How to Succeed at M&A

Companies constantly seek new growth opportunities, but organic new growth is far from a sure bet. While business model innovation is a powerful path to sustained, robust growth, new businesses can take years to mature. The skills needed to conceive and incubate them present a unique set of challenges that many companies find difficult to overcome. "A large enterprise has trouble making an investment in innovation," says Brad Anderson, the recently retired CEO of electronics retailer Best Buy (BBY). "It's in part because Wall Street has trouble imagining a new way to operate but, more important, because people inside the company can't see the value of a new idea and so won't allocate the resources and support the new initiative needs to succeed."

But organic growth is not the only option available to companies seeking transformational growth. Though most of my book Seizing the White Space: Business Model Innovation for Growth and Renewal is dedicated to developing new business models within incumbent organizations, I don't mean to imply that incumbent companies shouldn't seek to achieve transformative growth and exploit opportunities in their white space through mergers and acquisitions—they should. Building models in-house is not the only option for companies seeking transformational growth. Corporations can transform their business models through acquisitions as well. When Anderson took over Best Buy, in fact, he led the company through a series of strategic acquisitions that helped it grow beyond a pure retail sales model.

But it's no news to point out that acquisitions, at the best of times, are tricky. Study after study finds that acquisitions tend to disappoint, variously estimating that half to as many as 80 percent fail to create value. The high-profile struggle of AOL (AOL) after its $180 billion acquisition of Time Warner (TWC) is one obvious example of an acquisition gone bad. But there are others: Daimler/Chrysler, Sprint/Nextel, and Quaker Oats/Snapple, to name only a few. Quaker Oats paid $1.7 billion for the Snapple brand in 1994 but sold it to Triarc three years later for a mere $300 million.

Business Model Development

I believe many M&A disappointments stem from a failure to understand the fundamentals of business model development. When one company buys another, what it's really purchasing is the target company's business model—its customer value proposition, its profit formula, its resources, and its processes. The new company's resources can be folded into the core of the acquiring company, but new business models resist such integration. Consequently, successful acquisitions tend to fall into one of two camps. An acquirer can buy a company solely for its resources, which it would then fold into its own business model, while jettisoning the rest. The bulk of Cisco's (CSCO) acquisitions follow that pattern. Alternatively, a company can seek to acquire another company's business model, which it then needs to keep separate, but can strengthen by injecting into it its own resources. That's what Best Buy did with Geek Squad.

Johnson & Johnson (JNJ) has understood this, buying business models at an early stage and then keeping them separate.

For example, its Medical Devices & Diagnostics (MD&D) division bought three business models that were fundamentally new to its respective markets: Vistakon (disposable contact lenses), LifeScan (at-home diabetes monitoring), and Cordis (artery stents used in angioplasty procedures). J&J bought these companies young and incubated them into the larger enterprise, where they became the growth engine of the MD&D division for many years.

All too often, attempts to fold an acquired business into the core can kill what made it unique in the first place. Video game maker Electronic Arts (ERTS) learned this the hard way. Propelled by investor expectations, rising development costs, and an industry consolidation trend, EA aggressively bought up small companies led by creative teams that had found success in the market. To profit from anticipated economies of scale, it built up a standardized technical infrastructure and imposed streamlined production processes on its new acquisitions.

The results were abysmal. EA fell into a pattern of producing mediocre products based on movie licenses and sports franchises, which were updated each year. Forcing creative teams to follow core processes was killing their innovative spirit. Luckily, CEO John Riccitiello saw the writing on the wall and announced a sea change in EA's operations: Independent creative studios would operate as "city-states" within the EA corporate structure.

Acquired Model Takes What It Needs

Most of the principles that govern the incubation, acceleration, and transition of homegrown new business models apply to acquired ones as well. Equally important is leadership's ability to allow a newly acquired business model to pull what it needs from the core, rather than having elements of the core model pushed onto it. Best Buy's Brad Anderson expressed this idea succinctly when, referring to the Geek Squad deal, he said, "Geek Squad bought Best Buy, not the other way around."

Anderson knew that the new model would produce growth and transformation for the company, but he also knew that the low-margin, high-volume, retail mentality of Best Buy could easily suffocate the high-touch, high-margin service orientation of Geek Squad. He let Geek Squad pull from Best Buy what it needed to thrive. At the time of acquisition, Geek Squad had 60 employees and was booking $3 million in annual revenue. Today, working out of 700 Best Buy locations across North America, Geek Squad's 12,000 service agents clock nearly $1 billion in services and return some $280 million to the retailer's bottom line.

As Vijay Govindarajan and Chris Trimble noted in Ten Rules for Strategic Innovators, a newly acquired business based on a model distinct from the core should decide what it can borrow from the parent, what it should forget (or forget about), and what it will do or learn that is completely new. The key to understanding what to forget and what to learn lies in the business model. You must understand both your own business model and the new company's model completely, so you won't throw away the most valuable thing you bought—the very thing that will help your company grow.

- Provided by Strategy and Innovation—published twice-monthly by Innosight, an innovation consultancy. Innosight's approach and proprietary tools facilitate the discovery of new, high-growth markets and the rapid creation of breakthrough products and services.