Part of my quest is to convey to business owners, particularly those of middle market and lower middle market companies, the tremendous opportunity to “build” proactively. Within this low organic growth environment, companies can grow by acquisition. The marketplace is populated with abundant resources ready willing and able to fund and support value-creation for a business. There is an art involved in defining the best proposition to embrace and execute to enhance your brand and offering. In short, enhancing your brand through acquisition can be an excellent strategy.
A Key Definition
The basis of any acquisition or organic growth initiative is to create new value. So, let’s define what this means… “Value creation” is defined as the outcome associated with increasing earnings of the proper quality (repeatability, composition, etc.), and the growth potential. At the end of the day, quality earnings and growth potential are the two predicates of valuation.
The current market setting is highly conducive to acquisition activity. This this is the “carrot.” The market-metric dashboard for acquisition activity is affirmative in five areas:
- modest GDP growth;
- decreasing productivity indices;
- tremendous liquidity residing within companies and the capital market;
- the low cost of capital based on the low cost of debt and relatively high equity valuations; and
- low VIX index which is a pro’s measure of uncertainty and fear.
A survey conducted by Deloitte indicates that CEO sentiment is currently oriented toward building proactively. Almost 60% of CEOs responding anticipate increased build activity, and over 70% foresee opportunities for significant high returns. These results are aligned with a Cogent survey confirming that acquisitions are now the best way to grow revenue. 80% of the companies surveyed companies are currently, or will be involved with an acquisition. So, a positive climate and orientation exist, but there is not too much unprecedented about this.
An unprecedented volume of business sales and wealth transfer are coming into the market over the next few years, which in turn, will equate to an unprecedented buyer’s market.
The number of companies owned by baby-boomers is at an all-time high (almost 40% of private companies are owned by individuals 55 years of age). These numbers afford unique opportunities for those companies that are prepared. The consequences for buyers include the ability to cherry-pick acquisition targets, and buy them at reasonable prices and terms. The consequence for sellers is that valuations will likely be decreasing and verticals will experience consolidation. In this environment, sellers might want to consider liquefying over the near-term. A second approach is to first become builders of value to further distinguish their offering.
In summary, today the setting is positive. Tomorrow acquisitions will be entering a new era. First-to-market buyers will benefit the most, and sellers need to think. How do I stand out from the crowd?
Since fear can become an effective motivator, there is a risk of not building proactively. So, these words are dedicated to those companies that believe “all is fine” and a “need does not exist.”
Two seminal studies burst this illusion. tThe Olsen study in 2008 looked at 500 companies over 50 years, while the Nunes study in 2011, encompassed 800 companies over 10 years. These studies concluded that those companies which do not regularly modify their product/service become “disrupted,” and recovery is very difficult. Disruption is a key word in the lexicon of Bain and McKinsey, and it is the bane of all companies. In short, disruption is a precipitous fall in revenue typically after the best year of performance, so a pre-disruption condition does not manifest financially (a silent killer).
The preventive counter-measure is to modify continuously, and based on the foregoing, acquisitions are considered the optimal prescription.
Since we have covered the key contextual matters, now we can get to the fun stuff. There are four different types of acquisition or build types, although only three should be considered, and one of those three is the superior option.
- Building the “core,” involves expanding the same offering to the same customer group. This is usually expressed in the form of acquiring market share to gain certain leverages.
- Building an “adjacency” involves a new offering to an existing customer group, usually expressed in terms of expanding the product or service line.
- Pursuing “related diversification,” involves providing a new offering to a related customer group, achieved by adding a different but synergistic business, e.g., FedEx/Kinkos.
- Pursuing “unrelated diversification,” is making a new offering to an unrelated customer group, by adding a different and non-synergistic business.
Can you guess what the most robust alternative is from a return perspective? If you guessed No. 2, Building an Adjacency you would be correct. Building an Adjacency is about bundling as much value as possible, or customizing an offering to a special segment of the customer group. In turn, this affords new and dramatic branding opportunities.
The Best Build Practice.
The generally accepted best build practice is to implement the “Duality of Growth,” a concept that focuses upon building the core, and an adjacency at the same time. In most cases, the former has an immediately actionable character, while the latter first requires proper analysis. Some of the more salient build considerations include:
- Modifying the Model vs. CVP
- Building vs. Buying
- Horizontal vs. Vertical Integration
- Revenue vs. Cost Synergy
Most companies modify their customer value proposition (CVP), since altering their business model is a much more invasive event. When it comes to organic vs. acquisition growth, the two key elements are the time to market for the former, and the target availability of the latter. Horizontal integration (aka the adjacency option) is the most prevalent build architecture because it possesses the most attractive risk reward relationship. Vertical integration should only be pursued if control becomes an integral consideration because this entails management of an entirely different business. Lastly, the most compelling propositions result in revenue synergy, which should be sought in all any acquisition analysis. Acquistions that result in cost synergy produce value, but not in the same profound manner as revenue synergy.
Advice: Implement the Duality of Growth, carefully locate and implement the best adjacency, remembering revenue synergy is king.
No. 4 Unrelated diversification should not be considered as a build option because the marketplace can replicate the diversification, so the proper value cannot be realized.
The “Black Box”
The key to a successful build option or acquisition is its original design. The weakness of most acquisitions has been poor integration. However, based on the availability of “swat teams” dedicated to effectuating integration, this element should no longer be problematic. Design, or defining the nature of the build/acquisition objective has been an art form. However, based on the advent of a proprietary best practice, I will argue it is now much more of a science. This best practice has five steps the end result of which is a value creation agenda whose engagement will produce new value and brand enrichment based on that company’s risk, capacity, resource, etc., profile.
Implement a Program
All companies should engage in a regular process dedicated to creating and revising a value creation plan. By the way, just having a plan can increase the “franchise” value. Many large companies use the process and its outcome to enroll and excite employees.
“People” best practices include creating a diverse group to create the plan, establishing a competing group, and dis-incentivizing orthodoxy. Some information best practices include obtaining information from the “edge of the company and the edge of its marketplace (“Edge-Centricity), segmenting data as much as possible, and testing ideas with customers.
While all companies possess a “strategic opportunity cost,” which is cost of “staying in the box” (and the greatest source of benign neglect), most companies will find an abundance of opportunities by implementing a formalized process. The challenge is differentiating among the choices, and thus, the imperative of design. The capital market will always support opportunities to create value.
An unprecedented buyer’s market is coming, and for those companies ready to act, the benefits will be substantial. When acquisitions are executed in the proper manner, there is not a more impactful event for a company, its ownership, its brand and its offering and competitive position in the marketplace.