Every Friday RE:INVENTION’s team reviews a recent news article or research study and provides analysis and insights from each of our cross-functional perspectives. We call this weekly blog feature, 5×5.
UP THIS WEEK: SHORTCUTS TO INNOVATION?
With terms like “innovation” and “change” becoming ever-popular buzzwords in today’s marketplace, companies are faced with resounding pressures to figure out ways with which they can maintain competitive advantage in their respective industries. This leads to firms scrambling to come up with the next great idea so that they can live on to see the next day of operations. Darwinians call this survival of the fittest. Innovate or die.
This Week’s Reference Article:
• “No Shortcut to Innovation“, an October 2013 MarketWatch article about a new academic study conducted by Borah and Tellis titled “Make, Buy, or Ally”.
THIS WEEK’S QUESTION
Can M&A be a shortcut to innovation?
OUR TEAM’S RESPONSES
Kirsten Osolind (“Change Catalyst”)
Could M&A be a path to innovation and growth or is it just “a shortcut”? A thoughtful response to this week’s question starts with an evaluation of the Borah and Tellis “Make, Buy, or Ally” study reported by Marketwatch. A study that concluded that the market frowns on firms that attempt to innovate through acquisitions. Sadly, the Borah and Tellis study is fatally flawed for two reasons.
First, Borah and Tellis only analyzed 192 firms over a five year period during the “Great Recession”. Second, their analysis involved tracking stock prices immediately following an M&A announcement. Their conclusion: “On average, a company’s stock rallied following an announcement of an R&D drive and fell following news of an acquisition.”
The Corporate Finance student in me is compelled to roll my eyes and say, “well, duh.” It’s pretty common knowledge that when a firm acquires another entity, there is a predictable short-term effect on the stock price of both companies. The acquiring company’s stock typically falls. Why? Well, there are a number of uncertainties involved with acquisitions. But more importantly, the buyer in merger deals often issues stock and uses it as currency for the acquisition. By issuing stock, the company is carved into additional slices, making each piece worth less. Wall Street refers to this as dilution. Investors pretty much loathe anything that devalues their stock.
This says absolutely nothing about the long term impact on the acquiring company’s stock value or ability to innovate. In fact, if an acquisition goes smoothly, it’s good for the acquiring company — very good — with respect to financial performance, growth, and innovation.
Bain and Company’s 2013 “Renaissance in Mergers and Acquisitions” Report, based on an 11 year longitudinal study, found that companies that conducted disciplined mergers and acquisitions — those that acquired frequently and strategically to expand into new geographies, new markets or both — significantly outperformed the market as measured by total shareholder return. The best returns were achieved by those companies that invested a significant portion of their market cap in inorganic growth. Experience counts.
And it’s not just about revenue growth. It’s about growing innovation capabilities. Research proves that successful acquirers make M&A deals that boost innovation performance. Booz & Company calls this phenomenon “the capabilities premium in M&A.” Successful deals accelerate innovation.
For the record, M&A is actually more effective for small companies as a growth, value creation, and innovation strategy than it is for large companies according to Accenture Research. Accenture analyzed deals from 2002 through 2009 and found that 58 percent of all mergers and acquisitions during that period created value and smaller deals led by smaller acquirers do better than larger ones.
The trick is doing “M&A right.”
For M&A to work, the deal needs to:
- enhance your company’s distinctive capabilities
- leverage your existing competitive advantages
- complement your innovation processes
or (and in my humble opinion, “IDEALLY”) do all three.
Deals that enhance the acquiring company’s capabilities, competitive advantages, and processes are far more likely to generate value over time. Google, Microsoft, Oracle, Anheuser-Busch, even my old employer Whole Foods Market are examples of companies that have delivered results through M&A and used deals to propel both company innovation and growth.
As long as companies understand how to manage post-merger integration and cultural change…as long as they have strategic alignment and internal innovation processes primed for performance pre- and post- merger…M&A can improve a company’s ability to innovate. Ultimately M&A is an investment in both innovation and future growth.
As for the rest of the Borah and Tellis report findings, innovation involves much more than R&D spending. It’s about creating value. It’s about effective commercialization of new ideas. In the words of Booz & Company Senior Partner, Barry Jaruzelski, “Year after year our Global Innovation 1000 study has demonstrated that it is not how much companies spend on research and development that determines success — what really matters is how companies invest in talent, process, and tools.” R&D spending is merely one input, and it can be misleading.
Joe Barrus (“The Technologist”)
Can M&A be a shortcut for innovation? The answer is …. It depends! M&A can be a powerful overall growth strategy for capital rich companies but not necessarily a good strategy to drive growth through innovation because innovation is primarily seen as a methodology to drive organic growth; thus, leveraging M&A as a methodology to implement innovation seems counterintuitive.
