Growing for Broke

Look, you’ve got to grow. It’s what our economy is all about. Hey, it’s what our country is all about! Certainly, it’s what drives me. My father, Constantine Anaptyxi, came to America from Greece because he saw big opportunities here. He worked hard, took a few risks, and realized his dreams. I came to this company as CEO five years ago—giving up a senior VP position at a Fortune 500 manufacturer—because I saw big potential for Paragon Tool, then a small maker of machine tools. I didn’t make the move so that I could oversee the company’s downsizing! I didn’t intend to create value—for our customers, for our employees, for our shareholders—by thinking small!! I didn’t intend to shrink to greatness, for God’s sake!!!

Okay, so I’m getting a little worked up over this. Maybe I’m just trying to overcome my own second thoughts about our company’s growth plans. I know it isn’t just about growth; it’s about profitable growth, as my CFO, William Littlefield, is always happy to remind me. “Nicky,” he’ll say, “people always talk about getting to the top when they should be focusing on the bottom…line, that is.” Quite a comedian, that Littlefield. But lame as the quip is, it tells you a lot about Littlefield and what, in my opinion, is his limited view of business. Sometimes you’ve got to sacrifice profits up front to make real profits down the line.

To me, acquiring MonitoRobotics holds just that kind of promise. The company uses sensor technology and communications software to monitor and report real-time information on the functioning of robotics equipment. By adapting this technology for use on our machine tools, we could offer customers a rapid-response troubleshooting service—what consultants these days like to call a “solutions” business. Over time, I’d hope we could apply the technology and software to other kinds of machine tools and even to other kinds of manufacturing equipment. That would make us less dependent on our slow-growing and cyclical machine-tool manufacturing operation and hopefully give us a strong position in a technology market with terrific growth potential. It would also nearly double our current annual revenue of around $400 million—and force Wall Street to pay some attention to us.

What does Littlefield say to this? Oh, he gives a thumbs-down to the acquisition, of course—too risky. But get this: He also thinks we should sell off our existing services division—a “drag on profits,” he says. With the help of some outside consultants, the senior management team has spent the last few months analyzing both our services business and the pros and cons of a MonitoRobotics acquisition. Tomorrow, I need to tell Littlefield whether we should go ahead and put together a presentation on the proposed acquisition for next week’s board meeting. If we do move forward on this, I have a hunch a certain CFO might start returning those head-hunter calls. And I’d hate to lose him. Whatever our differences, there’s no denying that he’s capable and smart—in fact, a lot smarter than I am in some areas. On this issue, though, I just don’t think he gets it.

Mom and Apple Pie

In 1946, when my father was 21, he left the Greek island of Tinos and came to New York City with his new bride. He worked at a cousin’s dry-cleaning store in Astoria, Queens, then started his own on the other side of town. When I was seven, he took his savings and bought a commercial laundry in Brooklyn. Over the next several years, he scooped up one laundry after another, usually borrowing from the bank, sometimes taking another mortgage on the three-family home in Bensonhurst where we had moved. By the time I was a teenager, he was sitting on a million-dollar business that did the linens for all kinds of hotels and hospitals around greater New York. “Nikolas, growth is as American as Mom and apple pie,” my father would say to me—he loved using all-American expressions like that. “You gotta get bigger to get better.”

My mom was somewhat less expansive in her outlook. She kept my father’s accounts, having studied bookkeeping in night school as soon as her English was good enough. And she had her own saying, one that deftly, if inadvertently, bolted together two other platitudes of American slang. “Keep your shirt on,” she would say to my father when, arms waving, he would enthusiastically describe some new expansion plan for his business. “Or else you might lose it.” My father was the genius behind his company’s growth, but I have no doubt that my mother was the one responsible for its profits.

When I was 15, we moved to a nice suburb in Jersey. I never quite fit in: too small for sports, a little too ethnic for the social set, only a middling student. I worked hard, though, and went to Rutgers, where I majored in economics and then stayed on to get an MBA. Something clicked in business school. I seemed to have a knack for solving the real-world problems of the case studies. And I flourished in an environment where the emphasis was on figuring out what you can do instead of what you can’t, on envisioning how things could go right instead of trying to anticipate how they could go wrong. (Thank God I didn’t follow my uncle’s advice and become a corporate lawyer!)

