Organic growth definition
/What is Organic Growth?
Organic growth is the increase in internally-generated sales of a business. The concept is used to differentiate between sales generated from existing operations and those operations that were acquired during the measurement period. In particular, organic growth is used to determine whether existing operations are in a state of decline, neutral growth, or expansion. A focus on increasing organic growth will likely lead to more investment in innovation and employee training, as well as new distribution channels. Organic growth nearly always refers to changes in sales, but can be used in reference to changes in profitability or cash flows.
The organic growth concept is a solid growth strategy for many businesses. This approach depends on internally-generated growth, rather than through acquisitions, and is a particularly viable option for a business that does not have sufficient cash to acquire other entities. However, this type of growth tends to be rather slow, especially when compared to the massive sales gains that can be achieved through an acquisition strategy. Also, organic growth could be in a sales segment that does not generate much cash flow, whereas an acquisition could generate sales in a more profitable segment of the market.
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Organic Growth vs. Inorganic Growth
Organic growth is generated from the internal operations of a business, while inorganic growth is derived from outside the entity. This usually means that a business acquires another entity, thereby taking over its sales. Inorganic growth tends to be more rapid than organic growth, since large blocks of revenue can be acquired quickly. However, buying another entity can put the acquirer at financial risk, since it must pay the shareholders of the acquiree a substantial amount of assets. Conversely, organic growth tends to be less expensive, depending on how prudently management invests in marketing, distribution channels, and new product development.
Example of Organic Growth
A company has been selling widgets for the last 10 years, and sales have plateaued. To generate more organic sales, it invests in an online store and markets it with online advertising, resulting in an immediate 20% jump in organic growth. Later, the company spends $5 million to buy a competitor, along with its annual sales of $3.5 million. These additional sales are classified as inorganic growth, since they were purchased, rather than coming from internally-generated sales.
Organic Growth Strategies
There are several ways in which a business can achieve solid organic growth. One option is to increase unit prices, so that customers are paying more for the same unit volume of sales. This approach is most tenable when pricing is relatively inelastic - that is, customers are willing to pay more, rather than buying elsewhere. If pricing is elastic, then price increases will result in an immediate decline in unit volume sales, which can be catastrophic.
Another option is to increase the number of units sold of existing products. This may be accomplished with more extensive marketing, essentially by selling more into existing sales regions. It may mean that existing customers buy in greater volume, or that new customers are found within existing sales regions. Unit volume can also be increased by expanding into entirely new markets. Margins can decline when pursuing this strategy, as there may be additional marketing or expansion costs. For example, selling internationally may mean that a business must sell through distributors, who will want a substantial price discount. A further option is to expand the number of distribution channels, for example by selling through retailers, an online store, and a catalog.
A third option for organic growth is to sell entirely new products. This will require an investment in research and development. The new product path can be a difficult one, since the market may not accept newly-launched products. However, some industries have very short product cycles, requiring businesses to continually churn out new products. If so, a business may need to engage in new product development, irrespective of the risks involved.
It is customary for a business to only pursue one or two of the preceding organic growth strategies, since each one requires a great deal of management attention. Also, the second and third strategies can be expensive, so a business may not have sufficient cash to pursue both. That being said, larger and more profitable organizations may pursue all options at once, since they have the financial resources to do so.
Measuring Organic Growth
When a business does not engage in acquisition activities, all of its sales growth is organic, and so is easily measured. This is not the case when there are ongoing acquisitions, since the sales of the acquired entities are mixed into the reported sales of the acquirer. In the latter case, a good way to measure organic growth is by comparing same-store sales for the current year to the sales for the preceding year. This approach will only work in the retail sector, where such comparisons are common. For other markets, consider conducting comparisons at the product level for the current year to sales for the preceding year.