EXPANSION STRATEGIES

EXPANSION STRATEGIES

 

Every enterprise seeks growth as its long-term goal to avoid annihilation in a relentless and ruthless competitive environment. Growth offers ample opportunities to everyone in the organization and is crucial for the survival of the enterprise. However, this is possible only when fundamental conditions of expansion have been met. Expansion strategies are designed to allow enterprises to maintain their competitive position in rapidly growing national and international markets. Hence to successfully compete, survive and flourish, an enterprise has to pursue an expansion strategy. Expansion strategy is an important strategic option, which enterprises follow to fulfil their long-term growth objectives. They pursue it to gain significant growth as opposed to incremental growth envisaged in stability strategy. Expansion strategy is adopted to accelerate the rate of growth of sales, profits and market share faster by entering new markets, acquiring new resources, developing new technologies and creating new managerial capabilities. 

 

Expansion strategy provides a blueprint for business enterprises to achieve their long term growth objectives. It allows them to maintain their competitive advantage even in the advanced stages of product and market evolution. Growth offers economies of scale and scope to an organization, which reduce operating costs and improve earnings. Apart from these advantages the organization gains a greater control over the immediate environment because of its size. This influence is crucial for survival in mature markets where competitors aggressively defend their market shares.
 

Conditions for Opting for Expansion Strategy 


Firms opt for expansion strategy under the following circumstances: 

1.   When the firm has lofty growth objectives and desires fast and continuous growth in assets, income and profits. Expansion through diversification would be especially useful to firms that are eager to achieve large and rapid growth since it involves exploiting new opportunities outside the domain of current operations.

2.   When enormous new opportunities are emerging in the environment and the firm is ready and willing to expand its business scope

3.   Firms find expansion irresistible since sheer size translates into superior clout. When a firm is a leader in its industry and wants to protect its dominant position.

4.   Expansion strategy is opted in volatile situations. Substantive growth would act as a cushion in such conditions.

5.   When the firm has surplus resources, it may find it sensible to grow by levering on its strengths and resources.

6.   When the environment, especially the regulatory scenario, blocks the growth of the firm in its existing businesses, it may resort to diversification to meets its growth objectives.

7.   When the firm enjoys synergy that ensues by tapping certain opportunities in the environment, it opts for expansion strategies. Economies of scale and scope and competitive advantage may accrue through such synergistic operations. Over the last decade, in response to economic liberalisation, some companies in India expanded the scale of existing businesses as well as diversified into many new businesses.

 

Growth of a business enterprise entails realignment of its strategies in product-market environment. This is achieved through the basic growth approaches of intensive expansion, integration (horizontal and vertical integration), diversification and international operations. Firms following intensification strategy concentrate on their primary line of business and look for ways to meet their growth objectives by increasing their size of operations in this primary business. A company may expand externally by integrating with other companies. An organization expands its operations by moving into a different industry by pursuing diversification strategies. An organization can grow by “going international”, i.e., by crossing domestic borders by employing any of the expansion strategies discussed so far.

 

EXPANSION THROUGH  INTENSIFICATION 

Intensification involves expansion within the existing line of business. Intensive expansion strategy involves safeguarding the present position and expanding in the current product-market space to achieve growth targets. Such an approach is very useful for enterprises that have not fully exploited the opportunities existing in their current products-market domain. A firm selecting an intensification strategy, concentrates on its primary line of business and looks for ways to meet its growth objectives by increasing its size of operations in its primary business. Intensive expansion of a firm can be accomplished in three ways, namely, market penetration, market development and product development first suggested in Ansoff’s model. Intensification strategy is followed when adequate growth opportunities exist in the firm’s current products-market space. However, while going in for internal expansion, the management should consider the following factors.

 

1.   While there are a number of expansion options, the one with the highest net present value should be the first choice.

2.   Competitive behaviour should be predicted in order to determine how and when the competitors would respond to the firm’s actions. The firm must also assess its strengths and weaknesses against its competitors to ascertain its competitive advantages.

3.   The conditions prevailing in the environment should be carefully examined to determine the demand for the product and the price customers are willing to pay.

4.   The firm must have adequate financial, technological and managerial capabilities to expand the way it chooses.

5.   Technological, social and demographic trends should be carefully monitored before implementing product or market development strategies. This is very crucial, especially, in a volatile business environment.