When I graduated, I got a job at WRT, the Cleveland-based industrial conglomerate where I’d interned the summer before. Over the next 15 years or so, I moved up through the ranks, mainly because of my ability to spot new market opportunities. And by the time I was 45, I was heading up the machine-tool division, a $2.3 billion business. Both revenues and profits surged in the three years I was there, it’s true. But I still found my job frustrating. Every proposed acquisition or new initiative of any substance had to be approved by people at headquarters who were far removed from our business. And whenever corporate profits flagged, the response was mindless across-the-board cost cutting that took little account of individual divisions’ performance.

So when I was offered the opportunity to head up a small but profitable machine-tool maker in southern Ohio, I jumped at the chance.

Sunflower Tableau

I still remember driving to work my first day at Paragon Tool five years ago. Winding through the Ohio countryside, I saw a stand of sunflowers growing in a rocky patch of soil next to a barn. “Now there’s a symbol for us,” I thought, “a commonplace but hardy plant that quickly grows above its neighbors, often in fairly tough conditions.” I was confident that Paragon—a solid, unexceptional business operating in an extremely difficult industry and economic environment—had the potential to grow with similarly glorious results.

For one thing, Paragon was relatively healthy. The company was built around a line of high-end machines—used by manufacturers of aerospace engines, among others—that continued to enjoy fairly good margins, despite the battering that the machine-tool industry as a whole had taken over the previous decade and a half. Still, the market for our product was essentially stagnant. Foreign competition was beginning to take its toll. And we continued to face brutal cyclical economic swings.

I quickly launched a number of initiatives designed to spur revenue growth. With some aggressive pricing, we increased sales and gained share in our core market, driving out a number of our new foreign rivals. We expanded our product line and our customer base by modifying our flagship product for use in a number of other industries. We also made a string of acquisitions in the industrial signage and electronic-labeling field, aiming to leverage the relationships we had with our machine-tool customers. No question, these moves put real pressure on our margins. Along with the price cuts and the debt we took on to make the acquisitions, we had to invest in new manufacturing equipment and a larger sales force. But we were laying the foundation for what I hoped would be a highly profitable future. The board and the senior management team, including Littlefield, seemed to share my view.

Indeed, the CFO and I had developed a rapport, despite our differing business instincts. Early on in our working relationship, this sixth-generation Yankee started in with the kidding about my alma mater. “Is that how they taught you to think about it at Rutgers?” he’d say if I was brainstorming and came up with some crazy idea. “Because at Wharton, they taught us…” I’d just laugh and then tell whoever else was in the room how proud we were that Littlefield had been a cheerleader for the Penn football team—like that was his biggest scholarly accomplishment. One time he “let it slip” that in fact he was Phi Beta Kappa, and we all just groaned. I said, “Give it up, Littlefield. You may have been Phi Beta Kappa, but, despite those letters on your gold pin, you’ll never out-Greek me.” To tell the truth, our skills are complementary, and between us we manage to do a pretty good job for the company.

As Paragon grew, so did the sense of excitement and urgency among our managers—indeed, among the entire workforce. People who once had been merely content to work at Paragon now couldn’t wait to tackle the next challenge. And that excitement spread throughout the small Ohio town where we are based. When I’d go with my wife to a party or speak at the local Rotary Club or even stop to buy gas, people would show a genuine interest in the company and our latest doings—it helped that we always mentioned the job-creation impact when announcing new initiatives. There’s no doubt it stoked my ego to be one of the bigger fish in the local pond. But even more important for me was the sense that this was business at its best, providing people with a justified sense of well-being about the present and confidence in the future.

