(Excerpts from Chapter 3 of “The Art of M&A Strategy”, Smith & Lajoux, McGraw-Hill, New York, 2012.)
In Part I, we looked at why M&A based on revenue synergies creates superior value to cost synergies. We also noted the difficulty in achieving revenue synergies and the risks associated with aggressive M&A growth strategies.
In Part II, we look at four generic revenue-based strategies and the role of M&A in each, including successful examples:
- Growth within a current market with current product offerings
- Growth within a current market with new products
- Growth into a new market with current products
- Growth into a new market with new products
In each case, there could be a make versus buy decision. That is, if there is growth potential available, is it best achieved organically or by acquisition? While most acquisitions cover more than one of these four vectors, this categorization provides a convenient framework for examining the unique issues associated with each.
Current markets and current products
If a company has growth potential within current markets and product categories, it is either because there is potential to expand the market (additional customers or increased consumption) with the products “as is”, there is potential to expand the market with product improvements, or the potential new customers or consumption is currently being served by competitors.
In the first case, M&A likely has no role. For example, many people who could afford life insurance choose not to buy it, even though there are numerous product variations in the market. This is primarily a marketing and sales challenge to interest new customers in life insurance or to improve the coverage of existing customers.
In the second case, there is capacity for market expansion with product improvements. For example, you might use your favorite search engine more often if it were more effective for your purposes. In this case, there could be a make versus buy decision for the needed product improvements. For example, Google is constantly acquiring innovations to improve its core product, such as Deja.com in 2001 for search capabilities, Applied Semantics in 2003 for text processing for online advertising, and Picas in 2004 for photo recognition.[1] (Google uses acquisitions in all four generic growth strategies—discussed later.)
In the third case, the make versus buy decision is between competing for the competitor’s customers versus acquiring the competitor. In effect, this is in-market consolidation in which customer acquisition may be a primary motivator.
However, absent significant cost synergies or issues with market structure, an in-market acquisition for customers is unlikely to pay off. There are two problems with such an acquisition. First, the target’s acquisition price will already factor in the net present value of the contribution of all of these customers (less fixed overhead, of course). Second, in this scenario the buyer may not retain all the customers—these customers all bought from a competitor before, and nothing prevents them from doing so again. If there are other choices in the market, it is highly likely that at least some customers will go to them. (If there were no other choices in the market, there would be an antitrust problem.)
So the revenue synergies are negative, and the deal economics can’t work on customer acquisition alone. The only way for such an acquisition to pay off, therefore, is if other synergies such as R&D, manufacturing, marketing, or corporate overhead are significant.
This theory was demonstrated in the in-market mergers during US bank industry consolidation. As deal pricing ran up to and above the value of cost synergies, banks began identifying a range of revenue synergies in their deal proposals, including product growth and pricing synergies. However, when products unique to one bank were offered to the customers of the other, there was little uptake. For common products, when the teams sat down to decide pricing, product by product they chose the lowest price between the two banks for fear of losing customers to other banks in the market. As a result, the revenue synergies were negative. Throughout US bank industry consolidation, the in-market deals performed worse than cross-market deals in which cost synergy was lower, but revenue synergy was positive. (More to come on this scenario.)
Moreover, M&A has a meaningful role in growth within current product markets only in the context of a make versus buy decision to advance product improvements or as part of a consolidation play. In the latter case, there must be compelling cost synergies to outweigh the inevitable negative revenue synergies.
New products in current markets
This type of business combination is sometimes called related diversification. Related diversification transactions are in general more likely to create value than unrelated diversification or consolidation.[2] If such a merger can introduce a product to new markets, then substantial revenue growth can occur with little impact on total costs.
This type of transaction is well illustrated in the acquisition of Lotus Development Corporation by IBM in 1995, which was IBM’s first large step from computer hardware into computer software. IBM acquired Lotus for $3.5 billion or $64 per share, double the trading value before the bid. In addition to the strategic imperative for IBM to diversify, the deal logic was to grow Lotus revenues by offering its products through the vast markets served by IBM.
Analysts were skeptical of the deal for three reasons—it was a diversification, the premium was high, and, at the time of the transaction, IBM had a history of crushing the entrepreneurial culture of the growth companies it acquired.
However, IBM carefully managed the integration issues and focused on achieving the product–market synergies. Protocols were established to keep the companies and cultures separate except for one thing—the IBM sales force was to sell the Lotus products. The number of Lotus “seats” (or desktops) was the measure of success, and “Get Lotus seats” became a rallying cry postdeal. The deal more than paid for itself and, in spite of the high premium paid, it created shareholder value and launched IBM successfully into software.
