Let’s face it, innovating is hard. Not only is it hard it’s also expensive, time consuming and full of risk.
For many large organizations facing up to these realities can be gut-wrenching, especially if your competitor already has a head start. For this and other reasons exploring an acquisition rather than building something in house on your own can be a wise endeavor. And the nice part about acquiring other companies is that usually a lot of the hard work of innovation has already been done.
Sounds easy, right? Well there’s definitely a catch…
The question that inevitably comes up is “Who should we acquire and why?”
Because acquiring companies is expensive (sometimes mind-bogglingly so), having a crystal clear answer to those questions is essential.
In this post I’ll go through a framework for how to think through your acquisition strategy and give you a free PowerPoint template that will help you communicate that strategy to your peers and executives.
In July 2010 McKinsey wrote an article titled “The Five Types of Successful Acquisitions.” In that article they mentioned the following five reasons as typical for justifying an acquisition:
- Improve the target companies performance
- Consolidate or remove excess capacity from an industry
- Accelerate market access for the target’s (or buyer’s) products
- Get skills or technologies faster or at lower cost than they can be built
- Pick winners early and help them develop their businesses
While this list definitely isn’t comprehensive it does provide a good starting point for justifying a large investment in a target company.
On that list the most relevant to innovation are 3 and 4 while the others have more to do with standard investing or turnaround efforts. While investing in companies for reasons 1, 2 and 5 can be worthwhile, the frameworks for evaluating those types of investments are different than the framework for evaluating companies that fall into reasons 3 and 4. Private equity firms specialize in reason 1, large conglomerates may occasionally do acquisitions for reason 2 and any public or private investor might acquire a company for reason 5. In this article though I’ll focus on the framework that is most useful for investing in companies for reasons 3 and 4.
Who Should We Acquire?
As a framework for evaluating potential merger/acquisition targets, AT Kearney wrote an article titled “Merger Endgame Revisited” which outlined their approach to analyzing industry consolidation and merger endgames. While I like the template of visualizing merger endgames they provide at the end, the rest of the article is woefully over-complicated and formulaic. A simpler and more useful approach to understanding industry trend analysis is Clayton Christensen’s theory of value chain evolution. The best explanation for that theory is available in Christensen’s book “Seeing What’s Next.” I also wrote a blog post about it titled “How to Innovate by Capitalizing on Technology and Industry Trends.”
Value Chain Evolution Analysis
The first approach to determining who to acquire is related to Christensen’s theory of value chain evolution. This theory posits that industries transition between two phases over time: vertically integrated/interdependent and horizontal/modular. Whichever phase your industry is in likely means that the biggest threat to your industry is the opposite phase. For example, if your industry is primarily vertically integrated then your industry’s biggest threat is a disruptive entrant that enables lower costs and modular structure. Take higher education for example. For years higher education has been a vertically integrated industry with all classes coming from the same school in order to graduate. With the looming disruption of MOOC’s higher education could be transformed into a fully modular or horizontal industry where your degree is made up of classes from schools all over the world – all at a much lower cost.
Conversely, consider the computer industry of the late 1990’s and early 2000’s. At the time, Dell was king of the hill with an approach that was built on the idea of modularity and horizontal design. A few years later though, Apple, a vertically integrated computer manufacturer upended Dell’s success with a series of computer products that only a sophisticated vertically integrated company could create. These products put Dell into a tailspin that they’ve yet to fully correct.
So what do these cycles have to do with acquisition strategy?
Suppose your company is a dominant player in a horizontally aligned industry, such as Microsoft. For years Microsoft led the industry by doing two things but doing them very well – OS’s and office productivity apps. Since the launch of the iPhone in 2007, Microsoft, and the rest of the OEM computer manufacturers who partner with them, have faced a serious challenge from the vertically integrated Apple. Because of this threat Microsoft made the strategically vital decision to get into the computer hardware business by launching Surface and acquiring Nokia.
So if your industry has been dominated by horizontal firms, it’s important to think through the opportunity vertical firms and integrative innovation could bring in creating more value. Conversely, if your industry has been dominated by vertically integrated firms then you must consider what a disruptive innovation and horizontally optimized firm could bring in creating more value. Each scenario can help inform your acquisition strategy.
The second approach to determining who to acquire has to do with portfolio analysis and evaluation of how the target company can fill in holes in your desired portfolio. For this assessment AT Kearney’s Acquisition Endgame template really shines.
At the top of the template you list your company’s desired portfolio of products or services and the regions that are relevant (you could also remove regions and put in sub-products/sub-services). Along the left side is a list of the key value chain components of each product/service that you wish to analyze. Once those are filled in, shading the center boxes at each intersection relative to your company’s strengths or weaknesses in that particular area will give you a clear picture of where the holes are in your portfolio which will help determine the right acquisition target.
One of the recent acquisition deals that has been in the news lately involves a bid from Monsanto for a company called Syngenta. Since Monsanto is located in St. Louis where I live, I tend to pay a little more attention to their activities than I otherwise would. Recently I came across this article in the Wall Street Journal that explained part of the rationale behind the proposed acquisition. As I thought about their rationale I realized their situation could be well explained by the Acquisition Endgame Template.
In Monsanto’s case, their main goal is in broadening their portfolio of products to include a strong presence in pesticides. Monsanto is mostly known by their famous herbicide product RoundUp and their strong genetically modified seed business. To help illustrate the situation Monsanto is in, I filled out an example template that partially shows Monsanto’s desire for a strong presence in pesticides as well as their willingness to divest Syngenta’s seed business if necessary post-merger. Many of the other areas I made up regarding Dow Agro and ADM’s strengths and consideration as an acquisition target.
Communicating Your Strategy
One of the biggest challenges innovators and business leaders face in trying to grow their company is communicating ideas clearly and getting buy-in from bosses, peers and direct reports. With the acquisition endgame template it becomes much easier to think through and explain to others the rationale behind a potential acquisition target. To help make that communication as seamless as possible check out this link to a PowerPoint version of this template so you can use it in your business to suit your needs.