Organic Growth Meaning
Organic growth is the rate of growth that a company achieves by increasing sales revenue by increasing volume of products sold or by achieving greater operational efficiency leading to a reduction in the cost of production or any other internal improvement such as increased marketing and sales efforts. It does not take include incremental revenue and profits that accrue from acquiring external companies.
- A company has several ways of achieving growth and several measures of measuring the same. The sources of growth can be broadly classified into two categories, Organic growth, and Inorganic Growth. It implies the internal growth, which is an outcome of increasing efficiency or improvement in market conditions such as economic cycle, greater demand for products, and other such factors that increase the sales revenue and profit of the company.
- Inorganic growth, on the other hand, deals with growth achieved through the synergies of mergers, acquisitionsAcquisitionsAn acquisition is defined as the act of taking over or gaining control of all or most of another entity's stocks by purchasing at least fifty percent of the target company's stock and other corporate assets. , and other such takeover activities. It is so-called because the company uses external growthExternal GrowthExternal growth is an inorganic growth strategy in which a company expands its business activities by using external resources and capabilities. opportunities and the capabilities of other companies to increase their own growth rate.
Examples of Organic Growth
Coca-cola, one of the oldest companies in the beverage market, was first started in 1886, and till 1948, it captured approx 60% of the market share, and by 1984, this share reduced to 21% when it started facing stiff competition. The company made its first acquisition in 1960 by acquiring Minute Maid. Therefore it is clear that from 1886 to 1960, the company grew organically, which is a growth period of 74 years.
During this time, the ownership of the company changed many times; however, the company didn’t make any acquisition. It based its growth solely through organic development.
Every company uses a combination of both the strategies because, after a while, the company reaches the mature stage of the product life cycle, and to stay relevant, it either has to diversify or develop new products. In 2018, the organic growth of the company was 5% globally.
There can be several drivers of organic growth that tackle different line items on the income status to increase the bottom line. These can be broadly classified as follows:
#1 – Increase in Sales Revenue
It can be achieved in various ways:
- Selling more units at the same price requires increasing product awareness through sales promotion and marketing efforts. Developing brand investing in advertising might expand the demand
- Selling the same units at a higher price by creating segments of the market, for example, the snacks in the multiplexes are one way of doing this
- Also, it can be done by exploring more geographical areas, such as rural areas or international sales. Therefore one way of achieving growth is by impacting the top lineThe Top LineThe top line is the revenue earned by the business by selling goods or services, reported in the income statement for a defined period. .
#2 – Reducing Cost
There are various kinds of costs which go into the production of goods and services. Material, Labour, and Overheads are three broadheads for the same.
- Being able to source raw material cheaply through developing a vendor network is one way to keep material costs in check.
- Hiring more contract labor as per the regulatory guidelines is another way of cost-cutting.
- Locating the plant near the source of raw material is also a way to reduce transportation costs.
- These days people have also reduced office space as a lot of work can be done online. Companies opt for shared working spaces to reduce fixed expenditures.
#3 – Improving Operational Efficiency
This can be achieved by conducting periodic training of the operations personnel so that the marginal productivity of labor increases and the value added by each labor is higher.
Below is some importance.
#1 – Brand development
Organic growth is an essential factor in developing the brand. The sustainable existence of a company in its range of products for decades is what makes the company a household name. For example, Coca-cola has existed for decades because it grew organically first. One product has to become successful for the company to create faith and confidence in the consumers about the company.
#2 – Drives Inorganic Growth
Organic growth provides the companies the resources to achieve growth through M&A. It acts like a platform that is used for inorganic growth because even the target companies would want to merge into more prominent brands only if they see some benefit out of it. MergersMergersA merger is a voluntary fusion of two existing entities equal in size, operations, and customers deciding to amalgamate to form a new entity, expand its reach into new territories, lower operational costs, increase revenues, and earn greater control over market share. imply that both the companies exist but under the same umbrella. Therefore Target companies would not want to involve themselves in a merger, which doesn’t lead to any synergies.
Difference between Organic Growth and Inorganic Growth
#1 – Meaning
Organic growth is achieved through increasing sales revenue or by reducing costs to achieve greater profits. Inorganic growth is achieved through mergers and acquisitions done by a big company where it thinks that a specific smaller player would add synergy or help in diversifying its product range.
#2 – Life Stage
Organic growth is mandatory at a primary stage for any successful company. Inorganic growth can only follow a steady growth. No company exists solely for acquiring other companies. That is the motive of a retail investorRetail InvestorA retail investor is a non-professional individual investor who tends to invest a small sum in the equities, bonds, mutual funds, exchange-traded funds, and other baskets of securities. They often take the services of online or traditional brokerage firms or advisors for investment decision-making. who invests in the stock of a company. An investor who has a control perspective needs to have a more significant reason for entering into inorganic growth.
#3 – Growth Rate
Organic growth is achieved slowly over time as the brand gets established. Inorganic growth is achieved relatively quickly because both acquirer and target have achieved a certain level of organic growth, and if it is not a hostile takeover, it is a consensual interaction and therefore, can be achieved quickly.
- Brand Grooming: It leads to the development of the brand. If successful, the brand reaps benefits for centuries, and the company reaches the too big to fail level
- Streamlining and optimization: It leads to greater efficiency and streamlining costs and sales to the optimum level, which might not always be possible in case of inorganic growth which may lead to several duplications of areas as each company has its own existing systems and when they merge, these systems may not gel well with one another and therefore may have to exist independently, however, causing the drain on the company resources.
- Slow: It takes years or even decades to get established in the market and stay relevant. Organic growth can be achieved overnight, and in comparison, inorganic growth is a lot faster if not overnight.
- Low success rate: Not every company can succeed organically. Out of many coming into the business, very few are able to stay till they can start earning profits, and even fewer are able to become a going concern in the true sense. The failure rate is very high.
Therefore, we understand that Organic growth can be achieved through increasing sales, reducing costs, and increasing efficiency. It leads to brand development, but it is a long term process. It has a high risk and high return profile because success is achieved after a long gestation period, but if achieved, it lasts for decades and, in some cases, for even centuries.
However, we also need to understand that it ends after the product or the company reaches saturation. From this point onwards, the company has to either diversify or integrate. These can be achieved either internally or through Inorganic growth channels.
This article has been a guide to Organic Growth and its meaning. Here we discuss examples, strategies, and the importance of organic growth along with advantages and disadvantages. You may learn more about financing from the following articles –