Unless your business model is something akin to a holding company that acquires autonomously run companies as investment assets, all successful M&A growth strategies, regardless if its purpose is to drive innovation, have common attributes. Acquisitions must align well with core competency business models and strategies and companies must have efficient and effective methods to assimilate the acquisitions into existing value chains and corporate culture. But is M&A a good methodology to implement an innovation growth strategy? The answer is that it can be if:
- You have sufficient capital
- You have established and repeatable innovation processes
- You have an effective methodology for assimilating acquisitions into these innovation processes and culture
Now, let’s look at how companies at different stages in their evolution can assess this. A small company is less complex and thus probably more able to assimilate acquisitions of companies who are at a similar evolutionary stage even if they don’t have fully definable and repeatable innovation processes. And the acquisitions may have achieved their current success more by blind luck than any serious analysis of a market. But as they acquire other companies, they will become more complex and they will have to start formalizing their innovation and acquisition processes to ensure future acquisitions are as successful. Larger companies that have matured their processes can ensure their acquisitions are successful through proven and repeatable processes. By assuring integration into existing processes, they will optimize their ability to leverage that acquisition to integrate, extend, complement or transform existing offerings so that it takes on the characteristics of an internal innovation effort and achieves the same intended outcomes. Ultimately innovation isn’t just about growth, it’s also about sustainability and survival in a world of rapid and accelerating change. All companies whose business models are formed around creating value that consumers want will eventually have to adopt innovation as a standard business practice regardless of growth. Companies that have established mature and repeatable innovation and acquisition processes can very well take advantage of M&A as the fuel to drive innovation based growth. But without that, most companies will be unable to leverage that acquisition properly. The exception to this may be those companies that are smart enough to recognize they don’t have mature processes but the company they look to acquire does and that part of the acquisition strategy is to not only acquire the innovation itself but to acquire the innovation processes that allowed that company to successfully innovate in the first place and adopt those practices as their own. Then they can set themselves up to continue M&A as a methodology to drive innovation.
Jorge Barba (“The Culture Guy”)
It depends. I believe that the most important factor in growth through M&A is culture. For example, there are many lessons we can learn from Google on how they’ve successfully integrated the companies they’ve bought into their well known culture of innovation. Since 2001, Google has purchased and integrated over 110 companies.
Some have been acqui-hires, others, such as YouTube, have been strategic acquisitions. There are many companies who would love to be acquired by Google, simply because they want to be a part of that culture. That is the Google effect. Like attracts like. Of course, this makes sense for Google. Because when the acquirer is already innovative, that culture will automatically push out what doesn’t fit. Bottom line: culture integration is the challenge.
Dennis Jarvis (“The Marketeer”)
Growth by organic innovation? Or, growth by acquisition? Is this really an either-or situation? Not really, in my opinion. Doesn’t it come down to a balanced business strategy that includes a strong commitment to R&D, with a business development eye to identifying external competencies that enable the company to leapfrog its own R&D initiatives with patented technologies? These external technologies can be incorporated into the company’s own development portfolio, or provide it with an already successful product where there is opportunity for substantial growth with a new or improved marketing strategy.
Certainly, there is cause for concern based on the recent statistics reported by A. Borath and G. Tellis in “Choice of and Payoff to Alternate Strategies for Innovation,” which emphasize the pitfalls of attempting to shortcut innovation with acquisition, as well as the 70%-90% failure rate for M&As noted by C. Christensen, et al (“The Big Idea: The New M&A Playbook,” Harvard Business Review, March 2011). However, T.J. Heed and R. McManus of Accenture (“Who Says M&A Doesn’t Create Value?”) note a less severe failure rate of 58%. What it seems to come to is how well an acquisition fits with the overall strategy, and is then integrated into the company, or as Christensen et al might call, “the nuts and bolts” of putting it all together. Keep in mind that strategic fit is also fundamental to organic development. What are the parameters of the technology and product portfolio, and how much of the R&D budget goes to any initiative? Additionally, there is no guarantee that organically driven products will be successful, as attested by industry data indicating that 80% of newly introduced products will fail to meet business goals in three years. This is often the reason why companies place an emphasis on proof of concept and proof of market potential for committing to a new innovation. As the economy is moving beyond the recent recession, companies are showing more of an appetite for M&As. Robert Shea, writing for Forbes in 2012 (“Why Half of M&As Fail and What You Can Do About It.”) notes several key questions that a company needs to address in an acquisition.
- Is there sufficient management capacity to take on the integration process?
- Has the culture of the target acquisition been thoroughly assessed and is it compatible with that of the acquiring company?
- Is the deal in line with corporate strategy?
- Is the deal priced so that the acquiring company can invest adequate resources for the integration, and still have an ROI that passes the hurdle rate?
- Is the acquisition, a better choice than all other alternatives?
I recommend the balanced strategy for growth. Organic innovation may be the preferred path, but a wise assessment of acquisition opportunities may be the wise choice. Just don’t forget the nuts and bolts.
Kane (“K-9 Intern”)
I received the Borah and Tellis “Make, Buy, or Ally”report last night after the rest of the team had reviewed it. My thoughts? It tasted pretty good, but not nearly as good as kibble.
THE FINAL WORD
Much like in the natural world, players in the business world need to be able to adapt to changes and innovate in order to survive and thrive. Under high stress to innovate, it is important for firms to carefully assess and contemplate each potential “shortcut” they may be taking to adapt quickly in this world’s business environment.