Such deals can be highly successful because they create new value, almost from nothing. Unlike consolidation synergies, these are not one-time revenue synergies but continue into the future. Such synergies are also less transparent and less transferable to other potential buyers, and hence less likely to get negotiated into the price of the deal.
Another domain of similar product–market combinations is the bancassurance market in Europe. Deals such as Credit Suisse–Winterthur, Lloyds TSB–Abbey Life, Banco Santander–Banco Hispano (BSBH), and Den Danske–Danika created value by offering the comprehensive channels of the banks for the marketing of insurance products. For example, 65% of BSBH’s mortgage customers were acquiring life insurance from them when offered. While the famous acquisition of Travelers Insurance by Citibank in 1998 is often used as proof that such deals don’t work, life insurance premiums were multiplied through Citibank channels, in spite of what many say was only a partially executed deal logic. The success rate of these so-called cross-pillar deals was over 70% versus the dismal 40% success rate of in-market bank mergers.[3] Over the past decade, banks remained one of the fastest-growing channels for insurance products in Europe, and in the years following the passage of the Gramm-Leach-Bliley Act in 1999, allowing bank-insurance integration in the United States, US banks bought more insurance brokers than banks.[4]
In markets in which customers want end-to-end service, the acquisition of an additional piece of the offer can add value even beyond the growth of the new product by making the entire customer offering more complete and compelling.
For example, United Parcel Service has acquired various customs brokerage services. One such acquisition was Livingston Customs Brokerage in Canada in 2000.[5] Canada and the United States are each other’s largest trading partners so the North–South lanes between Canada and the United States are strategically important to any freight transportation company. The services of Livingston were, of course, marketed across UPS’s vast US customer base achieving growth for the Livingston products through UPS channels, similar to the foregoing examples.
However, the benefit to UPS far exceeded the direct impact of brokerage sales growth. First, UPS could then offer to its US shippers and Canadian consignees a simple, complete, and speedier service than if they used the Livingston brokerage directly. This was a competitive advantage over companies that did not offer a complete service of transportation and customs clearance. In addition, the economics of the Canadian lanes downstream from Livingston then benefited from greater route density—a key driver of courier economics.
Google acquires to offer new products to existing markets as well. The acquisition of Neotonic in 2003 led to the launch of a an e-mail platform with superior spam filters (gmail), and Google’s acquisition of YouTube in 2006 undoubtedly fueled growth of both the search engine and video sharing.[6]
However, while product–market combinations are strategically compelling, there are also many failures. Most of the failures are the result of trying to sell products through unsuitable channels. For example, many technology firms combined with strategy consulting firms in the 1990s and early 2000s believing that the strategy firms would offer channels to the senior executives that would help sell all of their products. In fact, the sales context and skills for strategy versus IT sales are very different, and the acquired channels did not work well. For example, McKinsey & Company acquired Information Consulting Group (ICG) in 1989, a 250-person information technology firm based in Washington, D.C. By 1993 half of the partners and more than half of the staff left.[7] Electronic Data Systems’ acquisition of A.T. Kearney was eventually undone—long before EDS itself got acquired and renamed by HP. The US Web–Mitchell Madison Group combination later went bankrupt.[8] Accenture organically grew a large, top-tier strategy practice that disbanded within a few years (although Accenture has more recently reentered general management consulting).
The lesson of these failures is the lesson of all revenue-based M&A strategies: revenue synergies are earned when customers like the idea. So a product–market combination will have compelling deal logic if and only if it also presents a compelling value proposition to customers. Few clients would clamor for IT and strategy help in one basket, but many do want other kinds of combinations. For example computer hardware with software that works is an attractive proposition.. So is being able to insure your home where you get your mortgage (and have to provide proof of insurance), or being able to ship items using a complete, door-to-door, cross-border freight transportation service. In revenue synergies, the customer is always right.
Taking existing products into new markets
This is another type of M&A strategy with compelling logic for some of the same reasons. Successfully entering a new market segment or geography creates new value, whether done organically or by acquisition. It also carries substantial risk in either case.
There are many examples of geographic expansion through acquisition. For example, while Wal-Mart developed across America organically, it chose to acquire in order to enter some international markets. While it initially opened new stores in Mexico and Hong Kong, it acquired 122 Woolco stores to enter Canada and 21 Wertkauf units in Germany, and it entered China and Korea through joint ventures.[9]
The advantages of using M&A in international expansion are speed and market knowledge. Wal-Mart acquired complete chains in Canada and Germany that it then rebranded as Wal-Mart. It brought instant value to these acquisitions by reducing the cost of goods, leveraging its buying power and vast supply network. In some cases, its selection, layout, operations, and brand added value through growth in same-store sales.
