by Tom Allen
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Digital business models and the innovation, efficiencies and new market opportunities they can offer are fueling an M&A storm. Today, traditional motives for M&A, such as the pursuit of synergies or gaining entry into a geographic market, are being replaced by the pursuit of digital transformation. For many companies, emphasis is now geared around acquiring new technologies or capabilities - these represent the promise of rapid growth and can help to “future-proof” a company as innovative and disruptive ways doing business become the new normal.
An increasing number of the world’s most active M&A companies are committed to digital deals. A look at Siemens’ M&A strategy provides a striking example of this. The company has showcased a commitment to digital and cloud offerings for the past decade - with $10 billion in investments made in software companies since 2007. Today, Siemens’ digital business generates nearly $5 billion annually. Clearly, digital is a priority for Siemens – despite the company having origins in the physical equipment and infrastructure supply business. Similarly, GE displays such an appetite for software, IT service and Internet companies that Forbes labels them a ‘serial digital acquirer’.
These examples reflect an industry truism: digital is the future.
Digital Deals by Design
Many of today’s digital deals are shifting the fundamentals of traditional business models. Companies are acquiring new, unrelated capabilities or investing in additive digital improvements. These capabilities such as advanced analytics or IoT software (think Smart homes, etc.) are orientated around improving how a product is made, improving the product itself or enhancing the overall consumer experience to provide a better fit with today’s lifestyles. Furthermore, digital-focused M&A may be intended to build an enriched social market presence. These outcomes broaden the context of business models and products/services entirely. They reflect new ways of marketing or selling in an online, network-led way. By way of example, Walmart, with its acquisitions of digitally native brands such as Jet.com, Modcloth and Bonobos, demonstrates how digital acquisitions can accelerate progress to an entirely new goal: tapping into the millennial segment.
Walmart’s strategy for Jet.com, which was acquired for more than $3 billion in 2016 along with the $50-$75 million it spent on Modcloth and $310 million for Bonobos in 2017, represents a major shift in direction. This campaign of deal making is about bringing a new target into the Walmart ecosystem and focusing on a digital-first user experience.
With the proliferation of digital disruption, business leaders are increasingly realizing that organic growth is not a viable defense. Indeed, traditional approaches to growth won’t bring the requisite technology and talent to keep pace with fast-growing, emerging brands. As performance pressures mount, traditional companies find themselves in a fight to maintain market leadership – or even for survival.
Opting to build digital capabilities in-house is generally an ineffective strategy to keeping pace with the current wave of digital transformation. The complexities of culture, legacy systems, historical processes and strategic repositioning make redefining R&D and innovations a near impossibility. In a 2017 Accenture Strategy survey, 75% of companies said they plan to acquire “five or more progressive companies” in the next three years. These include non-traditional companies that boast an innovative product or service, are digital, tech-driven and are seen as industry disruptive. Virtually all of the companies surveyed (96%) believe such investments are a central part of their corporate strategy and future success.
Dealing with Digital in Your M&A
The shift to digital-focused deals requires adjustments to even the most basic M&A fundamentals. Traditional approaches to M&A due diligence, valuation, talent retention and integration will need to be reassessed to capture intended growth. On this point, HBR acknowledges the starkly contrasting reality of digital M&A and traditional M&A, going so far to say that, “everything companies thought they knew about M&A may actually not help."
In a 2017 industry interview with top corporate M&A executives, Bain outlined that only 11% of leaders described themselves as being either “mature” or “advanced” on the digital M&A learning curve. Moreover, 75% of those surveyed said that digital disruption may even require a complete overhaul of their existing M&A strategy.
For companies considering the shift to digital-first deal making here are three key areas that need to be reconsidered to support the new deal paradigm.
