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Growth Strategy

Companies inevitably face the question: how to grow the business outside your existing market? Emerging companies as well as established companies face this question. When a company is started, the best strategy is to focus on a single product and a single market to marshal all your resources towards winning that market. After a few years, you realize that the growth rates of this market and your own growth rates begin to slow.

The chart below provides a high-level framework for thinking about your growth options. Of course, the hardest part about strategy is choosing the best strategy with the highest possible return and the highest probability for your success. Additionally, no strategy is effective unless you know how to effectively execute on the strategy. That said, the first step is to understand the potential growth options.

growth-strategy

Offering Expansion
For product companies, the natural growth option is offering expansion, such as adding support, consulting and other professional services. When adding services, there are a number of considerations. From a financial perspective, services have a different margin profile and business model, and may impact your financial model. From an operational perspective, this requires adding a services organization and usually requires changing internal processes to accommodate the new business model.

Another growth option is to add tangential products and move towards a solution offering, adding different hardware and software. The different solution offerings are usually third party products. Although this can increase revenue, the growth is incremental and doesn’t open up new market opportunities. Additionally, this can have different margin and logistical impacts for the internal organization.

Vertical Expansion
With vertical expansion, companies acquire different partners in the ecosystem or decide to directly compete with these partners. The two most common vertical plays are expanding into the go-to-market (GTM) area and supply chain area.

With GTM, this often happens in foreign markets where you utilize local partners to build a country/regional market presence for your products. You need to decide whether you want to directly enter the market with your own sales force or acquire the local partner. With the supply chain, this often happens when a supplier has high margins and you see the opportunity to reduce your costs by making a competing product or acquiring the partner.

New Market Expansion
With new market expansion, you are looking for new markets to enter that are unrelated to your existing business. Usually, you enter new markets with high growth potential to increase your growth opportunities or to prevent disruption of your core business from an emerging market.

When diversifying into new markets, choosing the best market is always a difficult task. Questions arise around whether the diversification strategy should drive the best market opportunity, the company’s core competency or other factors.

Horizontal Expansion
With horizontal expansion, you are looking for a strategic move in your existing market. Usually, you are acquiring new users through international expansion, for example, or through consolidating the market by acquiring competitors.

Growth in your existing market is usually the best and easiest place to begin growth discussions. Until you are a solid #1 or #2 in your market, expanding into new markets may leave you exposed to competitors if the diversification move distracts you from your core business.

Value Play
Another important consideration in deciding on a growth strategy is to be patient and wait for the right opportunity. You may not have the resources or the market conditions may not be right. You can consider becoming a “value play,” reducing costs and increasing margins while you wait for the right opportunities. The goal is to preserve cash for now and wait for the right opportunities.

Exit Strategy
After reviewing the different growth strategies, many companies decide that exit is the best strategy. Your partners or competitors may be better positioned to grow and expand the business. Understanding the market and competitive dynamics may lead to the conclusion that it is time to exit the business.

Once you understand the different options, it is easier to evaluate each option individually and in comparison to the others. One strategy is not necessarily better than the other. Certain strategies will involve higher execution risk, and should be deprioritized. Additionally, when choosing a strategy, you should remember that the best strategy in the world doesn’t matter if your organization can’t execute on the strategy.

How Risky Is Your M&A Strategy?

Some M&A strategies involve more risk than others. The biggest risk factor is the disruptive change required in your core business. For example, if you are trying to consolidate an industry through multiple acquisitions, then significant risk exists in the integration process. On the other hand, the classic private equity “financial engineering” is less risky. While you are slashing costs, there is no disruptive change happening to the core business. You’re still in the same business and don’t need to integrate different teams and products.

