We have all seen or heard of high-profile cases where M&A deals didn’t work out. AOL–Time Warner, HP-Compaq, Quaker-Snapple — these are just some of the big ones. An analysis of 2,500 such deals by our firm shows that more than 60% of them destroy shareholder value. Perhaps such deals should come with an official warning: “Acquisitions can result in serious damage to your corporate health, up to and including death.”
And yet even in light of such daunting data, many corporate leaders feel compelled to pursue growth through M&A, figuring the risks of inaction are just as high. After all, if acquisitions pay off they can provide a transformational antidote to a slowing core market and declining margins.
As our research has shown us, the core of the problem is not the high number of M&A deals in itself, but rather that too many executives bring insufficient discipline to the evaluation process that fuels these deals — as a result, they often get deals wrong. For instance, despite the importance of accurately identifying and calculating company synergies, diligence work frequently results in an overly optimistic view of the revenue synergy opportunity. Often the weakest assumptions involve estimates of how much additional revenue the companies can generate when combined. This, in turn, leads bidders to overpay.
Our experience with many global companies across industries and sectors has revealed a framework for pursuing growth through acquisition that lowers risks and helps beat the odds. As we’ve written previously, the best path to accelerated growth with limited risk often comes from creating new products and services that leverage a company’s existing resources, customers, and capabilities. In the course of research for our book, we’ve found that this approach also provides an ideal methodology for leaders to identify which M&A deals are most likely to pay off — a disciplined approach that acts as a kind of lens for effectively distinguishing gold from iron pyrite in assessing potential company synergies.
Helping customers complete their “journey”
An example of a stunningly successful merger was Procter & Gamble’s 2005 acquisition of Gillette. While some cost synergies were realized, the real payoff came because each company independently recognized that it had the permission to expand what it was offering to its core customers and that the capabilities to deliver on this potential resided in the other company.
Gillette dominated the men’s shaving market with its Mach series of razors. P&G was able to combine Mach blade technology with its women’s skin care expertise to market women’s shaving products under the Gillette Venus brand. Gillette introduced new shave lotions, deodorants, and shower gels for men using P&G’s soap, lotion, and antiperspirant technology and expertise.
These acquisition synergies worked because they leverage what we call a “journey edge” — a place where current offerings can be expanded in subtle but logical ways along the fuzzy demarcation between existing product definition and customer receptivity.
In accessing this type of opportunity, there is the challenge, “What permission would customers give us to extend our role in helping them to achieve their ultimate mission?” Gillette felt it had permission from its razor customers to offer them a bit more to support their ultimate mission of getting a great shave.
Contrast this with another well-known deal: When eBay bought Skype, eBay executives implicitly thought that video chat belonged somewhere on the journey their customers experienced, and that eBay would be granted permission to offer this extension to its core offering. The reality was that most customers didn’t see a need for video chat to conduct online auctions, and if they did, they didn’t feel they needed eBay to provide it for them. In part, the deal failed because the combination wasn’t welcomed as a way to better complete an important customer journey. By more rigorously mapping the journey and testing the premise of customer permissions, eBay might have seen that the cross-selling synergy was not as robust as thought.
Testing where else your foundational assets will work
Edge mindset and discipline can also increase the likelihood of a merger paying off by capitalizing on latent capabilities or underutilized assets of the combining companies.
This is the discipline behind what we term “enterprise edges,” where we ask, “Who besides a competitor would pay to access my assets?” This thinking helps identify new revenue streams for a business by challenging where else assets that have been assembled to serve our core business could be utilized. To test this framework in the M&A context, we ask, “In the absence of a deal, would the acquiree pay for access to my assets?” This relatively simple approach is actually a powerful tool to help confirm or deny the potential for synergies.
The rationale for this approach is highlighted when you compare, for example, the different approaches to M&A employed by a number of legacy pharmaceutical companies and by some relatively newer players in the biotechnology industry.
We have all seen big pharma deals in which companies were eager to find large sources of revenue growth to fill their pipelines and to meet ongoing shareholder expectations, making major acquisitions in order to access blockbuster ($1 billion or more) drugs developed by other companies.
However, this approach to seeking growth often saddled these companies with unwieldy portfolios of additional assets, many of which had to be unloaded at discounts to the original premiums paid (in other words, technologies they didn’t have the expertise to cultivate and markets they didn’t fully know how to commercialize).
By contrast, some of the key players in biotech (Biogen Idec, Amgen, Genentech) have tended to take a more disciplined approach. For example, Gilead grew from a tiny startup developing H.I.V. therapy to a major drug company with $30 billion in annual revenue by successfully deploying what we would call an “edge strategy” approach to M&A. It was propelled by a series of disciplined acquisitions, mainly of companies with drugs for other infectious diseases, such as Hepatitis B and Hepatitis C. In other words, Gilead capitalized on a key foundational asset — its deep expertise in developing and marketing an antiviral franchise — and used this to pressure-test where else this capability could be put to work.
While one can’t make a specific claim of causation related to these approaches, we believe it has helped lead to Gilead’s strong performance over the past 15 years, which significantly outpaced the broader Pharma index, and that it has played a part in the biotech sector’s remarkable growth over the same period.
Ultimately, the key is discipline. By rigorously and relentlessly asking two questions — “How will the deal help our customers to complete their journey?” and “How is the deal using our foundational assets to create value in a different context?” — an edge strategy approach to M&A can mitigate the risks of an inherently risky business.