Opening stores in these markets one at a time clearly would have taken longer. An organic approach in this case also opens up additional costs and risks. First, there were loyalties to the incumbent discount operations that would have taken time and money to overcome. Second, as a new entrant, Wal-Mart would have been more likely to miss the mark on selection and marketing. Third, the acquisition approach provided a local executive team and resources across each market, saving recruiting and training costs.
However, the acquisition approach also multiplies the consequences of getting it wrong. For example, in 1982 Canadian Tire Corporation, Canada’s largest and most successful hard goods retailer, entered the US market through the acquisition of White Stores, a chain of more than four hundred automotive retail stores. Canadian Tire attempted to convert the stores into a format similar to that used by its Canadian stores. Unfortunately, this failed, and Canadian Tire took losses of over $300 million and faced a lawsuit of $400 million launched by dealers who had come south to start stores. In 1985 Canadian Tire exited.[10]
The successes outnumber the failures. Cross-border deals in Europe substantially outperform domestic deals. Only US overseas transactions have a success rate below 50%, and this is due mainly to poor postdeal management failing to deliver on attractive potential.[11]
Among the many companies that have grown internationally by acquisition are Manulife in financial services (e.g., John Hancock in the United States, Daihyaku Mutual in Japan, and Pramercia Life in the Philippines), UPS in transportation (e.g., Alimondo in Italy and Germany and a number of freight airline services), and General Foods, now part of Kraft, in consumer goods (e.g., La India Company in Venezuela, Hostess in Canada, Kibon ice cream company in Brazil, and Krema Hollywood Chewing Gum in France), and Google (e.g., Chinese search engine Baidu in 2004), to name a few.
It should be noted that among the successful transactions during the US bank consolidation were the cross-region deals.[12] It may seem counterintuitive that the less the overlap the more likely is success. However, the cost synergies were often negotiated into the acquisition price of the US banks, and the revenue synergies in in-market deals were negative, as noted earlier in this chapter. The cross-region deals averted the negative revenue synergies and in the best cases brought a better national brand, filled in product gaps, and introduced a superior operating approach to the acquired bank.
However, the magnitude of some of the failures is sobering. For example, the 1998 merger of Chrysler with Daimler-Benz, a $37 billion stock-swap deal, was the largest trans-Atlantic merger to that day. The new company, with market capitalization approaching $100 billion, saw synergy potential in retail sales, purchasing, distribution, product design, and research and development. Three years later DaimlerChrysler’s market capitalization was $44 billion and its stock was dropped from the S&P 500, largely due to clashes of culture and mismanagement.[13]
Geographic expansion (even domestically) almost always crosses cultural borders, so in addition to the usual challenges of the integration of corporate cultures, these deals must manage across national or regional cultures and must do this across vast distances.
To enter new markets with new products
On the face of it, this sounds like unrelated diversification. However, we refer here to situations in which there are product synergies and/or market synergies.
The growth strategy of Zwilling J.A. Henckels of Germany illustrates how M&A can facilitate growth across products and markets simultaneously. Zwilling is best known as the manufacturer of fine cooking knives under the brands Henkel and Zwilling. Over the past 10 years they have expanded into new segments of cooking knives as well as into cookware and beauty, each time through acquisitions in a new market.
The 2004 acquisition of US Tweezerman in the beauty segment significantly enhanced Zwilling’s footprint in US department stores while providing a new product line to market around the world. In 2008, Zwilling acquired Staub of France, a manufacturer of fine cast iron cookware. Staub is now marketed throughout Zwilling’s international markets, and Zwilling cooking knives have enjoyed increased sales in France. Similarly, that same year the acquisition of Demeyere Cookware of Belgium, manufacturer of fine stainless steel cookware, added a product to market internationally while gaining better access in the Benelux countries.[14]
Moreover, with each of these acquisitions Zwilling was able to simultaneously take new products to its existing channels and take its current product lines to new markets, thus gaining the benefits of both the second and third types of growth strategies.
Like the foregoing strategies to use current markets for new products and to bring current products to new markets, this type of acquisition creates new revenue with little added cost, and hence can add significant value. (Zwilling is a private company and the actual value created in these deals is not available.)
