I know what makes an M&A successful. I’ve participated in successful M&As, and I’ve studied successful M&As. But I haven’t seen anyone quantify the key factors in a merger and acquisition until I met John Jullens and learned of the study conducted by Strategy&.
Jullens is a consultant with Strategy&. I met him at the AWA Executive M&A Study, where he presented the eye-popping findings of Strategy&’s study on the role of capabilities in a merger and acquisition success. The big number:
The overall premium for capabilities-driven deals over other deals was a 14.25 percentage point compound annual growth rate.
That’s a big, big, BIG number. Let’s take a look at why it’s so important, and dig into the specifics of capabilities-driven deals.
The Right M&A Metrics Can Yield the Right Strategy
I’ve stressed on this blog how critical metrics are for success. From Tom Hubler’s advice to base family businesses on a metrics-driven business system, to our continued insistence on the need for business valuations as a strategic tool, metrics can show you the path to success.
That’s why I was so excited about Strategy&’s study. It showed the quantitative results from a qualitative strategy.
Before we get into the study, here’s a little background on Jullens. As a consultant with Strategy&, he works with Fortune 500 companies on developing M&A strategies. While Jullens works with companies of larger size than our mid-market focus of up to $10M in revenue, the fundamentals in the study apply to anyone considering growth via M&A.
Listen to the audio interview here:
The Study: Three Types of Deals
From 2001 to 2012, Strategy& studied over 540 major global deals in nine industries, and concluded that deals taking into account the buyer’s key capabilities produced better results that local stock market indexes or deals based on other rationales.
They categorized deals into three areas:
1. Leverage Deals
Leverage deals are situations in which acquirers buy companies that will be a good fit for their current capabilities. A company may buy a smaller competitor to extend its marketing reach in a vertical sector they both serve.
For example, Essentra, headquartered in the UK, became a global leader in pharmaceutical and beauty packaging by acquiring US-based Clondalkin and gaining access to the US market.
2. Enhancement Deals
Enhancement deals are designed to bring acquirer capabilities it doesn’t yet have to intensify its own capabilities system. In the printing and converting world, 3M provides us with a perfect example.
3M, always looking for new innovative ways to add capabilities, acquired Original Wraps in 2011 because of the company’s unique personalization platform for vehicles and vehicle accessories.
3. Limited-Fit Deals
This is a transaction that doesn’t improve upon or apply the acquiring company’s capabilities system in a major way. In this deal, a company may acquire another company so they can pool accounting or distribution resources.
While not as printing industry-related as the first two deals, Nestle’s acquisition of Pfizer Nutrition is an example of a limited-fit deal. It provided access to new geographic locations for Nestle, but no capabilities were added.
The Results: Capabilities-Driven Deals the Big Winner
As a benchmark for success, the study compared the local market index to shareholder returns. Note the 14.2 spread between capabilities-driven deals (which is a combination of leverage or enhancement deals) and limited-fit deals.
It should be noted that these are average returns. The highs are much higher and the lows lower with enhancement deals.
That makes intuitive sense. With a leverage deal, you’re going to build onto the things you already do well. With the enhancement deal, you’re venturing into unknown territory - working in areas outside your expertise.
There is a greater chance for higher returns with an enhancement deal. There is also more risk.
What is the Intent of Your M&A?
When you break down the M&A deals even further into specific goals, once again you see Capabilities-Driven deals are the clear winners -- especially those based on consolidation.
Check out the returns based on the goals of each M&A deal:
Product/Category adjacency is the natural inclination for companies pursuing an M&A deal. Companies want to grow from their core into adjacent categories. Yet consolidation typically yields better returns.
What Type of Capabilities Should You Pursue?
If you’re going to use a capabilities-driven approach to M&A, it’s essential that you understand the three types of capabilities, and which one can result in the fastest sustainable growth path for your company:
1. Lights-On Capabilities
These are the essential things you need to run the company, but aren’t critical to your overall success. Your ability to distribute payroll, for example, is a basic function of being in business.
2. Table-Stakes Capabilities
These are the capabilities that allow you to be competitive in a market place. Do other printers in your geographic region offer wide-format? If you want to compete against them, you need to do the same.
3. Differentiated Capabilities
These are what truly makes your company unique and gives it a competitive edge. They meet the following criteria:
Value: Does your target’s capabilities add value to your customers? Can that value be quantified and proven, so that you can trace the direct ROI of your efforts?
Rare: Are the capabilities commonplace in the market, or are they rare? Do your current customers have access to this capability through the marketplace, or are you bringing something new to the table?
Difficult to copy: Does your target have a capability that is difficult to replicate? Nothing is impossible to reproduce, but the harder it is for the competition to duplicate your product or service, the more unique (or rare) your offering becomes.
Difficult to buy and sell: Does the addition of an acquisition make your product or service difficult to break apart? For example, if the competition can piecemeal your offering, then you can be replaced.
In a leverage deal, your company already possesses differentiated capabilities, and you want to add more to build scale. In an enhancement deal, you’re looking to add differentiated capabilities that you don’t already possess.
The ultimate goal, however, is when your acquisitions create a company in which all the various differentiated capabilities mutually reinforce each other.
Mutually-Reinforcing Capabilities: The Toyota Difference
Jullens uses Toyota as a classic example of a company that has developed a series of capabilities that integrate the “building scale” criteria above.
Toyota was able to build excellent cars at a lower cost because of their interlocking capabilities. From lean manufacturing to the way they do purchasing and product design, all of their capabilities support each other.
“If you have 3 to 5 capabilities that mutually reinforce each other, it becomes all the more powerful,” Jullens said.
Don’t Overlook the Importance of Execution
The study’s findings show the overall success of capabilities-fused deals. But that doesn’t mean that capabilities will always succeed, or conversely, that a limited-fit deal can never produce excellent returns.
“People overestimate synergies,” Jullens explains. They get caught up in the heat of the moment, and they forget to consider the mechanics of an M&A, such as the importance of blending cultures; communicating goals; and defining new management roles.
What looks good on paper doesn’t always translate into positive returns. It’s smart execution that contributes to 14.2 percent returns. However, Jullens is careful to point out that while execution is important, if you don’t have the correct strategy in the first place, the deal isn’t likely to succeed.
Numbers Don’t Lie - But Take Them With a Grain of Salt
Why do we get excited about studies like this? Isn’t Strategy& proving the obvious?
It seems like they’re quantifying common sense - and they are. But in that quantifying of successful M&A returns, they’re also helping us prioritize our decision-making.
We have statistically-valid information that shows us the criteria for success. We know that capabilities-driven deals yield the greatest chance for success, and that limited-fit deals are an uphill battle.
Strategy& have provided us with a clear sense of what has worked in the past. Now it’s up to you to determine how to make it work for your company in the future.