Ann: xTV to Acquire Hendrik - Health Care Content Provider, page-55

----just some notes on mergers acquisitions, and buying of customer / resource base-----

--Ports----

When a CEO wants to boost corporate performance or jump-start long-term growth, the thought of acquiring another company can be extraordinarily seductive. Indeed, companies spend more than $2 trillion on acquisitions every year. Yet study after study puts the failure rate of mergers and acquisitions somewhere between 70% and 90%. A lot of researchers have tried to explain those abysmal statistics, usually by analyzing the attributes of deals that worked and those that didn’t. What’s lacking, we believe, is a robust theory that identifies the causes of those successes and failures.
So many acquisitions fall short of expectations because executives incorrectly match candidates to the strategic purpose of the deal, failing to distinguish between deals that might improve current operations and those that could dramatically transform the company’s growth prospects. As a result, companies too often pay the wrong price and integrate the acquisition in the wrong way.

To state that theory less formally, there are two reasons to acquire a company, which executives often confuse. The first, most common one is to boost your company’s current performance—to help you hold on to a premium position, on the one hand, or to cut costs, on the other. An acquisition that delivers those benefits almost never changes the company’s trajectory, in large part because investors anticipate and therefore discount the performance improvements. For this kind of deal, CEOs are often unrealistic about how much of a boost to expect, pay too much for the acquisition, and don’t understand how to integrate it.


The success or failure of an acquisition lies in the nuts and bolts of integration. To foresee how integration will play out, we must be able to describe exactly what we are buying.
The best way to do that is to think of the target in terms of its business model. As we define it, a business model consists of four interdependent elements that create and deliver value.

1/customer value proposition: an offering that helps customers do an important job more effectively, conveniently, or affordably than the alternatives.
2/ the profit formula, made up of a revenue model and a cost structure that specify how the company generates profit and the cash required to sustain operations.
3/resources—such as employees, customers, technology, products, facilities,
4/ processes such as manufacturing, R&D, budgeting, and sales.

Under the right circumstances, one of those elements—resources—can be extracted from an acquired company and plugged into the parent’s business model. That’s because resources exist apart from the company (the firm could disappear tomorrow, but its resources would still exist). Such deals are “leveraged business model” (LBM) acquisitions.

A company can’t, however, routinely plug other elements of an acquisition’s business model into its own, or vice versa. Profit formulas and processes don’t exist apart from the organization, and they rarely survive its dissolution.

Boosting Current Performance
A CEOs first task is to deliver the short-term results investors expect through the effective operation of the business. Investors rarely reward managers for those results, but they punish stock values ruthlessly if management falls short. So companies turn to LBM acquisitions to improve the output of their profit formulas.

A successful LBM acquisition enables the parent either to command higher prices or to reduce costs. That sounds simple enough, but the conditions under which an acquisition’s resources can help a company accomplish either goal are remarkably specific.

Acquiring resources to command premium prices.
The surest way to command a price premium is to improve a product or service that’s still developing—in other words, one whose customers are willing to pay for better functionality. Companies routinely do this by purchasing improved components that are compatible with their own products. If such components are not available, then acquiring the needed technology and talent—usually in the form of intellectual property and the scientists and engineers who are creating it—can be a faster route to product improvement than internal development.

There is one category of deal making not addressed here:acquisitions that build or optimize the parent company’s portfolio of businesses. Leveraged buyouts by private equity firms are the most prominent example of this kind of deal. Although many LBO firms try to add value to their portfolio companies through operational improvements, much of the actual value to the acquirer is created by the use of leverage and the accompanying tax shield.

As a general rule, the impact of an LBM acquisition on the acquirer’s share price will be apparent within one year, because the market understands the full potential of both businesses before the acquisition and has had enough time to assess the outcome of the integration and any synergies that may arise. Investors are often much less optimistic than CEOs about LBM deals, and history generally proves them right: The best-case result is a jump in share price to a new plateau.

Some managers hold out hope that buying another company for its resources can unlock unexpected growth, but they are likely to be disappointed.

A word of warning is in order for companies seeking to boost current performance through LBM deals aimed at acquiring new customers: All the successful examples we’ve identified involve selling “acquired” customers the products they were already buying. Acquisitions made for the purpose of cross-selling products succeed only occasionally.

Why? Let’s say Bruce is a typical shopper, who buys both consumer electronics and hardware. Wouldn’t Outlet A, which carries both product categories, have a better chance of winning his business than Outlet B, which sells only consumer electronics, or Outlet C, which sells only hardware? In a word, no. That’s because Bruce needs to buy electronics just before birthdays and holidays, whereas he needs to buy hardware on Saturday mornings, when he intends to repair something at home. Because these two jobs-to-be-done arise at different times, the fact that Outlet A can sell him both kinds of products does not give it an advantage over the specialists. Typical shopper Bruce does, however, buy diesel and junk food at the same time—when he’s on a road trip. Hence, we have seen a convergence of convenience stores and fuel stations. In other words, an acquisition whose rationale is to sell a variety of products to new customers will succeed only if customers need to buy those products at the same time and in the same place.
More than once, ambitious executives, such as Sanford Weill of Citigroup fame, have assembled “financial supermarkets,” thinking that customers’ needs for credit cards, checking accounts, wealth management services, insurance, and stock brokerage could be furnished most efficiently and effectively by the same company. Those efforts have failed, over and over again. Each function fulfills a different job that arises at a different point in a customer’s life, so a single source for all of them holds no advantage. Cross-selling in circumstances like these will complicate and confuse, and will rarely reduce sales costs.


Avoiding Integration Mistakes

Approach to integration should be determined almost entirely by the type of acquisition you’ve made. If you buy another company for the purpose of improving your current business model’s effectiveness, you should generally dissolve the acquired model as its resources are folded into your operations.

Failing to understand where the value resides in what’s been bought, and therefore integrating incorrectly, has caused some of the biggest disasters in acquisitions history.

Companies rightly turn to acquisitions to meet goals they can’t achieve internally. But there is no magic in buying another company. Companies can make acquisitions that allow them to command higher prices, but only in the same way they could have raised prices all along—by improving products that are not yet good enough for the majority of their customers. Similarly, they can make acquisitions to cut costs by using excess capacity in their resources and processes to serve new customers—but again, only in the same way they could have by finding new customers on their own. And companies can acquire new business models to serve as platforms for transformative growth—just as they could if they developed new business models in-house. At the end of the day, the decision to acquire is a question of whether it is faster and more economical to buy something that you could, given enough time and resources, make yourself.

Every day, the wrong companies are purchased for the wrong purpose, the wrong measures of value are applied in pricing the deals, and the wrong elements are integrated into the wrong business models. Sounds like a mess—and it has been a mess.