by Craig Mullett, President, Branison Group.
The "new normal" of a bumpy economic recovery is placing more emphasis on how to grow the top line of large connector companies. In this tough environment, innovation that translates into the needed revenue growth is highly sought-after by interconnect management teams. While research-and-development (R&D) spend has been seen in the past as the leading indicator of success, a strong case can be made that strategic merger-and-acquistion (M&A) spend is now a more powerful predictor of future innovative growth. Several factors, detailed here, contribute to the effectiveness of M&A versus R&D for connector companies.
Making an immediate impact
Acquired businesses deliver incremental revenue streams immediately after closing, while the R&D process can take years to deliver a new-product revenue stream. Proven products already being purchased by a target's customers allow for a much quicker cross-sell to the acquiring company's existing customer base, as evidenced by Tyco Electronics' acquisition of ADC announced in July. A new product internally developed through R&D would typically require beta customers and testing periods before gaining the same level of acceptance. The cross-selling of new products frequently generates new applications for those products, fostering further innovation and consequent revenue growth.
Innovation: More than just product
Most R&D is product-focused, which often ignores the other powerful forces that drive innovation. Acquiring target businesses can bring not only new products, but also new markets, new customer segments, new suppliers, new domain knowledge and new talent to the acquiring company. Smart acquirers are able to leverage the effects of the infusion of this "newness" through carefully planned strategic integration of the target with the acquirer. Harnessing the energy and smarts of acquired entrepreneurial teams can also enhance the dynamics of organizational innovation.
Best use of relative strength
The efficiency focus of modern corporations struggles with small product runs, even though a slow numeric start is expected with most new-product introductions. Internal R&D efforts are often mismatched compared to smaller competitors that are entirely focused on developing and selling a smaller product set. The upside rewards that an entrepreneur can receive for success will almost always exceed the annual bonus of an R&D engineer. Internal engineers are also more likely to "play it safe" and strive to hit singles that allow them to keep their jobs, rather than risk it all swinging for the fences. Recognizing this, large companies are increasingly outsourcing this phase to startups and smaller companies, then buying the best when critical mass is reached. This model is frequently used in the pharmaceutical industry looking for new breakthrough drugs and also by consumer-goods companies looking for new brands.
Better risk/reward ratio
Many R&D projects are evaluated using complex capital payback models. These models are by necessity filled with assumptions that will be wide off the mark, as the projects are frequently being evaluated before any significant product success or cash flow has occurred. In an acquisition, the cash flow track record is already in place and payback models can more tightly model future success with fewer variables, such as the FAKRA product-line acquisition by Rosenberger from Huber & Suhner.
Narrow pipeline fills quickly
An active acquirer should be able to strategically narrow the focus of an M&A process much more quickly than a comparative analysis of R&D product-development options. A finite number of "perfect fit" targets exists, while new products or product modifications could be endlessly developed internally. Using outside professional advisors to enhance filling the M&A pipeline and accelerating deal flow will increase the probability of success compared to internal R&D efforts.
As corporations decide how to spend their accumulated cash, every R&D project should be compared to the M&A alternatives. A structured "buy or build" questioning process, which plots out how innovative growth is planned, could create tremendous shareholder value in the future.
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