14 December 2012

The Curse of the Defensive Deal

I've written extensively about how acquisitions, despite Management's gravitation towards them, generally fail to produce the expected results.  Defensive transactions in which a Company has fallen behind or fears disruptive players or technology is one of the most popular deal rationales.  In the short-term, buying the capability seems to be an easy way to catch up; but they are categorically the worst poorest performers of all deals.  They destroy shareholder value, fail to rejuvenate the acquirer, and slows the momentum of the targeted company.

Technology disruption is a classic area of defensive deals.  During dot com mania, traditional companies were scrambling to figure out the internet revolution.  Time Warner merged with AOL.  Barry Diller bought Ask.com, Match.com, and other properties. Valuations would never prove in not only because of price but also because of the struggle between cannibalizing existing business and investing in competitive areas.  The “do both” strategy may leave a company well hedged but far from market leadership.  Legacy companies have even tried to build barriers around competitive threats by forming consortia such as Hulu and Orbitz, but ultimately spun them out when they realized the upstarts were better off without their larger agendas involved.

Cost deals are another example.  These generally occur in declining markets with hopes of building stronger cash cow market positions.  Alcatel tried it with Lucent as Daimler did with Chrysler.  These were both on Businessweek's worst deals of all time list.  As HP doubled down with Compaq, IBM divested its PC business on a road to a successful transformation.  You can't stop a downward moving train - declining markets tend to fall quicker than any cost synergy model can offset.  The "more of the same" strategy fails to address the underlying problem of changing market dynamics. 

Even today’s best tech companies can fall prey to the prevent defense.  In hopes of buying some time to figure out mobile, Facebook paid a whopping $1B for pre-revenue Instagram.   Amazon’s acquisition of Kiva Systems screams defense as they try to take their robots away from its competitors.  Does Amazon not think new technology will not spring up in the marketplace?  It is ironic because the spread of ground-breaking concepts is how Amazon itself rose to ubiquity.  As the pace of change continues to accelerate, even the new leaders cannot rest on their relative positions.  Apple's erratic stock price clearly shows the markets are uncertain of whether it will be able stay ahead of the pack. 

To me, the biggest drawback is that consumers lose out when these deals stifle the offerings of the acquired company.  Google killed Dodgeball which years later came back as the white-hot Foursquare. Sprint eliminated Nextel's push to talk as signs point to competition vying for those consumers.  Do you think if Visa bought Square early on we would see the spread of mobile commerce as quickly as we do today?   Whether entities can't maximize the benefits or struggle to integrate into existing products,  stand-alone offerings oftentimes perform better when they are not clouded by alternative agendas or red tape.

Companies certainly can use M&A to reinvent themselves as part of larger turnaround strategy.  They should be careful to gain a solid understanding of the target's capability and market, build an integration plan to scale it, and protect the DNA of the acquired company.  Whether it be the result of the Innovator's Dilemma or a poor strategy for reacting to market changes, many continue to utilize a flawed defense-based acquisition strategy that leaves them worse off.   While buying might be a quick fix, a company that is facing new competition or a declining market must ultimately face those bigger challenges head on.

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