Getting the Price Right
Of course, not all digital targets are early stage. Where they are, however, getting the price right can mean traditional valuation methodologies are sent to the touch-lines. If M&A teams are tasked with needing to compensate for the lack of financial history associated with early-stage venture targets they may have to build a quasi-DCF for a technology that is unproven, while trying to make sense of the value the product/service/innovation/people/etc. will bring. Fortunately, there are a number of digital tools to complement traditional datasets or which can act as a high-level substitute where information is really lacking. CB Insights is one such provider - offering information-rich company profiles and therefore helping acquirers to visualize competitive dynamics and uncover non-financial performance metrics around market share, growth, momentum and other social sentiment, etc.
Even armed with a range of unconventional data, acquirers of digital need to be unified around what value actually means to them. As many digital targets may be pre-revenue/burning cash/loss making they won’t be immediately accretive. Internal agreement around how a target will support an intentional shift in direction and support a digital-first strategy is therefore imperative.
Where an acquirer is targeting an unproven technology in the digital space they might need to be creative with deal structuring and consider earn-outs or deferred payment mechanisms. This can help mitigate some of the risks associated with transacting on a high deal multiple, for instance. In a similar vein, if a minority equity stake in a venture target is being acquired, a call option could be incorporated in the deal mechanics – the idea being for an acquirer to “stake their claim” to a potential full-acquisition at a reasonable valuation should a venture target go on to greatness in the future.
The Importance of a Digital Vision
Buying digital capabilities and somehow hoping that they will work in harmony with the existing parent is an unfortunate, but often seen, trait of acquirers. While Accenture acknowledges the benefit of preserving the cultural DNA of start-ups, stringing a number of acquisitions together to create a new capability and a combination of the best of all cultures could create a competitive advantage. However, this comes down to effective integration. To get this right, integration strategy needs to be considered in well in advance. This includes everything from a CEO being supportive of a new, digital vision to establishing the cross-functional teams and plans required to spread digital savvy across the broader organization. Of course, this is a complex but very necessary undertaking.
Closing on the acquisition of a company with digital capabilities is merely the starting point of the digital learning curve. The next step is to compile an organized integration plan with clear activity and ownership, which becomes particularly critical when a novel business model is not totally understood. As part of this, a company must determine the level of integration required to unlock the acquisition’s full potential (e.g. full, partial, or stand-alone). On this note, a detailed plan showing how and where digital fits within, or should replace, existing business models should also be created.
Preserving Digital DNA
For top teams and talent swept up in a digital acquisition, money talks. But often – and perhaps even more so amongst disruptive startups – other factors hold more loyalty sway. While there’s no universal truth around motivation, those building innovative start-ups may be motivated by their role in building something revolutionary more so than their monthly paycheck. This sense of mission is pervasive and a unique motivator within the startup community – essentially, this sense of motivation acts as the rocket-fuel needed to propel a start-up to greatness. This is why companies need to identify and communicate what an acquired team can achieve by working closely with the acquirer. Conventional motivators may not work here – for instance, big earn-outs and hefty stock options won’t necessarily placate key talent that harbors anxieties around losing their identity, culture or sense of autonomy.
Acquirers must therefore show that the innovation and values that gave birth to the digital technology in the first place remain valued in context to the direction the acquirer wishes to move the acquired company and team. Furthermore, for some, an acquisition represents the end of an entrepreneurial existence. Visions of bureaucratic management or having to navigate a convoluted leadership matrix can be terrifying for those accustomed to the start-up world. HBR offers some advice here: “...acquirers must accommodate the inevitable differences in decision-making speed [...] More broadly, acquirers may face the need to diffuse a digital acquisition’s risk-taking culture and mindset within their larger corporation.”
Traditional companies are fighting to maintain their position in shifting market environments. In doing so, many are recognizing that organic growth is unlikely to provide the capabilities, talent and innovation required to compete with today’s fastest-growing disruptive tech-fueled brands. More and more, a trend towards large companies acquiring smaller, more digitally-savvy companies, in a bid to boost their own capabilities, is being observed. In recognizing digital transformation as a growth enabler and by remodeling M&A processes to incorporate acquired digital competences, companies in the eye of the digital storm can navigate to safer waters. If executed correctly, such an acquisition strategy has the potential to steer a company from fading away to keeping-pace with or even leap-frogging the competition.