Adding capabilities

In the search for growth, what’s the most important question on business leaders’ minds? Our survey says: “how can I future proof my business?”  It’s a central issue for companies and one that we think is changing the way they are thinking about deals. Companies are still buying for reach and scale; but increasingly they’re looking to buy skills, IP and talent to stay ahead of the curve in this digital age. So, this week we’re looking at the rise of capability-based transactions. Why and how are companies refining their strategies?

Not if, but how…

In our recent global survey ‘Dealing in a Digital World’ we found that almost three-quarters of respondents said that digital has had a “substantial or transformative effect” on their business operations and processes and two-thirds said it was having an equally strong impact on their relationships with customers.  Just one per cent strongly believed that digital was having a minimal impact on their industry. Of the 600 executives we questioned, 90% said that their companies faced increasing competition from companies that had embraced digital.

CCB Boardroom Agenda1

So it’s hardly surprising that, despite undoubted economic and political disruption,  it’s the impact of digital technology that tops the global boardroom agenda in our latest Capital Confidence Barometer (CCB)  – whilst also coming close second amongst UK executives.

Bigger isn’t always better…

CCB - deal sizeCompanies are responding to the challenge in the M&A market, taking one of the fastest strategic routes to fill their capability gaps. The mega-deal is by no means dead, but companies are refining their strategies and looking for more than scale. A big leap in the percentage of companies looking for acquisitions under $200m reflects this shift in thinking to more strategic purchases. When looking at companies’ prime drivers for deal making, the quest for market share and geographical reach isn’t dead; but companies are recognising the need to make acquisitions that provide access to new technology or talent and the attraction of innovative start-ups to stay ahead of the curve and drive innovation in their own businesses.

CCB - M&A strategic drivers

The last few years, we’ve seen a great leap in non-tech companies buying technology companies – a trend we expect to accelerate as sectors continue to blur and converge, customers change their needs, and technological change marches onwards. Executives will need to continually reassess and reinvent their businesses and think about new capabilities – and therefore new transactions. Although M&A isn’t the only route companies can use to stay relevant.

Tech buying non-tech M&A

Partners in tech

The automotive sector – previously one of the most traditional – is being subjected to game-changing disruption all along the value chain. From the fundamentals of how a car is actually built, propelled and controlled to the development of ‘smart cars’ and flexible concepts of ownership there are new paradigms and consumer expectations. Car advertisements seem to be as much about connectivity as performance – indeed connectivity could now be said to be an essential part of a car’s performance metrics.

Automotive companies have responded by doing deals in key areas to add to their capabilities and meet this disruptive challenge. But, if we look at our heat map, there has been more activity in joint ventures (JVs) and alliances than in traditional M&A in recent years. Industry convergence is creating greater opportunities for collaboration and companies may choose this route because it isn’t possible or advantageous for them to acquire all the capabilities they need to compete. The automotive industry is now such a huge ecosystem that no company could possibly hope to cover it all from end-to-end. JVs and alliances enable companies to share risk and split their capital across more options.

CCB - auto heatmap

And with the speed of change being so fast, it can be better to take a more flexible approach. Control is becoming less important in some areas than access to technologies and expertise. This trend is by no means limited to the automotive sector, with companies increasingly looking at JVs, including those outside of their own sector to gain access to new products or service innovations.

CCB - JV outside sector

New approaches

The scale of transformation required – and the constant need to adapt – will require companies to take a holistic view. Digital should be a key component of capital allocation, with companies finding the best combination of organic investment, strategic M&A and JVs and alliances. Success obviously isn’t achieved by simply buying up a selection of ‘online’ assets – a mistake made in the past. Boards need to build a digital vision that aligns with their overall strategy, looking deeper into where the value now sits in the supply chain and perhaps rethinking long-held assumptions about the deal process and integration.

Buying and building capabilities might not be new, but the speed with which companies need to act is different, as our Dealing in Digital survey shows. Companies may need to take greater leaps on valuation and diligence than they are used to – also as discussed at last year’s EY CDO Summit.  Buying fully-fledged ‘disruptive’ assets can seem expensive, especially if the rest of the industry is looking in the same areas. But, buying earlier in the lifecycle means purchasing smaller start-ups with less data and surety. Either way, integration issues are different to other transactions. The early-stage business will need careful nurturing and in both cases the purchaser will need to ensure that the acquired asset retains a entrepreneurial and innovative culture. In this sense, the corporate acquirer is acting more like a venture capital fund, which is why more companies are creating their own corporate venture funds – as I’ve talked about here previously.

Thus, companies will still buy for reach and scale; but it has to be meaningful scale, with access to capabilities that enable them to lead their market.