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Inorganic Growth

Guide to Understanding Inorganic Growth

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Inorganic Growth

What is the Definition of Inorganic Growth?

Generally speaking, growth can be categorized into two types:

  • Organic GrowthOrganic growth stems from the business plans set into motion by a company’s management team, such as cost-cutting measures, internal research and development (R&D), and operational improvements.
  • Inorganic Growth → Inorganic growth results from mergers and acquisitions (M&A) or strategic alliances to drive revenue.

As part of the normal course of the business lifecycle, the growth opportunities available to companies will eventually fade over time.

Companies that have reached a stable rate of growth with limited growth opportunities in their pipeline are most likely to turn to and begin to rely increasingly more on inorganic growth strategies.

Examples of inorganic growth strategies are the following:

  • Mergers
  • Acquisitions
  • Strategic Alliances
  • Joint Ventures

What is the Difference Between Inorganic Growth vs. Organic Growth?

The desired end result of organic growth strategies is for a company to improve its growth profile using its internal resources, whereas inorganic growth strategies seek to derive incremental growth from external resources.

While achieving organic growth depends on a company’s internal resources and improvements to its existing business model to increase revenue and profit margins, inorganic growth is created by external events, namely mergers and acquisitions (M&A).

Therefore, most companies that pursue inorganic growth strategies tend to be mature and characterized by stable, single-digit growth, with sufficient cash on hand or debt capacity to fund a potential transaction.

Learn More → Hedge Fund Primer

Inorganic Growth Advantages – Benefits of M&A

Inorganic growth strategies are frequently considered to be the quicker, more convenient approach to increasing revenue relative to organic growth strategies, which can often be time-consuming even when successful.

Once the merger or acquisition has been completed, the combined entities should theoretically benefit from synergies (i.e. revenue synergies and cost synergies).

For instance, acquiring a company located in a different country could expand the global reach of a company and its ability to sell products/services to a broader market of customers.

In addition, the overall risk of the company can be reduced from the increased market share and size of a combined company, as well as the diversification of revenue, which can also improve per unit costs, i.e. economies of scale.

Inorganic Growth Disadvantages – Risks of M&A

Still, the combination of two or more companies in M&A is a complex matter with rather unpredictable outcomes

Any type of M&A transaction – e.g. add-on acquisitions and takeovers – are risky endeavors that require substantial diligence into all the factors that can impact the performance of the combined entity.

M&A is also disruptive to the core operations of all the companies involved, particularly in the early phases of integration right after the transaction has closed.

As a result, inorganic growth is viewed as the riskier approach – not because the success rate is lower – but due to the sheer amount of factors that are out of the direct control of management, such as the cultural fit between the companies.

The outcome of any plan is dependent on the execution of the strategy, meaning that poor integration can lead to value destruction instead of value creation.

In the worst-case scenario, attempting to pursue inorganic growth can actually cause a decline in growth and erode a company’s profit margins considering how costly M&A can be.

The most common causes for inorganic growth strategies falling short of expectations include overpaying for acquisitions, inflating synergies, corporate cultural differences, and inadequate due diligence.

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