We hope you’d kick the executive out with instructions to come back with a plan that has less risk and more certain payoff. Yet, a record number of companies last year embraced an approach with attributes identical to what we just described. That strategy is mergers and acquisitions.
As you seen with other companies, there are a lot of deals that don’t work out. We recently looked at 2,500 deals done over two decades. The research confirmed the bleak picture that academics have long warned against: approximately 60% actually destroy shareholder value.
However, we believe there are tests that CEOs can use to greatly improve their odds of not making bad deals. In fact, the tests are the basis of a framework that can help leaders cut through the hype that accompanies “synergies” to better understand which potential acquisitions are more likely to be worth the risk.
It starts not with targets, but with your own core operation; before you can truly understand the value of synergy, you must re-challenge whether you’ve captured all the opportunities for growth that reside in your existing assets.
Rather than choosing between winning share gain in your core business—no doubt you’ve run that well dry—and riskier moves into new markets or transactions, consider opportunities on the periphery, or edge, of your operation. That’s where you may find the capabilities, customers and assets you can use to access sustainable, incremental growth without making huge bets.
Many successful leaders and companies do a few essential things. Here are 3 key steps they take.
These could be products or services that address the broader missions of your customers before and after they buy your products, or they could be “upsell” options that give customers more choice while increasing your revenue. An acquisition target is more attractive if it is really completing a solution that you have arrived at independently, knowing your customers the way you do.
Dozens of companies in nearly every sector have improved their returns by scrutinizing the peripheries of their assets and operations to develop organic growth strategies. Whole Foods, for example, extended its role in supporting its customers’ underlying needs and desires (think “dinner,” not groceries) and now sells a vast array of prepared food—from fresh-baked pizza to store-made sushi—to eat in store or take home. These offerings represent 10% to 15% of company revenue, but, by some measures, nearly half the company’s profit.
This same edge mindset can also help identify acquisitions that will pay off. The best deals create new revenue by using the assets and customer permissions of one company to exploit opportunities at the periphery of the other’s existing business.
To see how this works, let’s compare two deals: eBay’s 2004 acquisition of Skype and Best Buy’s 2002 purchase of Geek Squad. On the surface, both offer plausible synergies. Buyers and sellers on eBay could use Skype for voice and video chats while negotiating deals. And Geek Squad could provide training, installation and repairs for the gadgets sold by Best Buy.
Yet within three years of the purchase, eBay wrote off $1.4 billion of the $2.6 billion in cash it paid for Skype. eBay’s critical error was misunderstanding the objectives of its customers. Auction sellers didn’t need or even want to chat with buyers. Meanwhile, Skype users overwhelmingly used the service to chat with family and friends, not for shopping.
By contrast, Best Buy’s purchase of Geek Squad complemented Best Buy’s core products by completing the missions of Best Buy’s existing customers. Geek Squad enables Best Buy customers to achieve exactly the goals that bring them to the store: watching football in high definition, helping kids use the Internet for homework, or getting a phone loaded with the latest apps. For many people, a little help from Geek Squad reduces stress, saves time and is well worth the additional expense. As a result, Geek Squad has grown to be a $3 billion business for Best Buy, a thousand-fold increase from when it was purchased. And it’s a key differentiator in the hyper-competitive electronics business.
So, the next time one of your executives proposes an acquisition, be ready with two questions: Have we already exploited the opportunities at the periphery of our existing operations? And then, does this acquisition extend and leverage the mindset that will exploit those edges?
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