Anyway, my point here is that we’ve grown fast since I arrived, but we still have a long way to go. I’ve come to think that the real key to our future is in the company’s services division. We currently offer our customers the option to buy a standard service contract, under which we provide periodic machine maintenance and respond to service calls. But we’ve been developing technology and software, similar to MonitoRobotics’, that would allow us to respond immediately if a machine at a customer’s site goes down. The division currently accounts for less than 10% of our revenue and, because of the cost of developing the new technology, it’s struggling to turn a profit.

But I can see in the services division the seeds of a business that will ultimately transform us from a manufacturing company into a high-tech company. Such a transformation, requiring an overhaul of our culture and capabilities, won’t be easy. And it will surely require significant additional investments. But the potential upside is huge, with the promise of sales and profit growth that could make our current single-digit gains seem trivial by comparison. Besides, what choice do we have? A number of our competitors have already spotted these opportunities and have begun moving ahead with them. If we don’t ramp up quickly, we might well miss out on the action altogether.

A Company in Play

Just over a month ago, I was sitting at my desk preparing a presentation for the handful of analysts who cover our company. Until recently, most of them have had only good things to say about all our growth moves. But last quarter, when we again reported a year-on-year drop in earnings, a few of them started asking pointed questions about our investments and when they could be expected to bear fruit. As I was giving some thought to how I’d answer their questions in the upcoming meeting, the phone rang. It was our investment banker, Jed Nixon.

“Nicky, I think we should talk,” he said. I could tell from the sound of his voice he was on to something big, and then he told me what it was: “MonitoRobotics is in play.”

We both did some calendar juggling and managed to get together for lunch the very next day at Jed’s office in Cincinnati. The rumor was that one of our direct competitors, Bellows & Samson, was about to launch a hostile takeover bid for MonitoRobotics. As it happened, we had just started a conversation with MonitoRobotics’ management a few months before, about collaborating on remote servicing technology for machine tools. But Jed’s call had had its intended effect, changing my thinking about the company: Why not acquire it ourselves?

Although MonitoRobotics’ technology was designed to detect and report operating failures in robotics equipment, managers there had told us when we met that adapting it for use on other industrial machinery was feasible. Indeed, MonitoRobotics had recently licensed the technology to a company that planned to modify it for use on complex assembly lines that experienced frequent breakdowns. Our engineers had confirmed that a version could be developed for our machines—though in their initial assessment they hadn’t been exactly sure how long this would take.

Still, the potential benefits of acquiring MonitoRobotics seemed numerous. It would give us a powerful presence in a fast-growing business while preempting a competitor from staking a claim there. Whatever the time lag in adapting MonitoRobotics’ technology for use with our products, we would almost certainly be able to offer our customers this valuable troubleshooting service more quickly than if we continued to develop the technology ourselves. And though our products were different, MonitoRobotics and Paragon potentially served many of the same manufacturing customers. “Think of the cross-selling opportunities,” Jed said, as he took a bite of his sandwich. The greatest opportunity, though, lay in the possibility that MonitoRobotics’ software technology would become the standard means for machine tools—and ultimately a variety of industrial machines—to communicate their service needs to the people who serviced them and to other machines that might be affected by their shutdown.

This was a fairly speculative train of thought. But a MonitoRobotics acquisition had for me the earmarks of a breakthrough opportunity for Paragon. And our earlier conversations with its management team had been cordial, suggesting the company might welcome a friendly offer from us to counter Bellows & Samson’s hostile bid. Of course, even if we were able to get MonitoRobotics at a fair price, an acquisition of this size would further delay our return to the margins and profit growth we had known in the past. And that, I knew, wouldn’t sit well with everyone.

Management Dissension

The day after my meeting with Jed, I called together members of our senior management team. There was a barely suppressed gasp when I mentioned the potential acquisition, particularly given its size. “Boy, that would be a lot to digest with everything we’ve got on our plate right now,” said Joe McCollum, our senior VP of marketing. “It also might represent the chance of a lifetime,” countered Rosemary Witkowski, head of the services division. Then Littlefield spoke up. His skepticism wasn’t surprising.

