What is Organic Sales Growth?
The process of generating growing revenues within the company by using its own operations and resources is called organic growth. In fact, there are two major strategies that companies use to grow their sales – organic and inorganic. While investors pay close attention to both, being able to increase sales organically would normally mean the business has an efficient revenue generation model and may be expanding its market share of an existing product or service, or has developed additional channels. In contrast, the inorganic approach includes acquiring other companies and their stake in the market to increase sales.
Key Learning Points
- When considering an investment, investors would typically look at the potential share price or dividend growth of a company. That is normally a reflection of its growth in sales, increasing earnings and revenues.
- There are two major approaches to growth – organic and inorganic. Should the company grow internally, using its own capabilities, it means that it is growing organically.
- To achieve organic sales growth, companies need a robust business model and efficient use of its resource. However, this strategy might struggle in more challenging (or changing) market conditions.
- Inorganic growth comes in the form of acquisitions. It could be a good solution from a strategy perspective, but the execution process could be quite difficult if the acquired company is not a good fit.
Organic Sales Growth Strategies
There are several ways in which companies can expand their sales organically. They can be employed either individually or in a combination, but have to be carefully considered in the context of the specific market. For example, launching a new product in an overcrowded market may be higher risk as it would need a strong competitive edge (such as unique and innovative technology, patent, intellectual property) to penetrate and deliver revenues. Some of the most popular organic growth strategies include:
- Developing a new product or service and market it to existing and potential customers
- Business optimisation, meaning that the company should re-evaluate and improve efficiency of internal processes, optimise costs and make changes to the existing structure if required
- Running well-planned marketing campaigns that aim to increase awareness of existing products and/or services – that might include exclusive offers for existing and new customers
- Internal relocation of funds and resources to focus on products that are in higher demand
- Developing an improved sales strategy that aligns employee’s and company’s interests, i.e. commissions and targets
- Improve customer service and make the customer journey easier. This may require enhancing the business’ systems, technology, and training programs
How to Analyse Organic Growth?
Companies would normally split their organic and inorganic figures when reporting results. That enables investors to better understand the engine for growth. Investors would also seek to analyse the specific segment of growth in sales and how that translates into profit by looking at profit margins. Other metrics like Return on Assets (ROA), which is often used to analyse the quality of a business, effectively reveal how effective a company is in generating profits by utilising its own assets.
For example, if Company ABC is growing its sales at a 3% annually, and company Z is growing sales at 14%, investors might assume that the latter is a better investment opportunity since it could offer higher rate of return. However, if the company managed to achieve this growth rate via an acquisition of a competitor, it might turn out that its sales were declining. In addition, its sales growth has been achieved by taking on higher risk, while ABC was able to grow organically, making no acquisitions and maintaining a healthy balance sheets without taking additional debt. Here is comes to the investor’s risk profile – those that are less risk tolerant would normally opt for ABC, even tough it is growing at a slower rate.
Achieving sales growth through an inorganic process would typically benefit a company that looks to expand into new market and needs access to that market, or wants to increase its presence in a competitive sector. For some companies, especially those operating in mature or maybe contracting areas of the market, the room for organic expansion may be very limited. However, inorganic growth could potentially impact organic sales if the acquisition process is not handled in a disciplined manner. In the case of mergers, the integration of new employees and systems is usually a challenge, while acquisitions typically require an implementation of new technology to the acquired company.
Both aspects could be quite challenging and complex in terms of time and cost. For example, restricting fees could have a significant impact on the company’s expenses. Generally, gaining larger market share or ability to enter new markets are two of the biggest benefits of inorganic sales growth, which in theory should help the business to grow at a faster rate. On the other hand, major drawbacks could be the need for additional management resource to execute the integration, the large upfront costs (the standalone value of the business plus a takeover premium) and the potential debt of the acquired company.
One of the key advantages of the organic sales growth is that it allows the owners of the business (or the shareholders) to maintain control, where an acquisition or a merger could dilute their stake or strip them from independence. However, the process of growing existing revenues or creating new revenue streams is a long process that requires robust planning and commitment from the management. Overall, companies that combine both organic and inorganic practices could be able to achieve better diversification and would not solely rely on their own capacity. On the other hand, those that grow organically are unlikely to take substantial debt that could increase the company’s leverage (or debt to equity). Acquisitions also come with additional risks, such as the need for more capital to integrate a company. Sometimes, companies that are purchased, despite not being a good fit, could be even liquidated completely.
If you would like to see the key features of a company report that highlights organic sales growth, please open the attachment.