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Internal growth

Internal growth, as we have seen, is a firm expanding by using its own resources. This is achieved by:

  • Increasing sales revenue by improving products and services and making them more attractive to customers
  • Better marketing of its product range
  • Investment in research and development
  • Improved training of its workforce
  • Expanding the number of offices, factories and outlets

Benefits of organic growth

  • Internal growth is relatively inexpensive, and the firm will not have to rely on outside sources of funds as most expansion is funded by retained profits.
  • The owners of the business will be able to maintain control of the business whereas external growth may require the raising of additional capital. This may lead to a change in ownership.
  • The business will be able to retain its identity and corporate culture as these will not be diluted by joining with other organisations.

Problems of organic growth and a change in size

Internal growth can cause problems within the firm. Since growth requires change in management structure, decision making process and its reporting systems.

As more people are employed, there is a need for more layers of hierarchy. As a result the chain of command becomes longer and decision making slower. Businesses will have to decentralise, and allow decision making to be taken more remotely. Trust will have to be earned and given. This is the area of diseconomies of scale, and will be a distinct disadvantage to future growth. Firms will have to cut bureaucracy, and eliminate layers (de-layering) of non-productive staff.

If a firm grows faster than its ability to manage its staff or control its costs, it is said to be 'overtrading'. This is frequently the underlying cause for falling profits and cash flow problems.

For private and public limited companies, the owners are the shareholders. Even if the founders are still majority shareholders, they have a legal obligation to consider the interests of all the other shareholders. In reality they can often run the company for themselves, almost ignoring the shareholders. This may be easy to do if there are many small shareholders, but harder if there is a group of large shareholders. Real conflicts can develop between the owners and the directors of a large company.


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Conflict at Prudential AGM

Prudential plc is an international financial services group with significant operations in Asia, the US and the UK. They have approximately 25 million customers with 290 billion of assets under management. However, Prudential Chief Executive Tidjane Thiam was forced to apologize directly to shareholders when the insurer held its Annual General Meeting after it was humiliatingly forced to pull its $35.5 billion bid for AIA, the Asian insurance division of AIG.

The botched bid, which racked up $658.8 million in adviser fees and other costs, has led investors including top 15 shareholder Schroders to call for Thiam to quit, although other owners said it would be premature to force him out.

Read the article, Prudential bosses apologise for AIA deal collapse (you can do this in the window below or follow the previous link to read the article in a separate window) and then consider answers to the questions below.


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The reasons why the Prudential considered external growth are given in this article on:


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Questions:

  1. Define the terms:
    1. Annual General Meeting (AGM)
    2. Shareholder.
  2. Explain what is meant by the separation of ownership and control.
  3. Analyse the reasons why Prudential was considering expansion in Asia using a takeover.
  4. To what extent is there likely to be conflict between stakeholders within any business?


Change in legal structure

S:\pictures\economics_business\legal_gavel_s.jpgProblems of direction, management and control will occur when a firm grows if this requires a change in legal structure. Problems will occur on changes from sole trader to limited company, from limited company to plc, from national to international company. The business will also face problems if growth stops.

Legal actions have to be taken when the legal structure of a firm changes. These may be expensive. It may also be hard to change the legal structure unless conditions are right. It may not be possible to sell shares in a company unless:

  • The financial history of the firm is good
  • Its prospects for the future are good
  • The overall market conditions are good.

The recession of 2007 onwards has made it more difficult to businesses to convert to plcs.

Expansion of operations is a common form of growth. Becoming an international operation can cause real problems, examples of which are:

  • Adjustment to new laws.
  • Having to deal with foreign languages
  • Having to deal with different cultures.
  • Longer chains of command and communications.

Reductions in size

So far we have concentrated on growth. Many firms expand and shrink on a cyclical basis. Shrinkage can cause real problems, involving:

  • Reductions in staff levels. Trade unions will have to be consulted. Redundancies will have to be organised. Will these be voluntary or compulsory? How will a firm retain its key staff?
  • Loss of morale and motivation amongst the remaining staff, as they fear they may be next.
  • Cost of redundancies. Compensation to leaving staff may be considerable which will delay any cost savings for some time (costs may even rise for a few months).