Strategic growth is crucial for almost every firm, regardless of industry, size, and location. But what does strategic growth mean? Entering into new markets? Expanding a firm’s products and services? Increasing revenues? While growing in size is a powerful rallying force for firm management, employees, and shareholders, it also can require significant expenditures and expose a firm to many new risks. Rather than pursue growth for growth’s sake, firms need an economic framework for setting forth possible expansion paths, analyzing the business value they will create, and comparing them against other possible courses of action. This article discusses two specific growth benefits that should be incorporated into corporate planning: economies of scale and scope.

Growth vs. Strategic Growth

Strategic growth is a battle cry for almost every firm. But what does strategic growth mean? Strategic growth is a deliberate pathway that leads to increased revenues, a stronger competitive position, and increased shareholder value.

Strategic growth differs from ordinary growth because it is built on a reasoned analysis of market opportunity, the firm’s resources, and how it can turn a market opportunity into business results. It is planned, structured, and executed.

Growth that is not tied to strategy, on the other hand, may come from favorable short-term market movements or from business tactics that lead to growth spikes that are not sustainable. Some additional thoughts on the difference between growth and strategic growth are found here.

Strategic growth is different from growth.

The pathway to strategic growth can be based on many steps. The steps include:

• expanding a company’s revenue model, which can involve monetizing additional components of a product or service currently provided for free
• onboarding talented employees
• entering into new domestic or international markets
• building a company’s product and service distribution network
• developing new products and services
• acquiring companies
• building the company’s ecosystem, including entering into joint ventures and strategic alliances with other companies
• broadening a firm’s visibility and customer base.

There are many ways to drive strategic growth, including entering new markets, developing new products and services, and expanding the company’s ecosystem.

The Two Value Sides of Growth

Strategic growth does not necessarily lead to increased shareholder value. While growth may create additional revenues and expand a company’s market position, it can also have several negative value consequences.

Increased costs. Strategic growth is often costly and can put pressure on firm financial resources. Firms that plan to grow through the launch of new products often have to expend significant amounts of money on research and development and product positioning. These costs can be substantial, particularly for projects with extensive lead times, and take a long time to recoup.

Strategic growth expenses also can create upward pressure on firm operational costs. While it is typical that the costs of a strategic initiative will outweigh revenues when it is launched, some growth initiatives create costs that systematically eat into strategic growth gains. This is especially the case when revenues from a growth strategy fluctuate and expenses are fixed.

Loss of efficiency and agility. As firms go through strategic growth phases, departments, employees, and procedures tend to increase. This creates additional layers of horizontal and vertical firm bureaucracy, which can cause operational efficiency to decline. This loss of efficiency can negatively affect numerous organizational value drivers, including the time to:

• vet ideas and convert them into practice
• deliver products and services
• convert internal and external feedback into organizational changes.

Increased exposure to risks. Strategic growth tends to reduce some types of risks but create others. This can occur is because growth often leads to complexity, which increases the probability that things will break down. One place that this can happen is in the breakdown of logistical chains.

The Economics of Growth

Given the positives and negatives of strategic growth, it is crucial to have a framework to analyze the likelihood of a strategic initiative on long-term value creation. In addition to revenue and cost forecasts, two growth advantages are economies of scale and scope.

There are three critical types of economies of scale:

• Internal economies of scale
• External economies of scale
• Shared economies of scale.

Each of these economies of scale can build shareholder value.

Internal economies of scale. Internal economies of scale are the most common type of economies of scale. Internal economies of scale arise when, as a consequence of growth, its unit costs fall. Examples of internal economies of scale are:

• Pricing. As a company’s purchasing power grows and it buys larger product volumes, it can negotiate lower prices or more favorable payment arrangements.
• Financing. As a company grows larger, its revenues increase, and its risk falls, it can often reduce its capital costs. Lower interest rates on loans and better share valuations lead to increased cash flows that can be reinvested and used to drive other value-creating initiatives.
• Marketing. Larger companies can conduct marketing activities across multiple intersecting channels, reducing unit marketing costs.

Two types of benefits from strategic growth are economies of scale and scope.

External economies of scale. External economies of scale are economies of scale that a company benefits from rather than drives itself. These benefits may apply to certain companies in an industry or all companies.

Examples of external economies of scale are:

• Tax benefits. Companies of a specific size may be given tax benefits, which give them a competitive financial advantage.
• Trade tariffs. As a country grows, it may be able to negotiate more favorable export tariffs. This reduces the export costs of the country’s products, increasing competitiveness compared with other companies.

Shared economies of scale. Shared economies of scale refer to economic benefits negotiated by multiple parties. A single party may not have sufficient bargaining power to bargain down pricing or other transaction terms. However, if several companies join forces and act as a block, they may be able to secure better terms than if they negotiated individually. An example might be several exporting companies that collectively negotiate better shipping terms with exporters.

Economies of Scope

A second type of economic gain from strategic expansion is an economy of scope. An economy of scope reduces the effective costs of different business initiatives. A discussion of economies of scope can be found here.

Economies of scope reduce the effective cost of complementary business initiatives.

Data analysis and conversion. As businesses grow, they acquire large amounts of experience reflected in data. This data includes valuable product and service development, marketing, and employment relationship information. This data is a powerful asset that can significantly accelerate how quickly and effectively firms formulate and execute strategic plans in related business areas.

Business development. As firms grow, their client base grows. Once a firm has a client, it is often easier to sell a new product or service to the client rather than develop a new client. This is because there is a relationship of trust between the parties, and the business may have a good understanding of the issues the client is facing.

Product and services expansion. Once a firm has a product, moving horizontally into a related product is often cost-effective. For example, if a firm sells chocolate chip cookies, it is relatively easy to sell a new type of cookie that replaces chocolate chip cookies with nuts. This is because the new cookie incorporates 95% of the old cookie product.

If a company from another industry, such as beverages, wants to create a chocolate chip cookie line and compete in this space, it has to start from scratch. This will almost always take longer and cost more than a company with an established industry position.

Companies can apply the advantages of economic scope vertically as well as horizontally. For example, it can be cost-beneficial for a company that produces olives to produce olive oil because of their familiarity with the core product and the market.

Geographic expansion. Once a firm is positioned geographically in a market, developing new products and services is cheaper than for firms coming into the market for the first time.

Strengthening Strategic Planning

Understanding economies of scale and scope can help firms strengthen the corporate planning price in two key ways.

First, in addition to projecting the revenues that can be expected from a proposed strategic initiative, a firm can better quantify the benefits that strategic growth will create. If a firm purchases materials for one of its products, it can prepare projects based on lower cost assumptions. Rather than guess what cost benefits can be obtained, firms should actively speak with suppliers to understand what price adjustments can be expected if sales volumes are increased.

Second, the benefits of economies of scope can help firms not only grow but understand how they can take better advantage of market positions that they already have. As the ability to leverage product and geographical space to offer new products and services generates cost advantages, a favorable cost structure allows firms to lower prices, giving them further competitive advantages.

Conclusion

There are many strategic growth pathways. By considering the benefits of economies of scale and scope, firms can better gauge whether strategic initiatives will create short and long-term value. This can significantly strengthen the corporate planning process.

The source for the image of the Theatrum Orbis Terrarum global map, created in 1570, is found here.