“I was just running a few simple numbers on what the MonitoRobotics acquisition might mean to our bottom line,” he said. “Besides the costs associated with the acquisition itself, we’d be looking at some significant expenses in the near term, including accelerated software research, hiring and training, and even brand development.” He pointed out that these costs would put further pressure on our earnings, just as our profits were struggling to recover from earlier growth-related investments.

Littlefield did concede that a bold acquisition like this might be just the sort of growth move that would appeal to some of our analysts—and might even prompt a few more securities firms to cover us. But he insisted that if our earnings didn’t start bouncing back soon, Wall Street was going to pillory us. Then he dropped his bombshell: “I frankly think this is an opportunity to consider getting out of the services business altogether. Eliminating the continued losses that we’ve been experiencing there would allow us to begin realizing the profit growth that we can expect from the investments we’ve made in our still-healthy machine-tool business.”

Littlefield argued that, whether we acquired MonitoRobotics or not, it wasn’t clear we’d be able to dominate the machine-tool services market because a number of our competitors were already flocking there. Furthermore, the market might not be worth fighting over: Many of our customers were struggling with profitability themselves and might not be willing or able to buy our add-on services. “Last one in, turn out the lights” was the phrase Littlefield used to describe the rush to dominate a profitless market.

As soon as she had a chance, Rosemary shot back in defense of her operation. “This is the one area we’re in that has significant growth potential,” she said. “And we’ve already sunk an incredible amount of money into developing this software. I can’t believe you’d throw all of that investment out the window.” But a number of heads nodded when Littlefield argued that we’d recoup much of that investment if we sold the money-losing business.

Several days later, I polled the members of the senior management team and found them split on the issue of the acquisition. And, to be honest, I was beginning to doubt myself on this. I respected Littlefield’s financial savvy. And no one had yet raised the issue of whether Paragon, a traditional manufacturing company, had the management capabilities to run what was essentially a software start-up. We decided to hire two highly regarded consulting firms to do quick analyses of the proposed MonitoRobotics acquisition.

The Sunflowers’ Successor

Today, the consultants came back to us with conflicting reports. One highlighted the market potential of MonitoRobotics’ technology, noting that we might be too far behind to develop similar technology on our own. The other focused on the difficulties both of integrating the company’s technology with ours and of adapting it to equipment beyond the robotics field.

So as I drove home tonight, the dilemma seemed no closer to being resolved. In many ways, I am persuaded by the cautionary message of Littlefield’s number crunching. At the same time, I firmly believe the pros and cons of such a complex decision can’t be precisely quantified; sometimes you just have to go with your instincts—which in my case favor growth. As I turned the issue over in my head, I looked out the car window, half-consciously seeking inspired insight. Sure enough, there was the barn where the sunflowers had been growing five years before. But the bright yellow blossoms, highlighted by the red timbers of the barn, were gone. Instead, a carpet of green kudzu was growing up the side of the increasingly dilapidated building. This fast-growing vine, which already had ravaged much of the South, was now spreading, uncontrolled and unproductive, into southern Ohio.

My mind started to drift and the image of kudzu—a more sinister symbol of growth than the sunflower—began to merge with thoughts of my father, who had died of lung cancer two years before, and my mother, who these days spends most of her time managing her investments. Suddenly, my parents’ favorite phrases came to mind. It occurred to me that kudzu was now becoming as American as Mom and apple pie. Even so, its dense foliage certainly seemed like a place where, if you weren’t careful, you could easily misplace your shirt.

Rand Araskog was the chief executive officer of ITT Corporation from 1979 through 1998. He is the author of The ITT Wars: A CEO Speaks Out on Takeovers (Henry Holt, 1989).

Nicky Anaptyxi becomes too pessimistic as he drives home at the end of the story. When you have a unique acquisition opportunity, which MonitoRobotics would seem to represent, you have to move on it, even if it results in a short-term hit to profitability. You can’t spend too much time worrying about things—apart from the crucial issue of how much to pay—especially if a competing bidder is waiting in the wings.

