To achieve its mission, a company must have a balanced approach to growth through innovation and acquisition. The common denominator to successful execution is a commitment to tried and true market research, competitor intelligence and due diligence. For any company, the business decision to expand – whether organically or via acquisition – comes down to an assessment of opportunity versus risk.
But before either opportunity or risk can be considered, we need to know our market state. Questions about market state that need to be answered include:
- What is the expected growth of our current market?
- What is our relative competitive position in the market (have we lost/can we gain market share?)?
- What are the competitive dynamics of the market?
- Is there sufficient room to innovate (beyond minor unneeded tweaks or slight changes in formulation with a “new and improved” sticker on the package perhaps with a higher price)?
- Do we have adequate market presence today (enough salespeople, channel partners, including web geographic reach)?
In other words, have we maximized what we can do in our current market with the resources we have allocated given the market’s expected growth rate?
After we have answers to these market state questions, we can turn to opportunities and risks of expansion. This is a question of risk/reward that varies under the following scenarios:
- Is this a product line extension into our existing market?
- Is this a product line extension that we plan to introduce into a new/adjacent market?
- Is this a completely new product that we plan to introduce into our existing market?
- Is this a completely new product that we plan to launch into a new/adjacent market?
The bottom line on all of these is does the ROI support value creation?
Scenario #1 is the lowest risk. Assuming we have good answers to the market state questions above, then we analyze what the opportunity for this line extension is in conventional terms of revenue, margin and profit. We offset this against the risks, including cost of resources, including capital, cannibalization, competitive response, etc.
Scenario #2 is the second least risky. We need to fully assess the characteristics of the new/adjacent market – just like we did with our existing market. Then we repeat the opportunity/risk exercises in Scenario #1.
Scenario #3 is the third riskiest. We’ve already done the work on our existing market, so we can dive into the opportunity/risk exercises again with a little more confidence.
Scenario #4 is the highest risk. This is a blending of the new/adjacent market analysis from Scenario #2 with the opportunities/risks assessment exercises.
An ongoing process with inertia as the greatest risk
This process should be an ongoing one for every company. It allows management to keep its pulse on its own market, but also be aware of what is happening in adjacent markets. In technology, this is particularly critical as so often technologies overlap and converge to solve different pain points in different ways.
Start-up entrepreneurs are often so focused on the engineering aspects of creating and enhancing their products that they get blinded by merely trying to out-compete/out-run the big guys. The mission and principles of building a business tend to get short-changed as a result. Building a better mousetrap is not enough; the lesson about the company that is first to the market or has the best product in the market not winning the market continues to be repeated.
The only sin is inertia. We all know that models are flawed by inaccurate or incomplete data and inherent bias by those doing the modeling. There are as many projections on a market’s potential growth rate as there are prognosticators. Given this, the KISS principle applies: the new/adjacent market is higher growth than our existing market, it approximates the growth of our existing market or it is below the growth of our existing market. Don’t rule out the last one, because entry into a slower growth market can still represent incremental revenue and return for us vis-a-vis the competitors in that market.
If we decide to acquire, how do we mitigate the risks?
After all this, the analysis can turn to whether we should acquire:
- A competitor in our market to consolidate the market
- A company/technology in our market that gives us a faster path to entry than developing a product extension
- A company in the new/adjacent through which we can sell our existing product
- A company/technology in the new/adjacent market
Acquisitions should be viewed as a supplement to, rather than a replacement for growth and value creation. But many are often made under short-term pressures to show growth. Many are made purely on ego. A banker strokes a CEO with the image of being a business titan by making “XYZ” acquisition.
I have had CEOs tell me how dismayed they are at some of the suggested deals bankers bring to them. One CEO at a public company with a mid single digit market cap said, “They demonstrate no understanding of my company’s fundamentals, mission, strategy or markets. Instead, they are trying to drive short-term fees by baiting me into inappropriate deals”.
Another reason why so many acquisitions fail is inadequate due diligence by the company. Even when a deal seems sensible from afar, issues with culture, technology integration, go-to-market models, changing market dynamics, etc. are not fleshed out or understood in advance. Acquisitions also fail because the new parent tries to meddle with the acquired business. This causes an exodus of the intellectual property (IP) and entrepreneurial cache, leaving a shell of its former self.