Sunday, April 19, 2015
By Uday Phadke.
Against the back-drop of sluggish domestic economic growth, leaders of technology-intensive companies across Europe, North America and Asia face a major challenge in how they grow top-line revenues. Many of them also face the challenge of addressing the contrasting and dynamic economies in Asia, South America and Africa.
In Europe and North America, the wider picture is one of flat revenues, share buy-backs and expensive M&A to assuage pressures from investors eyeing the cash piles many of these businesses have built up. In Asia too, businesses are under pressure to deliver better growth. Overall, many "incumbent" businesses are struggling with how they generate significant revenue growth again, whether based on new products and services or through business model innovations, as they pursue the elusive ‘holy grail’ of ‘corporate innovation’.
The response to this challenge requires strategic clarity, a better understanding of the Build vs Buy alternatives, and the courage to seize the initiative rather than merely reacting to approaches from financial investors, who are not always driven by the medium-term and long-term industrial logic, but with engineering short-term financial exits.
So how can companies respond to this innovation and value-creation challenge?
Strategic clarity is an essential first step in this process, but this requires a deep understanding of the current (and future) eco-system that the company operates in. This is not an easy task as eco-systems are shape-shifting in unexpected and radical ways based on developments in technology, demographics, consumer behaviour and business models. It also requires the ability to accept the uncertainty associated with these changes and to "calibrate" different opportunities based on a realistic assessment of the available resources (technical, operational, financial and leadership resources). This understanding can then guide the strategic alternatives of Build vs Buy.
Building businesses within pre-existing company structures and cultures comes with the usual host of challenges. However, rather than spending a lot of time worrying about how to build a (more) entrepreneurial culture, companies need to have a more graduated approach which distinguishes between different types of business building, and to adopt a portfolio approach based on 3 different types of build:
- Incremental: this is easier to do because it harnesses the current "business DNA" but highly unlikely to deliver a big impact by itself;
- Small focused initiatives, which exploit eco-system changes, can be powerful but may not ‘move the dial’ on their own; but a family of such linked initiatives will have bigger aggregate impact;
- Major radical initiatives, which dramatically change the value relationships in the industry and have a major transformational impact on the fortunes of a company.
In practice, risk mitigation probably calls for a blend of all three types of build.
Buying businesses is often seen as a way by corporate leaders, under pressure from investors, to deliver results quickly. As all our research shows, the track record of companies successfully integrating acquisitions into their core businesses is very poor, particularly across borders, and many of these companies maintain acquisitions under distinct management while paying lip-service to the "strategic benefits of integration". The more important question is where the target companies are in their business maturity prior to the M&A intervention. Again, there is a trade-off here between company valuation and risk.
Our analysis based on the Triple Chasm Model illustrates this very clearly. Companies that have yet to cross Chasm II are likely to have low valuations but plenty of risk and uncertainty associated with them; but they may be interesting for corporates who are able to supply access to potential customers and the resources to support business model innovation. Post Chasm II companies have the biggest potential for scaling, but are likely to be quite expensive- they are also likely to have financial investors who have a vested interest in high valuations. Businesses that have crossed Chasm III will have the lowest relative risk but may also be prohibitively expensive.
This illustrates that buyers need to have a much better understanding of where the companies sit in the maturity curve: this then allows a much better understanding of the overall cost of acquisition. This is not just the cost of the initial purchase, but also the cost of turning it into a viable and valuable commercial asset. In our experience most acquisitions lack this kind of clear insight but are driven by opportunistic thinking, where financial investors and entrepreneurs approach corporates with an exciting proposition, which often ends up being analysed in isolation and in a limited manner.
We believe companies need to adopt a more structured and analytical approach to the challenge of growing top line revenues. A Portfolio Approach, based on an appropriate mixture of Build & Buy within a strategic context, is the key to building sustainable top line revenues quickly.