Microsoft has agreed to pay $26B for LinkedIn, but what are the odds that Microsoft shareowners and customers will benefit from the investment? The odds are heavily stacked against Microsoft, as the recent article by Roger Martin[i] in HBR, “M&A: The One Thing to Get Right” reminds us. The reality is that 70% – 90% of M&A investments end in failure[ii]. In one of many examples of wasted capital and strategic energy, HP paid $11.1B for Autonomy only to quickly write the acquisition down to $2.3B. As a stockholder and employee, it was sad to watch.
Acquisitions lagged all forms of organic investment by a factor of 2X to 100X in recent McKinsey study. McKinsey [iii] found that acquisitions lagged behind several organic growth approaches in value creation intensity (shareholder value per dollar of top-line revenue growth) – and not just a little behind.
Its all about strategy and integration. In ICG’s experience a majority of failing acquisitions are pursued as a quick fix to growth rather than as an integral piece of an innovative, holistic, deeply imbedded growth strategy. Call it “spreadsheet” growth strategy that does not really take into account the diverse technological, operational, and go-to-market knowledge that should inform strategy and execution.
A better way
A better approach is to focus organizational energy and investments on adjacent growth to maximize risk-adjusted ROI, and allow the resulting strategic foundation to drive M&A decisions. Companies that invest appropriately and consistently in core, adjacent and transformational growth establish a sustainable advantage as measured by P/E premium[iv].
Why Adjacent Growth?
Of course the first growth option is to expand a company’s core business as much as possible by investing in new products, sales, and marketing that are close extensions of the current business. For new companies or companies in high growth markets this strategy may get the job done for many years. But what happens after the market growth stops or the competitive environment is changing dramatically for the worse? The often overlooked place to invest is in opportunities that open up adjacent markets or products. Examples include taking printing from the enterprise to the home and commercial markets, or licensing existing technology to serve currently unreachable markets. These are not fanciful new businesses — but rather careful and thoughtful moves that leverage a company’s technology base into new markets or bring new products to existing customers. These adjacent investments grow revenue profitably because they leverage 50% to 75% of a company’s existing assets and capabilities.
There is a higher level of uncertainty in pursuing adjacent markets or products than in expanding a company’s core. In addition, organizational and investment competition between a company’s core business and adjacent growth businesses can stall efforts. Managing these issues adroitly is not magic but it requires skills and approaches that are often in short supply in even high quality companies. Stay tuned for future ICG blogs about managing uncertainty, maximizing organizational learning, and performing diligence while developing adjacent businesses.
There is a time for M&A. Warren Buffet, for example, has made a series of successful acquisitions. But the odds are stacked against the acquiring company. Maximize your company’s growth by investing in adjacent growth first — and allow that strategic foundation to drive your M&A decisions and execution.
[i] “M&A: The One Thing You Need to Get Right”, Roger Martin, Harvard Business Review, June 2016.
[ii] “The Big Idea: The New M&A Playbook”, Christensen, Clayton M., et al., Harvard Business Review, March 2011.
[iii] ,“Why the biggest and best struggle to grow”, Nicholas F. Lawler, Robert S. McNish, and Jean-Hugues J. Monier, McKinsey, January 2004.
[iv] “Managing Your Innovation Portfolio”, Nagji and Tuff, Harvard Business Review, May 2012.