You might think that I’d be a skeptic of acquisition-driven growth because of my experience at ITT, both working with Harold Geneen to build that quintessential conglomerate in the 1960s and 1970s and then, as CEO, separating ITT into independent, publicly traded companies. But there’s nothing wrong with acquisitions. We continued to make acquisitions in the 1980s and 1990s to fortify ITT’s various business segments. By the mid-1990s, it simply became clear that the company’s growth potential—and value to shareholders—would be enhanced if it were broken into separate entities, each with a clear business focus.

For Paragon Tool, the acquisition seems to have such focus and could thus strengthen the company’s competitive position in a market with lots of growth potential. If you sell reasonably complicated equipment, you should be the one to service it. And there’s money to be made in doing that; just ask United Technologies about the relative profitability of making Otis elevators and servicing them. In the case of Paragon, the services business, even if not yet profitable, shows the most potential for profitable growth, whether organically or through acquisitions.

The question of which way to grow the services business highlights Nicky’s real dilemma: How much should Paragon pay for MonitoRobotics? With a rival also interested, the company needs to quickly figure out the right price and do a deal before a bidding war commences. If the price becomes too high, though, the company must be willing to walk away from the acquisition and continue to build its services business internally.

The need to determine the right price presents an opportunity for Nicky to engage, and ultimately hold on to, his talented CFO. No matter how brilliant Littlefield may be, he is no good to Paragon if he and Nicky don’t operate as a team. They can do this by complementing and counterbalancing one another—for instance, Nicky as the gung-ho cavalry charger and Littlefield as the cautious fort holder. But they can’t be at odds. Nicky must make clear that the services division represents the future of the business. If Littlefield doesn’t agree, Nicky needs to hire a new CFO.

Meanwhile, Nicky can at least get Littlefield involved by appealing to his strengths and assigning him the task of determining a fair price for MonitoRobotics. While Nicky and the board might ultimately decide, for strategic reasons, that the CFO’s recommended offer price is too low—for example, they may be willing to accept a dilution in earnings for a year or two—Littlefield’s conservative perspective will still be useful. Indeed, his analysis may convince them that it would in the end make more financial sense for the company to focus on developing its own services technology. On the other hand, Littlefield might find in the course of his analysis that the deal does seem like the right move for the company.

There is one final thing Nicky needs to consider: his own character. He’s clearly a hard-driving builder who wouldn’t be happy—or successful—reconstructing a slimmed-down company. What might arguably be a viable strategy for Paragon—downsizing to increase profitability—isn’t viable if he is the one charged with executing it.

That’s why it is a mistake for Nicky to suddenly get discouraged at the end. He forgets—or perhaps doesn’t know—that in season kudzu blooms with clusters of stunning reddish-purple flowers. He shouldn’t let his current emotional trough obscure the potential beauty of this acquisition.

 

Ken Favaro is the chief executive of Marakon Associates, an international strategy-consulting firm based in New York.

Years of research on acquisitions point to the same conclusion: Up to 75% of them fail to create value for shareholders. When you take that into account, Littlefield’s opposition to acquiring MonitoRobotics seems to make sense. And yet, a recent study by our firm of the most successful value-creating companies found that many of them have, in fact, been acquisitive. In many markets, up to 50% of these companies have grown primarily through acquisition. Given this conflicting evidence, how is Nikolas to decide whether the acquisition would be a wise move?

The first thing he needs to do is stop viewing the potential acquisition in isolation and ask himself, “What are our growth alternatives?” Nikolas seems to focus on the question of whether to grow rather than how to grow. For example, when challenged by Littlefield, Nikolas engages in an unhelpful debate that focuses on the false dichotomy between short-term profit and long-term growth. In my experience, the only established companies forced to trade off near-term profits for top-line growth are those with broken business models. And if a company’s business model is broken, management should focus on fixing it and making it profitable before worrying about growth.

Nikolas’s failure to consider alternative paths to growth runs two important risks. First, if acquiring MonitoRobotics is the only alternative considered, then failing to acquire the company will leave Paragon without a growth strategy, potentially backing Nikolas and the company’s board into a corner. Since it is human nature to choose action over inaction—in this case, some growth strategy over no growth strategy—the deal will likely go through, no matter what the cost.

