Although most buyers we work with in the Acquisition Lab are first-time buyers looking to become an entrepreneur by following the buy then build model, I also work with buyers who already have existing businesses.
Unlike first-time buyers, these buyers are looking for the next step they should take.
Often, they’re asking the question: should they acquire a company in their industry or simply innovate by creating new business within their existing company?
In a world where startups reign supreme, you’d think innovation is the way to go, but I disagree.
I have long preached that, contrary to the belief of most entrepreneurs, acquisition is just as important as innovation.
But how do you know when to start another business from scratch or acquire an existing one?
How do you determine whether you should be innovating in your space or growing through acquisition?
Today, we dive deep into the research to figure it out.
Many Small Acquisitions or a Few Large Acquisitions?
A few years ago, a McKinsey consulting report came out about how lots of small mergers and acquisitions (M&A) deals add up to big value.
McKinsey found that companies building the greatest enterprise value and market share often pursued a “programmatic approach” to acquisitions (repeatedly acquiring a lot of smaller businesses in a programmatic way), versus occasionally going after large but selective deals. Between 1999 and 2010, these companies outperformed those that relied on selective deals, organic growth, opportunistic acquisitions, or large deals to grow their business.
Additionally, the trends showed that the larger companies get, the more they rely on M&A to grow.
In other words, the key determinant in recognizing the winner of any industry is figuring out which company consistently acquires small to medium-sized businesses. Companies that make frequent small or moderate acquisitions over time gain significant market share simply through acquiring it.
Additionally, repeating this practice allows these companies to refine their approach and manage financial risks. They have a lot of attempts to get it right by “firing a lot of bullets,” as Jim Collins would say. Because the smaller acquisitions are more financially affordable, it also allows companies to be financially diversified in spreading out their risk.
Why Companies Struggle with M&A Initiatives
That said, for as central as M&A is to a company’s growth plan, McKinsey also discovered that many firms struggle to transition to programmatic M&A initiatives.
“The data also confirmed just how challenging it is for individual companies to make the transition to programmatic M&A from any of the other models we identified. For instance, none of the companies that followed an organic approach between 2004 and 2014 had shifted to a programmatic model by the time we performed our latest analysis. And by 2017, more than a quarter of those companies had dropped out of the Global 1,000 altogether because of takeovers and other factors.”
This likely stems from the fact that most companies and entrepreneurs don’t see acquisitions as a core competency in business, especially when the primary focus for companies has been (and continues to be) creating a product-market fit.
Although acquiring a business is an entirely different skill set from creating a new product, those that excel in this area gain an invisible competitive advantage when it comes to long-term growth.
This is also why it’s important for a company to have a dedicated, systematized M&A team; this allows the team to spend more time on culture and post-merger integration, which are important factors (if not dealbreakers) in successful acquisitions. Between 70-90% of large acquisitions fail to extract the value they thought they would largely due to cultural issues and inefficiencies with post-merger integration. Companies that take a programmatic approach to M&A are able to manage those problems because they do so frequently and have a dedicated and experienced team that navigates these common post-merger issues.
The point is, acquisition should be an enduring capability of any company that’s looking to significantly grow – not simply an endeavor that’s done once or twice.
Four Stages of Industry Consolidation
A Harvard Business School article asserted that long-term success for a company depends on how it moves through the four stages of industry consolidation. Most industries experience a consolidation life cycle, over a period of roughly 25 years, and those who make it through all four stages are successful – those that don’t, disappear.
The four stages are Opening, Scale, Focus, and Balance.
- Opening: Companies in stage one are typically new technologies or players that define the market before it takes off. Companies in stage one should defend their competitive advantage by building scale, creating a global presence, developing proprietary technology, prioritizing revenue over profit to attain greater market share, and developing their programmatic acquisition skills.
