Is your M&A strategy too safe?

This week’s blog comes from Julie Hood, Global Deputy Vice Chair of Transaction Advisory Services at EY.

We’re all wrestling with how to future-proof our businesses. Digitisation and convergence have created bigger sector ecosystems with nimbler predators. The risk of being blindsided by a new technology or start-up has never been greater. Corporate longevity has never been shorter.

In this week’s Capital Agenda Blog, I’ll argue that companies can’t play it safe if they want to keep pace with change. It means taking on deals with less certainty. But, there aren’t many bigger threats to companies right now than the risk of being left behind.

The clock is ticking….

According to some estimates, around half of S&P 500 companies will be replaced over the next ten years. Some of this churn is due to mergers of near-equals; but we can all think of companies that have fallen behind and failed – or had their assets swallowed up by more resilient rivals.

Many of these companies disappeared because they failed to adapt to new technology and interlinked changes in customer demands. The question all companies need to ask is how they avoid becoming part of this trend.

Look beyond synergies

There isn’t one answer to this problem. But, what has really struck me recently is the number of companies that are stuck in a strategic paradox. Their boards grasp the issues at hand and the need for radical change within their business. But, in their M&A strategy at least, they are still playing it safe. They remain focused on buying similar businesses to increase market share and create cost saving synergies.

This type of deal is still strategically valid. Retail is just one sector where companies need to cut costs and M&A is an obvious route. But, in retail it’s also no longer enough just to buy more of the same market. Retailers also need to meet the demands of technology-driven changes in consumer behaviour – or else risk losing hard-won market share to nimbler competitors.

Understand your ecosystem

Large companies can be especially prone to paralysis, given the amount they have invested in the status quo. It is also very easy for successful companies to keep doing things the same way. As Bill Gates famously put it: “success is a lousy teacher, it seduces smart people into thinking they can’t lose”.

To avoid being blindsided by shifts in the value chain or new competitors, companies need to be watching their entire ecosystem. This isn’t easy. The automotive sector is prime example of how quickly technology and convergence can create a vast industry network.

Ideally, companies need to keep tabs on the strategic and M&A activities of not only their competitors, but also companies in adjacent sectors along with start-ups. It’s also vital to watch for changes in consumer behaviour – and this may also come from new data sources. It could be captured in internal data, but equally come from customer services functions and even younger employees.

Assess your portfolio

In EY’s 18th Capital Confidence Barometer, almost three-quarters of UK respondents cited portfolio transformation as the biggest factor driving UK deals – a strong sign that companies are seeking to deploy capital more effectively. A clear view of their sector ecosystem helps to ensure that a company’s portfolio review is based on an understanding of where value currently sits. This should then feed into a strong plan of action to ensure the business has what it needs to derive that value – be that investment or acquisition or even disposal.

Companies shouldn’t be afraid of selling previously prized assets to raise capital to invest in faster growing areas. Control of intellectual property used to be vital, but today’s value could be platforms and distribution. Changing market or regulatory conditions can also change the value equation.

Changes in emission regulations have accelerated the adoption of electric vehicles, whilst solar and wind are now either the same price or cheaper than new fossil fuel capacity in more than 30 countries. Together these forces have increased traditional energy companies’ investment in renewables. And major oil firms are investing in battery technologies and charging infrastructure to help them remain relevant on the forecourt – even in a petrol-free future.

Rethink deal making

As well as expanding their sector horizons, companies may also need to rethink long-held assumptions about the deal process and integration. Joint ventures and alliances are increasingly common in the automotive sector, where it’s become impossible for companies to buy all the capabilities they need to compete. JVs and alliances also enable companies to split their capital across more options – a positive advantage in an uncertain world, where it’s become expedient to hedge bets across a range of emerging technologies. Control is becoming less important than access to a range of technologies and expertise.

In deal integration, a lighter touch may be necessary to ensure that start-ups retain the entrepreneurial and innovative culture that made them such an attractive acquisition. In this sense, the corporate acquirer is acting more like a venture capital fund. Hence why more companies are creating their own corporate venture funds. Greater independence can also help to retain talent, which is often the primary driver for early-stage acquisitions.

Taking calculated risks

Change is uncomfortable. Companies accustomed to traditional deals, where they seek control of established businesses, will find buying and integrating early-stage start-ups especially alien. It’s not just the size of the business; but also the overall maturity of the organisation and length of management experience that will be unfamiliar. There is greater risk in ceding more control to management or sharing an asset with a partner. Valuation is also clearly much more difficult given the likely lack of data and track record.

But, on the other hand, once a technology is proven, a deal may not be possible – or will at least be more expensive. And if companies have done their homework on the changes within their ecosystem and perhaps engaged with other partners, then moving earlier becomes a more calculated risk.

The main message to take away here is that using M&A to obtain reach and scale, whilst still important, is no longer enough. Companies will need to take more calculated risks to ensure they gain access to the right technologies and talent. Otherwise they risk becoming just another corporate longevity statistic.