Navigating in Turbulent Times — Do you Grow Horizontally or Vertically?
On board, I’m the captain 🧑✈️
So climb aboard
We’ll search for tomorrow
On every shore and I’ll try
— — — — Come Sail Away, Styx
Now that the “eye of the storm” has likely (hopefully) passed us by, it is time to remain calm, regroup, and plan your path forward to find dry land. I refer you to the Top 10 list of things to do to help you navigate to get through the storm. (https://ruffoloj.medium.com/top-10-things-to-do-as-an-entrepreneur-in-navigating-the-storm-edf0e532d45f)
Number 6 on the list was “Re-evaluate your organic growth strategies to ensure steady, sustainable growth.” It is not nor really should ever be “growth at all costs” but rather it is sustainable, predictable growth that usually ends up winning in the end. In the words of Jim Collins, in his book Great by Choice, are you a Roald Amundsen or a Robert Scott? (I will let you read the book to figure out which one you want to be).
One such approach to a growth strategy is to determine whether you might want to embark upon a horizontal or vertical growth strategy. (h/t to ChatGPT for a comparison of both strategies).
Horizontal Strategy:
A horizontal strategy, also known as horizontal integration, involves expanding a company’s operations or market presence by acquiring or merging with competitors or building complementary businesses in the same industry. The benefits to this approach are as follows:
1. Market Expansion: A horizontal strategy captures a larger market share by leveraging existing customer relationships and distribution networks. By offering new products or services, organizations can cater to a broader range of customer needs, potentially increasing revenue streams and consolidating their position in the market.
2. Economies of Scale: Horizontal growth enables companies to achieve economies of scale by leveraging existing infrastructure, resources, and operational efficiencies. The larger volume of production or sales can lead to reduced costs per unit, enhanced bargaining power with suppliers, and improved profitability.
3. Competitive Advantage: By acquiring or merging with competitors, horizontal growth enables organizations to eliminate or mitigate competitive threats. Consolidation can create synergies and allow for the sharing of best practices, technological advancements, and intellectual property, strengthening the company’s competitive position.
The limitations to this approach include:
1. Market Saturation and Competition: In mature industries or highly competitive markets, expanding horizontally may be challenging due to market saturation. The company must carefully assess the potential for growth and weigh it against existing market conditions. Regulatory constraints and antitrust concerns may arise when acquiring competitors, requiring careful evaluation and compliance.
2. Integration Challenges: Merging with or acquiring competitors can present integration challenges, such as cultural differences, conflicting business processes, or overlapping product lines. Successfully managing these complexities is crucial for the success of a horizontal strategy.
3. Focus: There is a risk of overextension and lack of focus if companies pursue horizontal growth without a clear strategic vision.
Vertical Strategy:
In contrast to a horizontal strategy, a vertical strategy, or vertical integration, involves expanding a company’s operations along its supply chain, either backward (upstream) or forward (downstream). The aim of a vertical strategy is to gain control over the value chain, improve operational efficiency, and capture more profit margins. The benefits to this approach are as follows:
1. Supply Chain Optimization: Vertical integration allows organizations to have greater control over their supply chain, ensuring a more seamless and efficient flow of materials, information, and resources. By integrating backward, companies can secure access to essential inputs and reduce dependency on suppliers, thereby minimizing risks related to quality, pricing, and availability.
2. Cost Reduction and Profit Margins: Vertical growth provides opportunities for cost reduction by eliminating intermediaries, streamlining processes, and reducing transaction costs. By bringing different stages of the value chain under one roof, organizations can capture a larger share of the value created, potentially leading to increased profit margins.
3. Differentiation and Innovation: Vertical integration can foster innovation by facilitating closer collaboration between different stages of the value chain. Companies can develop unique products, differentiate themselves in the market, and respond more effectively to customer demands. Furthermore, vertical growth enables organizations to incorporate forward integration, allowing them to control the distribution and marketing of their products, thus enhancing brand image and customer experience.
The limitations to this approach include:
1. Capital Intensity: Vertical integration often requires substantial capital investments, especially when entering new stages of the value chain. Companies must carefully assess the financial feasibility of vertical expansion and ensure that the potential benefits outweigh the costs. Companies must carefully assess the long-term viability of integration, considering factors such as market volatility, the potential impact on existing relationships, and the level of control needed.
2. Limited Flexibility: Vertical integration can limit a company’s flexibility and agility, as it becomes responsible for managing a wider range of activities. This can divert management’s attention and resources away from core competencies and increase the complexity of operations.
Comparative Analysis and Suitability:
While both horizontal and vertical strategies have their merits, their suitability depends on various factors, including industry dynamics, competitive landscape, and organizational capabilities.
1. Industry Considerations: Horizontal strategies are often more suitable in industries with intense competition, high market fragmentation, and evolving customer preferences. Conversely, vertical strategies are better suited for industries with complex supply chains, limited supplier alternatives, and a need for greater control over quality and availability.
2. Competitive Advantage: Horizontal growth can yield economies of scale and enhanced market power, enabling companies to outperform competitors through price advantages and broader market reach. Vertical growth provides competitive advantages through improved operational efficiencies, quality control, and differentiation.
3. Risk and Flexibility: Horizontal growth entails integrating different product lines or businesses, which can pose integration challenges and diversification risks. Vertical growth, on the other hand, involves deeper integration within a specific industry, potentially reducing risks associated with external dependencies and fluctuations in the market.
Ultimately, the choice between horizontal and vertical strategies depends on an organization’s specific circumstances, industry dynamics, and strategic goals. It is essential for companies to thoroughly evaluate the potential risks, benefits, and alignment with their long-term vision before embarking on a growth strategy. By understanding the nuances and implications of each approach, businesses can make informed decisions that maximize their chances of sustainable growth and competitive advantage in the market.
I do realize there is no right approach. However, when I look back over my investing career, I have come to realize that I have a natural bias to thinking about horizontal growth strategies first. Maybe it is because it is more natural to think about your competitors or complimentary products in a given addressable market. But when I look back over the years and see why I passed on investing in some great companies, I underestimated the company’s ability to grow vertically.
This time, I won’t be so quick to judge!!
Founder & Managing Partner, Maverix Private Equity
