“Wise men say, only fools rush in,
But I can’t help falling in love with you”
These are the lines from the famous song by Elvis Presley. People who know me well, know that I love creating analogies between apparently disconnected things but ideas that seemingly have a logical angle.
In this article, I use the initial lines from the lyrics to create an analogy for creating a competitive advantage through M&As.
Creating a true competitive advantage happens in an M&A when two companies bring their core strengths to collaborate and create a new or highly improved solution. When employees from the two companies spend considerable time together in a focused manner, they can start unlocking a significant number of opportunities to create an advantage.
On the other side, companies who pursue a slash-and-burn approach on cost synergies, especially those who drive mass headcount reduction within the first quarter, end up destroying capabilities. While companies find it logical to remove costs as quickly as possible to make their financials look better, they end up destroying the very capability that created the competitive advantage of the acquired company. These impacts may not show up right away but when it hits, it hits badly. Four out of five companies within 12-18 months show a negative return on the acquisition. Within a couple of years, the acquired company completely disappears or needs to be carved out and sold at a loss.
So, what is it that many companies completely miss during an acquisition?
Wise men say (and they observe, learn, and implement),
Only fools rush (others just go blindly to reduce cost without understanding the full implication on capabilities),
But I can’t help falling in love with you (Most companies are so enamelled with the glamour and glitz of an M&A that they get blindsided and end up destroying critical aspects of a business)
The hullabaloo of the pre-deal stage gives a false impression that a business can gain a competitive advantage just by simply changing the ownership of the company. And by buying a company, they can lay their hands on the secret sauce of competitive advantage which will give them immortality.
Unfortunately, this is a hyperbolic illusion that many companies fall prey to.
1. Access to information
Secrets of competitive advantage are not necessarily available outright. This could be because the acquired companies never fully understood what created their competitive advantage. Or even if they did, they never codified that information. In the absence of any formal documentation, the exact information is extremely hard to come by.
In other cases where the secrets of competitive advantages are known and tangible, these are codified into intellectual property and fiercely guarded.
The reality is that details about competitive advantage do not get shared either because of anti-competition regulations or because the company leadership is protecting them.
No matter what, any information that is made available during the due diligence process by design will never spell out the competitive advantage details. Period.
The interesting part is that even after the acquisition is completed and the ownership transferred, the self-appointed guardians of the secret sauce will still not readily share the information. In fact, you will need to ask the right and specific questions to elicit any response.
2. Competitive advantage is not a binary state
Competitive advantage is not a binary state. It is a combination of several discrete elements that work in tandem to create an advantage. It is a specific combination of operating model, organizational structure, culture, leadership, and people that create a competitive advantage configuration.
This configuration due to competition rules cannot be unlocked prior to the closing of a deal.
Moreover, understanding and unravelling a configuration is a journey that takes time, effort and deep understanding before an advantage can be created. This understanding process can only take place once the deal has been consummated.
So, is there a standard set of elements that define a configuration?
A competitive advantage is a result of a configuration that is created based on the following elements:
- Financial elements: These include your financial conditions, valuations, risk management, supplier and customer terms and conditions, strategic and business financial planning. The financial elements give you the right levels of cash flow at the right time that can be used to generate more sales. Right levels of terms and conditions can shorten or elongate your cash cycles. Funding received at the right valuation can help create new revenues, new operating models or help in cost optimization. Financials can contribute to favorable pricing. A subscription-based model creates a massive continuity of clients and gives a significantly higher valuation. A higher valuation and a good financial position can get companies debt financing and even investments in a more competitive position than otherwise.
- Systems and Information elements: How data is captured, treated and how knowledge is created based on the information. How is the information stored, shared, and protected? How do employees use the systems to manage their operations, support as well as manage their relationships with their customers and suppliers? These days having the right information at the right time can be a great source of competitive advantage. Whether it is a market intelligence, real-time inventory positions, days sales outstanding, sales conversion and others can provide huge insights and create a position of advantage.
- Product portfolio: Is the company based on a sole product or is there a product portfolio that has products, services, products-for-free, consultation and advisory, solution design that provides a comprehensive package to a customer. Having a full portfolio can give better returns for the same sales and marketing effort.
- People assets: These would include skills, talent, organizational agility, and leadership that work in tandem to give a competitive operating model.
- Marketing and Brand elements: Are you perceived as an innovative company? Is your company associated with excellent operational delivery? This reflects the values that the market associates with your company. It also, includes your positioning in the market, your partnerships, as well as relationships with other players in the market.
- Innovation and IP (Intellectual Property): Are you a commoditized business or do you have innovative products or solutions? Commoditized businesses compete on price and price constantly keeps eroding as more competitors enter the fray. On the other side, companies that innovate and design new solutions can charge a premium for their services and products.
- Industry and market orientation: Are there large customers or suppliers that rule the market? Is your company dependent on one or two large suppliers or customers? These dependencies can completely wipe out a competitive advantage overnight whereas companies that have an adequate distribution of suppliers and customers can hedge their market risks considerably.
It is not enough to have an excellent product to be competitive in the market. A company must have a winning configuration to create an advantage. You cannot sustain a competitive edge with a great product with average marketing. Similarly, a great marketing effort for a below-average product will kill your brand in no time.
Superior post-sales support can be a major source of advantage. Similarly, providing a subscription-based model can massively bolster affordability for the customers.
As you can see, these elements need to be first identified and analyzed before opportunities can be unearthed that can be converted into an advantage. This process can only be justified if done post ownership transfer when access to information is fully available.
Here is a closing question.
Do you think that any company can ever unearth a source of advantage just through a due diligence process?
If not then, “Why do fools rush in?”