Strategic Acquisitions for Software and Technology Companies

Acquiring new products or whole companies is a popular activity for many growth and market-share oriented companies. Is it a good idea?

Well, as I often say--it depends. I get involved in company or product acquisitions quite often in my consulting practice. There is nothing inherently good or bad about acquisitions in the technology business. However, there is nothing inherently bad about opening a restaurant, either. Nonetheless, a very high percentage of restaurants (I've seen figures as high as 90%) fail within 5 years. The failure rate for acquisitions may not be quite as high as for restaurant startups, but technology acquisitions are also judged to be failures at shockingly high rates. Caution should rule when approaching either of these very popular activities. As I'm fond of saying about success or failure in any complex business activity--the devil's in the details.

Common Motivations for Acquisition Activity

Let's examine the common reasons that acquisitions are considered in the first place:

1) It's exhilarating and "sexy" to buy another company
2) Growth for growth's sake (often pushed by investors)
3) The belief that buying a competitor is the ultimate "victory"
4) A consolidating market (often commoditizing) where there is only room for a few large players
5) Diversification
6) A great strategic fit where 1+1 truly equals 3

As you might have guessed, reasons 1-3 above aren't great justifications for such a risky activity. Number 4 can be a good justification, but often this is given as the rationale, when the actual market case doesn't truly support it. Number 5 can be a good or bad rationale, depending upon whether the business case really calls for diversification--or if focus would make more sense. Number 6 is by far the best reason to acquire a company, particularly if you aren't an industry giant, pitted in a death match with another titan of your marketplace.

So let's say you've actually thought it through, and have used sound analysis and judgment in deciding to pursue an acquisition. Congratulations for passing the first test--but there are still myriad things that can trip you up, on the way to acquisition success:

Great Ways to Fail

First acquisition done "on your own"--I strongly urge all first time acquirers, whether of the product or company variety, to seek assistance. Acquiring a company and even a product is very complex, with a lot of places to trip up. Retaining an experienced hand that has seen and gone through the mistakes before, can prevent you from the most expensive education of your life.
Bad cultural fit--In the excitement of an acquisition or a merger, people have a tendency to not look past the surface. It's much like dating an attractive potential mate, and proposing based upon infatuation, without establishing whether there is common ground in the way you live your lives. This is the business equivalent of marriage, folks. Compatibility in business philosophies and practices is crucial--and often overlooked, until after the fact, when everything is unraveling.
Poor organizational integration-- Even with an excellent evaluation of potential partners, a great many mergers fail based on the execution of integrating the organizations. That's because it is HARD. You are generally merging two organizations with disparate operating styles, as well as overlapping functions and people. Fear, uncertainty and doubt of the individuals involved can by ITSELF scuttle a potentially great fit. This area is often quoted as the reason most acquisitions fail.
Poor product integration--This is the reason a lot of acquisitions in software and high tech should be called off early in the process. It is often very difficult to rationalize how you are going to support two different code bases or technologies, aimed at the same market. The plan usually call for integrating them over time, but that often proves to be very difficult from a technical perspective. This is a real red flag when buying a direct competitor. Yet the price of the merger in high tech often assumes that the products can be integrated acceptably, without losing customers from either of the existing products. Unfortunately this is usually a very tall order
Paying too much--Price plays a big role in software and technology acquisitions. Due to high growth rates and the perceived need to move quickly in fast-growing, competitive technology markets, acquisitions are often priced in multiples of revenue. This is in contrast to the more conservative multiples of EBITDA in other less dynamic industries. Often the target isn't even profitable yet, but still commands a high price-to-revenue multiple, due to the "hot" nature of the market space, and perceived value of the acquired technology. This high price puts a severe strain on downstream execution of the merger to be "perfect", as discussed above.

So with all of the landmines out there in the acquisition arena, along with the high failure rate, is it simply nuts to consider acquisitions? Doesn't it make sense to just stay away from them? NOT NECESSARILY.

Sound Approaches to Pursuing Mergers

Buying innovation--This often happens when companies reach a certain size; they simply lose their ability to innovate. Rather than innovate internally, they do so by acquiring small companies with market-changing technologies, which may not have the resources to fully exploit in the marketplace on their own. Even though multiples here tend to be high, risk is somewhat mitigated relative to internal Research and Development that might not "pan out", and the size of the acquisition is often very modest, relative to the resources of the acquirer. This is an example of a true 1+1=3 strategic fit. This strategy has been used with great success by Cisco, Microsoft, and many other large companies with successful acquisition programs.
Buying companies or products that truly fill a hole in your offering--While some companies tend to overuse this as justification, acquisition of a reasonably priced company or product at just the right time, can mean the difference between continued growth or inevitable stagnation.
Buying undervalued assets--This is harder to do in high tech than in other industries; high tech companies have a habit of overvaluing their businesses and technologies. But an executive team with a key eye for a bargain can often pick up a diamond in the rough, for example a division that has suffered because it isn't a good fit with the parent company's core business
Truly appropriate diversification--Sometime you run out of steam in your current market, and the amount of cash flow generated by your current business dictates that an investment in another growth area may be prudent. The key here is to pick a market segment adjacent to the existing business, or at least a business that the management team can easily adjust too. However, management teams often are over-confident and deceive themselves, and end up investing in an area where they really don't belong.


I could go on and talk more about acquisitions for a very long time. But instead of putting you all to sleep, let's begin a dialogue on this topic. Inform us of your own Merger and Acquisition stories, best practices, and cautionary tales.

Phil Morettini
PJM Consulting
http://www.pjmconsult.com/