How could the board of directors approve millions for acquisitions but ignore early attempts to explore formative markets?

It starts like this:  Sales sees the market opportunity first.  It is a sensible request from a growing client.  But no one else in the industry is doing it.   Sales approaches the Solutions group who points to Product Management who points to Marketing.  The Head of Marketing floats a few proposals, but none get company-wide support.

It’s not a lack of interest.  The entire company is deep into maintenance mode.  No one has the budget, the skills or the charter to investigate and validate adjacent markets.

Overtime, the nascent market that was identified by sales grows to a quantifiable size.  The company has waited too long and is missing the market.   Research firms are reporting growth projections and the CFO is able to detail a financial argument.  The urgency builds.

The fear of missing out empowers the CFO to acquire a target at extraordinarily high multiples. However, the business objective has changed. This is no longer a market-building exercise, it is a financial transaction.  Once the deal is finalized, the job is considered complete.  But the likelihood the   acquisition will contribute real value or even profits to the acquirer is highly unlikely.

Most acquisitions lag considerably in profit contribution.  In fact, McKinsey & Company reports that 70% of the acquisitions they track fail to achieve the anticipated revenue synergies [1].  And, empirical evidence for public companies shows 65% of acquisitions destroy value [2]. On average, the buyer pays a premium that equals all of the value generated by the merger [3].  Known as a ‘winner’s curse’, buyers consistently overestimate and over pay [4].

Even though the company purchases a revenue stream, it cannot capture the value of growing an early market. Buying into a market that is already formed, the company misses the high growth phase. They have foregone first mover advantages.  They have missed the opportunity to build a majority market share, erect barriers to entry and shape consumers’ buying preferences. Hesitating to enter the market, the company has also become less relevant to the early adopters in its client base.  Eventually the capabilities to seek and build new markets wither.

To many executives, the idea of waiting for definitive financial proof feels conservative.    But, in reality, this assumption puts the company’s profits, relevance and long term survival at risk.   Instead of nurturing early markets, the company over spends and under benefits.  It’s like missing the on-ramp to a highway only to buy a billboard to claim a presence on that road. 

Point Blank

Rather than nurture an early market, when a profitable leadership position could be forged, the company waits until a financial argument is decisive, and moves too late.   By then, the market is in the second or third phase of development and the company is one of many fighting price wars and replacement sales.

Waiting for definitive financial proof may feel conservative but it puts the company’s profits, relevance and long term survival at risk.  It’s like missing the onramp to a highway only to buy a billboard to claim a presence on that road. 

TAKE ACTION: Nurture Markets Early

 Bring a new conversation to this year’s plan: Demonstrate the value of exploring adjacent markets in their formative stage.   Questions to ask include:

• Who holds the budget and responsibility to investigate adjacent markets and emerging markets?
• Is there a framework to facilitate the funding, testing and validation of new initiatives?
• How can we benchmark the market share and profit contribution of organic growth versus growth through acquisitions?

Footnotes

[1] Scott A. Christofferson, Robert S. McNish, and Diane L. Sias “Where Mergers go Wrong” McKinsey Quarterly, May 2006

[2] Donald L. LaurieYves DozClaude P. Sheer ”Creating New Growth Platforms” Harvard Business Review, May 2006

[3] Hans Bieshaar, Jeremy Knight, and Alexander van Wassenaer, “Deals that create value,” The McKinsey Quarterly, 2001 

[4] Richard H. Thaler, The Winner’s Curse: Paradoxes and Anomalies in Economic Life, Princeton, New Jersey: Princeton University Press, 1992

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