 

Ansoff’s Product-Market Expansion Grid 

The product/market grid first presented by Igor Ansoff (1968), shown in exhibit 1, has proven to be very useful in discovering growth opportunities. This grid best illustrates the various intensification options available to a firm. The product/market grid has two dimensions, namely, products and markets. Combinations of these two dimensions result in four growth strategies. According to Ansoff’s Grid, three distinct strategies are possible for achieving growth through the intensification route. These are: 

1.   Market Penetration: The firm seeks to achieve growth with existing products in their current market segments, aiming to increase its markets share.

2.   Market Development: The firm seeks growth by targeting its existing products to new market segments.

3.   Product Development: The firm develops new products targeted to its existing market segments.

4.   Diversification: The firm grows by diversifying into new businesses by developing new products for new markets.

 

Exhibit-I : Ansoff’s Grid

 

Market Penetration

When a firm believes that there exist ample opportunities by aggressively exploiting its current products and current markets, it pursues market penetration approach. Market penetration involves achieving growth through existing products in existing markets and a firm can achieve this by:

 

1.   Motivating the existing customers to buy its product more frequently and in larger quantities. Market penetration strategy generally focuses on changing the infrequent users of the firm’s products or services to frequent users and frequent users to heavy users. Typical schemes used for this purpose are volume discounts, bonus cards, price promotion, heavy advertising, regular publicity, wider distribution and obviously through retention of customers by means of an effective customer relationship management.

2.   Increasing its efforts to attract its competitors’ customers. For this purpose, thefirm must develop significant competitive advantages. Attractive product design, high product quality, attractive prices, stronger advertising, and wider distribution can assist an enterprise in gaining lead over its competitors. All these require heavy investment, which only firms with substantial resources, can afford. Firms less endowed may search for niche segments. Many small manufacturers, for instance, survive by seeking out and cultivating profitable niches in the market. They may also grow by developing highly specialized and unique skills to cater to a small segment of exclusive customers with special requirements.

3.   Targeting new customers in its current markets. Price concessions, better customer service, increasing publicity and other techniques can be useful in this effort.

 

In a growing market, simply maintaining market share will result in growth, and there may exist opportunities to increase market share if competitors reach capacity limits. While following market penetration strategy, the firm continues to operate in the same markets offering the same products. Growth is achieved by increasing its market share with existing products. However, market penetration has limits, and once the market approaches saturation another strategy must be pursued if the firm is to continue to grow. Unless there is an intrinsic growth in its current market, this strategy necessarily entails snatching business away from competitors. The market penetration strategy is the least risky since it leverages many of the firm’s existing resources and capabilities. Another advantage of this strategy is that it does not require additional investment for developing new products.

 

Market Development Strategy

 

Market Development strategy tries to achieve growth by introducing existing products in new markets. Market development options include the pursuit of additional market segments or geographical regions. The development of new markets for the product may be a good strategy if the firm’s core competencies are related more to the specific product than to its experience with a specific market segment or when new markets offer better growth prospects compared to the existing ones. Because the firm is expanding into a new market, a market development strategy typically has more risk than a market penetration strategy. This is because managers do not normally possess sound knowledge of new markets, which may result in inaccurate market assessment and wrong marketing decisions.

 

In market development approach, a firm seeks to increase its sales by taking its product into new markets. The two possible methods of implementing market development strategy are, (a) the firm can move its present product into new geographical areas. This is done by increasing its sales force, appointing new channel partners, sales agents or manufacturing representatives and by franchising its operation; or (b) the firm can expand sales by attracting new market segments. Making minor modifications in the existing products that appeal to new segments can do the trick.

 

Product Development Strategy 

Expansion through product development involves development of new or improved products for its current markets. The firm remains in its present markets but develops new products for these markets. Growth will accrue if the new products yield additional sales and market share. This strategy is likely to succeed for products that have low brand loyalty and/or short product life cycles. A Product development strategy may also be appropriate if the firm’s strengths are related to its specific customers rather than to the specific product itself. In this situation, it can leverage its strengths by developing a new product targeted to its existing customers. Although the firm operates in familiar markets, product development strategy carries more risk than simply attempting to increase market share since there are inherent risks normally associated with new product development. 

The three possible ways of implementing the product development strategy are: 

1.   The company can expand sales through developing new products.

2.   The company can create different or improved versions of the current products.

3.   The company can make necessary changes in its existing products to suit the different likes and dislikes of the customers.