- Scale: The second stage is the adolescent phase where most consolidation occurs. The focus here is on building scale, with major players dominating by acquiring competitors. In this stage, companies must refine their merger-integration skills, protect their core culture, expand globally, and retain top talent from acquired firms.
- Focus: In stage three, companies focus on expanding their core business and outgrowing competitors. Private equity and institutional capital are common. This stage involves megadeals and large-scale consolidation, as companies aim to become global industry powerhouses. Companies in this stage should emphasize core capabilities, focus on profitability, and decide how to handle emerging competitors.
- Balance: Stage four is where established, stable industries live, with top companies holding 70-90% of the market. Growth becomes challenging, so large companies may form alliances. Firms in this stage must defend their positions, find new ways to grow in a mature market, and create growth by spinning off new businesses into emerging industries.
Now, as a small business owner, you may not be concerned about how to capture more of the global market in your industry just yet, but the big takeaway here is that to be successful in the long run, businesses must eventually incorporate a methodical approach to M&A.
You can either acquire or be acquired.
A Different Take on the “Merger Endgame”
The consulting firm A.T. Kearney came out with a very in-depth report with a thoroughly thought out alteration of the consolidation curve.
According to A.T. Kearney’s model, industry consolidation is not a smooth S-curve and it involves multiple re-openings (times to enter the market) due to technological innovations, economic changes, and other types of disruptions.
A.T. Kearney also developed a framework that illustrates which companies in an industry drive acquisition initiatives.
Is it you or is it them?
- First Mover: The first mover advantage is what happens when a company leverages new products or technologies to acquire market share. Within this approach, this is a good opportunity for a company to also leverage their acquisition skill sets to gain even more of the market.
- M&A Speed: M&A speed is where rapid consolidation gives companies the competitive edge. Whoever can acquire the most assets or businesses out there “wins.”
- Game Changer: Companies create innovations that redefine the market. This is the opposite of consolidation. In this case, companies can make strategic acquisitions to support the launch of their new product or service, versus the acquisition being the new product or service itself.
- Defense: When the industry as a whole is chaotic and unpredictable, and no one is certain what’s going to happen, a company might decide to sit on defense, waiting for market conditions to stabilize before making acquisitions.
What approach you take depends on a number of factors: profit margin, the value of information or data, and network externalities.
If your fixed costs are a big percentage of your revenue, economy of scale can help you. By adding more efficiencies to your business, improving the end user experience of that industry’s product or service, and acquiring multiple similar businesses, you can improve profit margin across the board.
If there’s a product out there that has data that provides increasing value to its end user, you can harness that data by acquiring market share.
Lastly, with network externalities, the more people that are on your platform, the more valuable your platform will be.
How to Incorporate M&A in Your Business Strategy
So as a small business owner (or future business owner), how does this apply to you today?
How can you take this high-level M&A data and incorporate M&A in your business strategy?
Here are three things to keep in mind as you grow your business:
- Systematized Approach: Successful businesses have a systematized approach to M&A. They systemize acquisitions by utilizing databases, CRMs, and dashboards to make acquisition a core competency, not just a one-off project. Acquisitions are a regular part of their ongoing business strategy.
- Repeated Small Acquisitions: Successful companies make lots of small acquisitions versus a few large ones. They are able to diversify their risk and ultimately have a greater net gain by taking this approach.
- Codified Learning: Lastly, successful businesses learn from multiple deals to identify effective strategies and gain a comprehensive view of what works and what doesn’t through multiple acquisitions. Practice makes perfect, and these companies have a dedicated acquisition function within the business that allows them to make repeat deals and gain expertise.
So back to the original question: should you acquire a company or innovate an industry?
Both – they’re equally important. Innovating is central to being an entrepreneur and growing a company, but a company will stall in its growth if it does not also develop a programmatic acquisition strategy to build value and gain a competitive edge in their industry.
Ready to acquire a business in the next 12 months? The Acquisition Lab is your first stop. Reach out to us today and get on the fast track to becoming an acquisition entrepreneur.