Riskier strategies are sometimes necessary and can achieve greater returns. You can’t avoid shifting market dynamics or other potential disruptions to your business. For example, if you are facing a rapidly declining market and technology disruption, a transformational M&A deal may be your best option.

common-m-and-a-strategies

The above chart categorizes the different M&A strategies from less risk to more risk based on the inherent risks in the M&A strategies. These strategies include:1

Financial Engineering: reduce costs/optimize taxes to increase profitability
Consolidate Capacity: remove excess capacity to fix oversupply problems
Sales Leverage: buy product to sell through your existing sales channels
Buy Tech/Skill: buy new technology or talent
Emerging Market: make small bets with startups in high growth new markets
Defensive Play: buy a disruptor company that threatens your core market
New TAM: buy into a new market to increase your market size
International Expansion: buy competitors in international markets to expand
Consolidate Competition: buy competitors to consolidate the market
Industry Rollup: consolidate a fragmented industry
Transformation: move a company in a new direction via acquisition
Buy Cheap: buy an asset because it is cheap

To ensure that your deal is successful, you should assess the risk factors to understand potential problem areas. If you are engaging in a riskier M&A strategy, you can significantly reduce the risks through an effective deal strategy, including utilizing a Deal Manager with experience in these deals and focusing on value creation throughout the deal process. You can never remove the risk from M&A, but you can achieve success if you understand the risks and diligently mitigate these risks.

1 See McKinsey article for their analysis of different M&A strategies. The five types of successful acquisitions, July 2010 | by Marc Goedhart, Tim Koller, and David Wessels.

Choosing A Buy-Side M&A Advisor

Choosing a buy-side M&A advisor requires deciding what skills and expertise you need to make your deal successful. Most M&A advisors focus on sourcing and structuring the deal, which is logical since most M&A advisors come from investment banking. However, if you want to make your deal successful, you should think about what other skills and expertise you need throughout the M&A deal cycle.

As the chart above illustrates, the M&A deal cycle requires significantly more skill than simply sourcing and structuring a deal. There are numerous areas where your company could utilize M&A expertise. Two examples will illustrate this point:

An M&A target could show signs of significant integration problems. An advisor with skills limited to sourcing/structuring wouldn’t necessarily see these problems, nor are they incentivized to deal with these problems (they are only responsible to get the deal done).
Your internal teams may have limited M&A experience and may not know what is expected of them or how to successfully complete their tasks. An advisor needs to recognize this problem, and have options to address the issue. Ideally, your M&A advisor would have sufficient experience to coach and guide the teams through the process.

These are just two examples of why you should expect your M&A advisor to have experience and expertise across the entire deal lifecycle. Even if you don’t need to hire the M&A advisor for the entire deal lifecycle, this integrated expertise will add significantly more value when you do need them.

When choosing an M&A advisor, you should utilize three basic questions to differentiate the advisors:

What direct experience do they have in each phase of the deal lifecycle: strategy, integration, etc.?
Does your advisor know what it takes to make a deal successful (not just getting the deal done)?
How can the advisor help your teams execute better at their tasks?

These three basic questions should enable you to differentiate between M&A advisors so that you can decide who is in the best position to make your deal successful.

If you want to dig deeper during the interview process, the chart below illustrates how an M&A advisor can and should be an effective Deal Manager. The role of a Deal Manager is to guide a deal from the beginning to the point where the deal achieves its expected outcome. To be successful, there are general skills required from a Deal Manager as well as specific tasks assigned to the Deal Manager at each stage of the deal lifecycle.

The “General Skills” are key attributes and tasks that a Deal Manager should perform across the deal lifecycle. For example, with Collective Wisdom, the Deal Manager should understand why the deal is being done (stated objective), and should track its progress across the deal lifecycle. The accumulated collective wisdom from strategy, sourcing and due diligence will enable the Deal Manager to keep the teams focused on what it takes to be successful and to guide the deal towards successful conclusion.

The “Specific Tasks” are separate from the traditional M&A tasks (valuation, legal negotiations, etc.). These tasks help you identify risks, deal with problems and drive the deal towards success. For example, in the strategy phase, the Deal Manager should quickly identify the riskiness of the strategy and outline a plan for managing these risks during the deal lifecycle (for more information on the risk profiles with different M&A strategies, please see my other article, How Risky Is Your M&A Strategy?).