 

Combination Strategy 

Combination strategy combines the intensification strategy variants i.e., market penetration, market development and product development to grow. In the market development and market penetration strategy, the firm continues with its current product portfolio, while the product development strategy involves developing new or improved products, which will satisfy the current markets.

 

EXPANSION THROUGH INTEGRATION 

In contrast to the intensive growth, integration strategy involves expanding externally by combining with other firms. Combination involves association and integration among different firms and is essentially driven by need for survival and also for growth by building synergies. Combination of firms may take the merger or consolidation route. Merger implies a combination of two or more concerns into one final entity. The merged concerns go out of existence and their assets and liabilities are taken over by the acquiring company. A consolidation is a combination of two or more business units to form an entirely new company. All the original business entities cease to exist after the combination. Since mergers and consolidations involve the combination of two or more companies into a single company, the term merger is commonly used to refer to both forms of external growth. As is the case in all the strategies, acquisition is a choice a firm has made regarding how it intends to compete (Markides, 1999). Firms use integration to (1) increase market share, (2) avoid the costs of developing new products internally and bringing them to the market, (4) reduce the risk of entering new business, (5) speed up the process of entering the market, (6) become more diversified and (7) quite possibly to reduce the intensity of competition by taking over the competitor’s business. The costs of integration include reduced flexibility as the organization is locked into specific products and technology, financial costs of acquiring another company and difficulties in integrating various operations. There are many forms of integration, but the two major ones are vertical and horizontal integration. 

i) Vertical Integration: Vertical integration refers to the integration of firms involved in different stages of the supply chain. Thus, a vertically integrated firm has units operating in different stages of supply chain starting from raw material to delivery of final product to the end customer. An organization tries to gain control of its inputs (called backwards integration) or its outputs (called forward integration) or both. Vertical integration may take the form of backward or forward integration or both. The concept of vertical integration can be visualized using the value chain. Consider a firm whose products are made via an assembly process. Such a firm may consider backward integrating into intermediate manufacturing or forward integrating into distribution. Backward integration sometimes is referred to as upstream integration and forward integration as downstream integration. For instance, Nirma undertook backward integration by setting up plant to manufacture soda ash and linear alkyl benzene, both important inputs for detergents and washing soaps, to strengthen its hold in the lower-end detergents market. Forward integration refers to moving closer to the ultimate customer by increasing control over distribution activities. For example, a personal computer assembler could own a chain of retail stores from which it sells its machines (forward integration). Many firms in India such as DCM, Mafatlal and National Textile Corporation have set up their own retail distribution systems to have better control over their distribution activities.

Some companies expand vertically backwards and forward. Reliance Petrochemicals grew by leveraging backward and forward integration: it began with manufacturing of textiles and fibres, moved to polymers and other intermediates then went into the manufacture of fibres, then to petrochemicals and oil refining. In power, Reliance Energy wants to do the same thing and the catchphrase that for this vertical integration is ‘from well-head to wall-socket’. Reliance Energy’s strategy is to straddle the entire value chain in the power business. 

It plans to generate power by using the group’s production of gas, transmit and distribute it to the domestic and industrial consumers, reaping the returns of not just generating power using its own gas but selling what it generates not as a bulk supplier but to the end user. 

In essence, a firm seeks to grow through vertical integration by taking control of the business operations at various stages of the supply chain to gain advantage over its rivals. The record of vertical integration is mixed and hence, decisions should be taken after a comprehensive and careful consideration of all aspects of this form of integration. In most cases the initial investments may be very high and exiting an arrangement that does not prove beneficial may be hard. Vertical integration also requires an organization to develop additional product market and technology capabilities, which it may not currently possess. 

Factors conducive for vertical integration include (1) taxes and regulations on market transactions, (2) obstacles to the formulation and monitoring of contracts, (3) similarity between the vertically-related activities, (4) sufficient large production quantities so that the firm can benefit from economies of scale and (5) reluctance of other firms to make investments specific to the transaction. Vertical integration may not yield the desired benefit if, (1) the quantity required from a supplier is much less

than the minimum efficient scale for producing the product. (2) the product is widely available commodity and its production cost decreases significantly as cumulative quantity increases, (3) the core competencies between the activities are very different, (4) the vertically adjacent activities are in very different types of industries (For example, manufacturing is very different from retailing.) and (5) the addition of the new activity places the firm in competition with another player with which it needs to cooperate. The firm then may be viewed as a competitor rather than a partner.

