KUHN CAPITAL Wednesday, October 18, 2017
Dispatches from the front

Let's Make a Deal

From the McKinsey Quarterly

Gold-standard companies understand that if transactions are to support larger strategies, as they must, those transactions should also reflect either the position of a company on the S-curve or the place where it wants to go. Our examination of the transactions of top performers showed precisely such consistency. These companies define a small number of investment themes — one to three in most midsize companies, five to ten in very large ones — that move them to or keep them at their desired place on the curve. In emergent markets, companies seek ways to build their customer base or to prove their technologies, often by striking deals or forming alliances with more established companies. The deals of companies at later stages of development are intended to build capacity, control the platform, or strengthen customer relationships.

Qualcomm, for example, found itself climbing the growth curve around 1995, 10 years after it was founded. The company decided that wireless infrastructure and handsets, then a large portion of its business, were no longer economically attractive or strategically important to its ultimate goal of profiting from the intellectual property it had built around the CDMA (code division multiple access) transmission protocols.

Adopting a "promoting innovation" theme, the company sold its handset and infrastructure businesses and concentrated on extracting value from its CDMA intellectual property. This approach drove a patent, alliance and licensing strategy that enables Qualcomm to realize this value from its semiconductor design operations and from royalty streams generated by wireless-infrastructure and handset manufacturers. As a consequence, CDMA is now the fastest-growing wireless technology and the standard for most third-generation mobile networks.

Climbing the curve
High-performing companies also revisit their strategies as their position on the growth curve changes. BEA Systems, a maker of applications-server software, did more than 20 deals from 1996 to 2001. Its "build a customer base" strategy was consistent with its entry into new markets. As its initial products took hold, BEA climbed the growth curve with a "manage the customer relationship" strategy, purchasing WebLogic and several other product and technology companies, along with some small training companies and service providers. In the three years ending November 2001, BEA’s stock price increased by 424 percent, for a 74 percent compound annual return to shareholders.

Deals gone wrong, by contrast, can often be traced to a disconnection between the transaction and the market’s growth curve. The IBM-Apple Taligent venture suffered operational and organizational breakdowns, but it basically fell victim to strategic misalignment. Taligent had banked on a "promoting innovation" strategy in hopes of capturing a share of the desktop operating-system market, which IBM and Apple viewed as still developing. In fact, the market had already grown well beyond that point, and Microsoft was consolidating its gains with a "controlling the platform" strategy for its Windows operating system.

Every separate business owned by a large diversified corporation lies at a different point on the S-curve. By plotting each of these positions, the corporation can assess the one it as a whole occupies, whether it wants to remain there, and the kinds of strategic acquisitions and divestitures it must make to move it in the desired direction.

Of course, such decisions can be made only by the corporate center, which is likely to want to divest slow-growing, noncore businesses and to invest in or acquire new growth positions earlier on the curve. Companies such as Corning, IBM, and Intel look to corporate business-development teams to work out transaction programs that not only take into account the maturity of the individual business units but also treat them as assets in a portfolio whose particular mix decides the fate of the parent. It is part of the assessment to view the position on the S-curve of every one of the parent’s businesses in relation to all of the others. While each business must be judged on its own terms, it is the combination—how the operations benefit and detract from one another and the company as a whole—that decides the parent’s overall position.

Corning, for example, has in recent years jettisoned low-growth consumer businesses approaching the top of the growth curve, made deals to strengthen the company’s existing optical-fiber manufacturing and distribution system, and built a portfolio of photonics products —- light-sensitive switches that sit at the end of customers’ optical-fiber networks. All three moves were initially orchestrated by the corporate center.

Intel, Microsoft, 3Com, and other companies have pursued similar strategies. IBM, under the leadership of Lou Gerstner, shifted its focus from hardware systems to services, software, and technology building blocks such as infrastructure software, semiconductors and storage. This repositioning led to a series of acquisitions, divestitures, spinoffs and alliances such as IBM’s broad 1999 technology partnership with Dell Computer. IBM’s largely autonomous business units, left to their own devices, might have lacked the perspective to embark on deals that, collectively, helped turn around the company.

Quick thinking
Frequent, focused deal making enhances the transactional skills of a company’s managers and thus increases the chance that any given deal will work. It helps managers identify strategically sound deals in the first place and to develop the collaborative skills to implement them. But to realize these benefits, managers must balance two competing imperatives: They have to think and act quickly, on the one hand, and execute exceptionally well, on the other. Gold-standard performers have fast and fluid decision-making procedures yet attend meticulously to the details of assessing, closing and, ultimately, integrating transactions.

In today’s volatile markets, the ability to move rapidly often determines the viability of a deal. The longer negotiations drag on, the more likely that market moves will render obsolete any agreement on pricing or structuring. Long due-diligence and negotiation processes almost always reduce the likelihood that a deal will be completed, and they drain the goodwill that is necessary if it is.

Companies that have already decided what kinds of acquisitions or alliances they need to make and know how these deals will fit into their existing structures can bring transactions to completion more rapidly than companies taking an ad hoc approach. The latter also often fall victim to protracted, bureaucratic decision making. The vice president for business development at one semiconductor manufacturer notes that his competitors’ slow decision-making processes give his company "a real advantage in getting a deal done."

By moving decisively, companies not only get more deals done but also are likely to be offered the more desirable deals. Potential acquisitions or venture partners prefer to work with companies that have a history of success. Thus some experienced acquirers report winning discounts of up to 15 percent.

The market correction of 2000 and 2001 has brought deal making almost to a standstill. After years of strong growth, the number of high-tech transactions fell by 53 percent between September 2000 and February 2001. Buyers and sellers alike are reluctant to move in an uncertain market. On either side of the equation, companies are consumed with improving their internal operations, not with driving growth and waiting for their valuations to rebound. Yet companies able to move quickly can still profit in such markets.

For more insight, go to the McKinsey Quarterly Web site. Copyright © 1992-2002 McKinsey & Company, Inc.

Ryan Kuhn

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