There is no magic formula to make acquisitions successful. Each deal must have its own strategic logic. What’s more, the stated strategy may not even be the real one: Companies typically talk up all kinds of strategic benefits from acquisitions that are really entirely about cost cutting.
The strategic rationale for an acquisition that creates value typically conforms to at least one of the following five archetypes: improving the performance of the target company, removing excess capacity from an industry, creating market access for products, acquiring skills or technologies more quickly or at lower cost than they could be built in-house, and picking winners early and helping them develop their businesses. If an acquisition does not fit one or more of these archetypes, it’s unlikely to create value.
Improve the target company’s performance
Improving the performance of the target company is one of the most common value-creating acquisition strategies. It is easier to improve the performance of a company with low margins and low returns on invested capital (ROIC) than that of a high-margin, high-ROIC company.
Consolidate to remove excess capacity from industry
As industries mature, they typically develop excess capacity. The combination of higher production from existing capacity and new capacity from recent entrants often generates more supply than demand. Reducing excess in an industry can also extend to less tangible forms of capacity.
Accelerate market access for the target’s (or buyer’s) products
Often, relatively small companies with innovative products have difficulty reaching the entire potential market for their products.
IBM, for instance, has pursued this strategy in its software business. From 2002 to 2009, it acquired 70 companies for about $14 billion. By pushing their products through a global sales force, IBM estimates it increased their revenues by almost 50 percent in the first two years after each acquisition and an average of more than 10 percent in the next three years.
In some cases, the target can also help accelerate the acquirer’s revenue growth. In Procter & Gamble’s acquisition of Gillette, the combined company benefited because P&G had stronger sales in some emerging markets, Gillette in others. Working together, they introduced their products into new markets much more quickly.
Get skills or technologies faster or at lower cost than they can be built
Cisco Systems has used acquisitions to close gaps in its technologies, allowing it to assemble a broad line of networking products and to grow very quickly from a company with a single product line into the key player in Internet equipment. From 1993 to 2001, Cisco acquired 71 companies, at an average price of approximately $350 million. Cisco’s sales increased from $650 million in 1993 to $22 billion in 2001, with nearly 40 percent of its 2001 revenue coming directly from these acquisitions.
Pick winners early and help them develop their businesses
The final winning strategy involves making acquisitions early in the life cycle of a new industry or product line, long before most others recognize that it will grow significantly. Johnson & Johnson pursued this strategy in its early acquisitions of medical-device businesses. When J&J bought device manufacturer Cordis, in 1996, Cordis had $500 million in revenues. By 2007, its revenues had increased to $3.8 billion, reflecting a 20 percent annual growth rate.
This acquisition strategy requires a disciplined approach by management in three dimensions. First, you must be willing to make investments early, long before your competitors and the market see the industry’s or company’s potential. Second, you need to make multiple bets and to expect that some will fail. Third, you need the skills and patience to nurture the acquired businesses.
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