Google’s 2011 acquisition of Motorola Mobility Holdings for $12.5 billion was, among other things, a new product—new market acquisition. The Motorola deal may have been in some measure a defensive move in light of mounting patent infringement cases against Google’s Android operating system used in 150 million mobile devices. However, the move simultaneously advanced Google in the telephony market with a leading smart-phone hardware product.[15]
Another company that executed multiple acquisitions of this type is Cisco Systems. Cisco grew to be a leader in digital network technologies through over 125 acquisitions from 1993 to 2010. Each acquisition added products to Cisco’s offering, bringing Cisco closer to a “one stop shop” for network technologies. Simultaneously, these acquisitions created a spider web of market channels, ideal for addressing its fragmented and entrepreneurial customer markets. Indeed, Cisco executed minimal integration, preferring to keep the market relationships of each acquired company. Yet it created substantial value for shareholders rising from its initial public offering (IPO) value in 1990 of $224 million to $84 billion in 2011. (At the height of the dot.com bubble, Cisco was the largest company in the world by market capitalization.)[16]
This type of growth is very difficult to achieve organically. Entering new products and markets simultaneously requires new resources and skills. Even if such investments can be made well, a new entrant must then win customers from existing competitors. So, at best, an organic approach to this type of growth strategy would take a much longer time to execute, and the probability of failure would be high.
However, it is also risky to execute such growth strategies through acquisition because diversification acquisitions have, in general, low success rates, and this type of revenue synergy can be a stretch—the deal logic is sometimes stretching reality, and, even when the deal logic is sound, the implementation can be a stretch of skills.
Keys to the success of the foregoing Zwilling and Cisco examples were excellent fit of new product lines, new channels highly suitable for a full range of products, and an implementation approach that preserved the strengths of the acquired companies.
In Part III, we extract the lessons from the successes and the failures, and outline the common risks and key success factors for revenue-based M&A strategies.
Notes
[1]. “Top 10 History of Google Acquisitions and Where They Are Today,” Lilo Magazine–Benny, March 22, 2011, accessed October 9, 2011, from http://lilomag.com/2011/03/22/top-10-history-of-google-acquisitions-and-where-they-are-today/
[2]. Kenneth Smith and S. E. Hershman, “How M&A Fits Into a Real Growth Strategy,” Mergers & Acquisitions, 32, no. 2 (1997).
[3]. SECOR Consulting, “Shareholder Value Created and Destroyed in Financial Services Mergers—Implications for Public Policy,”, report submitted to the Federal Consultation on Large Mergers in Financial Services, December 22, 2003, accessed October 9, 2011 from http://www.fin.gc.ca/consultresp/mergersRespns_9-eng.asp.
[4].“Banks in Insurance: A Five-Year Retrospective since the Passage of GLB,” Bank Director Magazine 2nd qtr. (2004).
[5]. “UPS Logistics Group to Acquire Livingston,” Business Wire, August 30. 2000, accessed October 9, 2011 from
http://findarticles.com/p/articles/mi_m0EIN/is_2000_August_30/ai_64997242/.
[6]. “Top 10 History of Google Acquisitions.” and Where They Are Today.”, ibid
[7]. International Directory of Company Histories, vol. 9. (St. James Press, Greenhaven, CT, 1994).
[8]. US Web acquired Mitchell Madison Group in 1999 and was subsequently acquired by Whitman Hartt in 2000 and renamed MarchFirst; MarchFirst filed for bancruptcy protection in 2001, see E-Commerce Times April 13, 2001.
[9]. See the Wal-Mart website at walmartstores.com at About Us – http://walmartstores.com/AboutUs/7603.aspx.
[10]. “Canadian Tire’s Mistaken Leap in the US Market”, Canadian Broadcasting Corporation, broadcast December 8, 1985, accessed October 9, 2011 from http://archives.cbc.ca/economy_business/consumer_goods/clips/16903/.
[11]. Ken Smith, “Losing (Ownership) Control,” speech to the Canadian Consulate in New York, February 24, 2010.
[12]. See Kenneth W. Smith and Eliza O’Neil, “Bank-to-Bank Deals Seldom Add Value”, ABA Banking Journal, December 2003, pp 7-10.
[13]. Sydney Finkelstein, “The Daimler-Chrysler Merger,” a case history developed at Dartmouth College http://mba.tuck.dartmouth.edu/pdf/2002-1-0071.pdf.
[14]. See the Zwilling website at http://www.zwilling.com/en-DK/Company-profile–company_profile/Chapter–kapitel/The-international-brand-policy-of-ZWILLING-J.A.-HENCKELS–1096.html, accessed October 9, 2011
[15]. Omar El Akkad,”Google’s Motorola Deal ‘by and large’ a Defensive Play in Patent Wars”, Globe and Mail, August 15, 2011, accessed October 9, 2011, from http://www.theglobeandmail.com/globe-investor/googles-motorola-deal-by-and-large-a-defensive-play-in-patent-wars/article2129737/
[16]. George Garza, “The History of Cisco,” Bright Hub, January 9, 2011, accessed October 9, 2011, from http://www.brighthub.com/computing/enterprise-security/articles/65663.aspx
bizpolicy 