Second, by not considering alternatives, Nikolas may be overlooking better ways to grow. The services business may be the wrong growth vehicle. After all, as Littlefield points out, it hasn’t been profitable, and the machine-tool services market—despite the positive aura that surrounds the concept of services these days—may well end up being profitless for all participants. Managers should be wary of plans to generate growth in unprofitable businesses, particularly when the rationale for doing so is grounded in a fear that, as Nicky puts it, you’ll “miss out on the action.” Venture capitalists have for years applied a “three years to profitability or out” test to their investments; corporations would be wise to consider a similar standard. While it may be time for Paragon to double its bet on its services division, it may also be time to fold and play a different hand. Nikolas and the board won’t know unless Paragon explicitly examines alternative growth strategies.

In addition to the risks presented by Nikolas’s failure to consider alternatives, there is the more basic question of whether acquiring MonitoRobotics is a smart move. For an acquisition to have a reasonable shot at generating value growth, it must meet three important criteria: a good fit, the right price, and excellent execution. At this point, Nikolas doesn’t know enough about fit to make a call one way or the other. He knows nothing about price. And one can’t help but sense that there will be real problems with execution. Nikolas has already acknowledged that the transformation of Paragon from a manufacturing company into a technology company will require an overhaul of its culture and capabilities. Without the support of his team and complete agreement on how best to generate growth, it is highly unlikely that Paragon’s management will execute the MonitoRobotics acquisition effectively—even if the fit and price are right.

So my advice to Nikolas? Stop, take a deep breath—and then take three months to get the top team, and ultimately the board, to agree on whether acquiring MonitoRobotics is the best alternative for growing the company. If the answer is yes, the team will have reached consensus around fit and price, making excellent execution much more likely. If, on the other hand, the answer is no, then Paragon will have dodged a big bullet.

 

W. Brian Arthur is the Citibank Professor at the Santa Fe Institute in New Mexico. From 1983 to 1996, he was the Morrison Professor of Economics and Population Studies at Stanford University in California. He is the author of “Increasing Returns and the New World of Business” (HBR July–August 1996).

The acquisition is an obvious go. If a company doesn’t keep developing and renewing itself, it can easily lose momentum and, eventually, its competitive edge. And MonitoRobotics seems to offer Paragon reasonable prospects for development, especially if its technology can be adapted for use with other classes of machinery—not just those of Paragon and its rivals.

But let me offer a few caveats. First, this doesn’t seem to be a case about growth but rather about repositioning. The acquisition would allow Paragon to build a new skill base and enter new markets, not simply grow within its existing set of capabilities and industry. And if you’re going to reposition yourself like this as a way to create a new platform for future revenue, you almost inevitably have to accept some temporary losses. Littlefield’s observation about profitable growth suggests that he doesn’t understand this.

Indeed, the CFO’s comments highlight the fact that Nicky faces not just a business problem but also a political one: If the acquisition represents a sensible repositioning of the company, he needs to build consensus among his executives, his board, and his shareholders. Of course, he may not be able to convince every one of his colleagues. If Littlefield continues to object to the acquisition, most likely he will start to make trouble later. In that case, the CEO should encourage him to walk.

Let me just add a quick observation about Paragon’s move into what it calls services. In this case, services actually means servicing—that is, the fairly routine business of troubleshooting and maintenance. But as fail-safe mechanisms increasingly are designed into complicated machinery, many servicing capabilities become redundant. It is ironic that for Paragon to gain market share in its main manufacturing business, it will have to make machine tools that are increasingly trouble-free—and such reliability may ultimately drive its nascent service arm out of business.

Despite that conflict, MonitoRobotics does create longer-term opportunities for Paragon. And these involve more sophisticated forms of monitoring and repair. MonitoRobotics’ current technology merely accelerates Paragon’s existing servicing process. Instead of a line worker reporting a problem to a foreman, who then calls a repairman, the company’s sensors detect a problem and immediately inform the manufacturer, who sends technicians to fix it.

