A company should focus on its core business and buy everything else it needs, right? Wrong, says Han Schaminee.
“We should buy that company,” a sales manager of one of my product lines suggested. We were discussing the margin a supplier made, leaving little room in our margin when reselling the product. I explained that our supplier does the same kind of calculations, meaning that the price we would pay would be at least their total margin over the next few years. And the depreciation of the acquisition costs would put even more pressure on our margin. Moreover, our competitors buying the same product would be less willing to continue buying from us, making it harder for us to realize the same margin as the current supplier. So, not a good idea.
To make an acquisition successful, you need to be able to run the business with higher returns than the previous owner, typically by exploiting synergies. Realizing these synergies is hard work, and failing to do so is one of the key reasons most acquisitions fail.
In the late nineties, after substantially growing my business unit, I was allowed to do an acquisition. The acquisition would give us access to a regional market we’d been weak in before. The business case was based on the strategic consideration that adding the new company would not only increase the revenue of my business unit but also grow revenue in that region for other products from the business group my business unit belonged to.
It started well, until the business group manager was replaced by Mr. X. Mr X wasn’t a great strategic thinker – he had other qualities – and decided to run the acquired company at arm’s length. Without synergies to exploit, the original growth of the business unit was undone within a year.
The business group I recently joined is the result of 8 acquisitions in the past 5 years. There’s no doubt about the potential of the current product portfolio, but realizing the full potential of the acquisitions requires constant attention – we need to make sure that the assumptions in the business case come true.
The above isn’t only relevant for the acquisition of companies. We often talk about making or buying in the context of products or components, and the general thinking is: you limit what you make yourself to what’s core for you. In the nineties, Philips embraced the thinking of Prahalad to focus on core activities. The silver bullet was the hollow company: you only invest in your core activities and buy the rest.
It was the start of Philips’ transformation from over 400,000 employees when I joined in 1981 to where it is today: much smaller, much more vulnerable and with a shareholder value growth below market average over the past decades. The logic of Prahalad looks great and is easy to agree with, but here, too, the difficulty lies in the execution.
At the level of product design, people often challenge the ‘make’ decision, as if engineers always want to do everything themselves and continuously suffer from the not-invented-here syndrome. And I agree, we shouldn’t all develop our own browser, graphical package or cybersecurity solution. It’s not true that you can only control everything if you make everything yourself. And the market is often unable to carry the costs of duplicating the development of each component.
But applying third-party technology causes other problems, like quality assurance and interface management. Making your product also work with future releases of third-party technology requires continuous investment. It’s hard work that’s often underestimated. Customers don’t always recognize the integration effort and refuse to pay a premium for it.
What can we learn from this? First, start with a limited number of activities, each with a clear customer proposition. Secondly, be humble in defining the scope of your business. Don’t believe that you can offer a wide scope by just buying everything you can’t make yourself. The perceived customer value may not exceed the cost of managing the buy. And thirdly, don’t believe you can overcome this by just buying a company. The synergies may not justify the premium price you pay.
Many people outside product development think in-house development is difficult, costly and unpredictable. They like to believe buying is much easier. But believe me, buying is often equally difficult as making.