grow.
Roy Graham and Eduardo Berdegué are Managing Directors of the San Antonio-Austin office of Corporate Finance Associates. CFA is a middle-market investment banking firm specializing in assisting business owners and corporations seeking to buy or sell a business, or recapitalize. CFA also has Texas offices in Dallas, Houston and Midland. www.cfaw.com
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