But this technology is only the first step toward machines that monitor themselves, that detect deviations and variations in tolerance and then automatically correct those problems as they continue to operate. This self-correction might require a digital link with the manufacturer, which could then automatically send adjustment specifications back to the machine through phone link or satellite.

This sounds futuristic, but it’s a natural set of activities for MonitoRobotics to move into. And it applies to all machines, not just those of Paragon and its competitors. So the acquisition has rich possibilities for future expansion.

The new combined company will be more high-tech than before. But will its technology allow it to dominate its market through network effects and the creation of a new standard? I don’t think so. Even if Paragon’s technology becomes widespread, it will not establish a “language” that other machines will have to speak. But the acquisition will establish a new skill base—a capability that Paragon can use to build on.

 

Jay Gellert is the CEO of Health Net, one of the nation’s largest publicly traded managed-health-care companies, based in Woodland Hills, California.

This case certainly provides a model for the wrong way to go about assessing a deal, especially in today’s environment. Indeed, Paragon seems to be taking a “very ’90s” approach. I speak with some authority here: One element of our company’s turnaround in the past two-and-a-half years has been the divestment of several businesses acquired during our rapid expansion over the previous decade.

Start with the fact that Paragon doesn’t appear to have in place a well-thought-out approach to growth. Now, you may do a deal because your own prospects are weak, and you realize that risky acquisitions are the only hope of avoiding an even riskier future—the classic case of one drunken man looking for another to hold him up. Or you may do a deal because you are in a strong position and acquisitions will allow you to pump more offerings through a healthy product and distribution infrastructure. You might even do a deal because you have determined it would be catastrophic if someone else beat you to it.

But you need a clear reason to make the acquisition. There is a kind of meandering quality to Paragon’s approach that borrows a bit of reasoning from each of the preceding scenarios. Indeed, the company’s interest in acquiring MonitoRobotics is primarily reactive: When the two companies were talking about a possible joint venture, before the rumors of a hostile bid, an acquisition wasn’t even considered. Certainly, there are times when you need to do something to match a competitor’s move, but if that is the sole reason for an acquisition, it’s almost guaranteed to fail. Paragon’s hazily defined approach to growth is highlighted by the management schism that has occurred. The differences between the CEO and CFO on the company’s direction should have been confronted long before a specific deal was even contemplated.

The potential acquisition raises a number of other red flags. It is portrayed almost entirely as what I call a “strategic deal”—that is, the financial benefits will only be realized far in the future or can’t be quantified at all. You get the strong sense that the acquisition would seriously stretch Paragon’s financial resources and that a lot of things have to go right in order for it to work. Again, such an acquisition may be justified if it is part of a cohesive growth plan. But this has that random-amalgamation feel that characterized many acquisitions in the 1990s.

Even more worrisome, the acquisition is billed as one that will transform the company—always a risky proposition, given the immediate change in culture that this requires. The management team appears clueless as to how it will manage this change and other aspects of integrating MonitoRobotics, whose main asset as a services business is its people. Such a transformative acquisition is doubly dangerous when done defensively, in reaction to a rival’s move.

The company also needs to think about how shareholders and analysts will respond. While they might have been enthusiastic about such an acquisition five years ago, they are unlikely to welcome it today. For one thing, there is less tolerance for revenue as a mere forerunner of profits. Concerns that a company isn’t moving fast enough have been replaced by fears that it doesn’t appreciate the execution challenges of a merger. People also demand greater line-of-sight linkage between an acquisition and its benefits; big-concept moves—“this transforms us into a technology company”—are met with more skepticism. And in these post-Enron days, the departure of a respected and conservative CFO over such a deal would set off alarm bells.

This might have been a brilliant acquisition for Paragon four years ago. Back then, many companies might have done such a deal. But times have changed. Realizing the potential perils of such acquisitions has made our management team and board much more disciplined in our thinking about them. Paragon should apply the same rigor.