 

Firms integrate vertically to (1) reduce transportation costs if common ownership results in closer geographic proximity, (2) improve supply chain coordination, (3) capture upstream or downstream profit margins, (4) increase entry barriers to potential competitors, for example, if the firm can gain sole access to scarce resource, (5) gain access to downstream distribution channels that otherwise would be inaccessible, (6) facilitate investment in highly specialized assets in which upstream or downstream players may be reluctant to invest and (7) facilitate investment in highly specialized assets in which upstream or downstream players may be reluctant to invest. 

The downside risks of an integration strategy to a company include (1) difficulty of effectively integrating the firms involved, (2) incorrect evaluation of target firm’s value, (3) overestimating the potential for synergy between the companies involved, (4) creating a combination too large to control, (5) the huge financial burden that acquisition entails, (6) capacity balancing issues. (For instance, the firm may need to build excess upstream capacity to ensure that its downstream operations have sufficient supply under all demand conditions), (7) potentially higher costs due to low efficiencies resulting from lack of supplier competition, (8) decreased flexibility due to previous upstream or downstream investments, (however, that flexibility to coordinate vertically –related activities may increase.), (9) decreased ability of increase product variety if significant in-house development is required, and (10) developing new core competencies may compromise existing competencies.

 

There are alternatives to vertical integration that may provide some of the same benefits with fewer drawbacks. The following are a few of these alternatives for relationships between vertically related organizations.

1. Long-term explicit contracts
2. Franchise agreements
3. Joint ventures
4. Co-location of facilities
5. Implicit contracts (relying on firm’s reputation) 

Illustration: Digital Giants to Accelerate Vertical Integration 

Samsung Electronics and LG Electronics plan to streamline production lines in cooperation with their affiliates to reduce factors of uncertainty in the procurement of components. The two South Korean giants seek to manufacture top-of-the-line products like cell phones and digital TVs in a self-sufficient fashion. LG Group will invest 30 trillion won by 2010 to develop certain electronic components that include system integrated chips, plasma displays and camera modules. Samsung Electronics already retains a strong portfolio, comprising Samsung Corning (display-specific glass), Samsung SDI (displays) and Samsung Electro-Mechanics (camera modules), and aims to further hone its push for vertical integration. 

So-called vertical integration refers to the degree to which a company owns or controls its upstream suppliers, subcontractors or affiliates and its downstream buyers. The advantage of the strategy is the expansion of core competencies by reducing risks in the supply of components as well as the slashing of transportation costs. Some experts have said vertical integration is vital to the improvement of these two giant digital firms’ competitiveness despite criticism that such expansion would increase the entry barriers for industry newcomers. 

Source: Korean Times

 

ii) Horizontal Combination / Integration: The acquisition of additional business in the same line of business or at the same level of the value chain (combining with competitors) is referred to as horizontal integration. Horizontal growth can be achieved by internal expansion or by external expansion through mergers and acquisitions of firms offering similar products and services. A firm may diversify by growing horizontally into unrelated business. Integration of oil companies, Exxon and

Mobil, is an example of horizontal integration. Aditya Birla Group’s acquisition of L&T Cements from Reliance to increase its market dominance is an example of horizontal integration. This sort of integration is sought to reduce intensity of competition and also to build synergies. 

Benefits of Horizontal Integration 

The following are some benefits of horizontal integration: 

1.   Economies of scale-achieved by selling more of the same product, for example, by geographic expansion.

2.   Economies of scope – achieved by sharing resources common to different products. Commonly referred to as ‘synergies’.

3.   Increased bargaining power over suppliers and downstream channel members.

4.   Reduction in the cost of global operations made possible by operating plants in foreign markets.

5.   Synergy achieved by using the same brand name to promote multiple products.

 

Hazards of Horizontal Integration 

Horizontal integration by acquisition of a competitor will increase a firm’s market share. However, if the industry concentration increases significantly then anti-trust issues may arise. Aside from legal issues, another concern is whether the anticipated economic gains will materialize. Before expanding the scope of the firm through horizontal integration, management should be sure that the imagined benefits are real. Many blunders have been made by firms that broadened their horizontal scope to achieve synergies that did not exist, for example, computer hardware manufacturers who entered the software business on the premise that there were synergies between hardware and software. However, a connection between two products does not necessarily imply realizable economies of scope. Finally, even when the potential benefits of horizontal integration exist, they do not materialize spontaneously. There must be an explicit horizontal strategy in place. Such strategies generally do not arise from the bottom –up, but rather, must be formulated by corporate management.