You can and should expect more from your buy-side M&A advisor. These advisors should have the skill to make your deal successful, not to simply get the deal done.

Making M&A Deals Successful

Everyone has heard the statistic that over 50% of buy-side M&A deals fail to meet their stated objectives. The reason is fairly straightforward: the M&A industry is geared towards “getting deals done” and not making deals successful.

Companies don’t engage in M&A simply to do a deal. Instead, the purpose of M&A is to achieve a corporate objective through which M&A is the means to achieve this goal. The M&A industry doesn’t talk about this type of success, because most experts don’t have the capability to see the bigger picture.

Eisbach Group was created to help companies make their deals successful and ensure that M&A deals meet their stated objectives. To achieve success, a new approach to M&A is required.

Below are the four keys to the Eisbach Group approach and to making your deals successful:

Integrated Approach. A deal has five key stages. A company needs to understand the five stages and take an integrated approach to managing these stages. Too often, different experts handle the various deal stages, leading to a disjointed approach. By taking an integrated approach, companies can tailor their M&A activities towards achieving the stated objective, and not just getting the deal done. Also, an integrated approach reduces the risk of error by following a deliberate and connected process through all five stages of a deal.
Deal Manager. To be successful, companies need a proper Deal Manager who understands what it takes to be successful and who can assist with specific tasks across the entire deal lifecycle. Normally, bankers manage the beginning of a deal, lawyers manage deal execution, and a project manager manages the integration process. The problem is that these people are managing the deal without a clear view on what it takes to make an M&A deal successful. A Deal Manager needs to drive the deal efforts towards achieving the stated objective. Also, the Deal Manager needs subject matter expertise across the deal stages so that the Deal Manager can understand when something is wrong or when someone is not performing, and can take corrective action.
Focus on the 5th Stage: Value Creation. Value Creation is a separate stage in the M&A process, and is a concept that Eisbach Group coined. Understanding this fifth stage of M&A is fundamental to achieving success. In my experience, deals are won and lost in the twelve months after the deal is closed. This is where the deal needs to be driven towards achieving the stated objectives. Everything in the initial four stages could be done perfectly, but a deal can still fail. To make deal successful, Value Creation must be recognized as the fifth stage and managed as part of the M&A process.
Pattern Recognition. Experience driven pattern recognition is an essential skill for M&A success. With enough M&A experience, you will start to recognize potential problems and will avoid making mistakes. These problems can occur anywhere in the deal cycle: there can be (1) M&A strategies that aren’t appropriate for your company; (2) acquisition targets in which the CEO micromanages every decision; (3) unsustainable business models; and (4) countless other potential problems. Associated with pattern recognition, you need to know where to look for potential problems. The private equity industry embraces the phrase “where there is smoke, there is fire” to mean that small discovered issues usually mean a larger underlying problem exists. To be successful with M&A, you need people with the experience to recognize patterns and potential problems. Your experts can’t just have experience in one aspect of the deal cycle; they need to have experience in each phase to fully recognize the patterns.

By embracing these four keys to M&A success, you can take control of the M&A process and start increasing the likelihood that your M&A deals will be successful. Your expectations of M&A advisors will shift from getting a deal done to helping you meet your strategic objectives.

A New Era For International Contract Law?

A new body of contract law was recently adopted in the United States by the National Conference of Commissioners on Uniform State Laws (NCCUSL) entitled the Uniform Computer Information Transaction Act (UCITA) for consideration and adoption by the legislatures in the fifty states of the United States as well as Puerto Rico, the District of Columbia, and the U.S. Virgin Islands. The UCITA could have a significant impact on international contract law, because the drafters envision the UCITA as the first step towards an international body of contract law that applies to computer information, and the Internet. Within the next couple of years, the international legal community could adopt a contract law very similar to the UCITA. This international contract law would stand in conjunction with the United Nations Convention on Contracts for the International Sale of Goods (CISG) to regulate international transactions.

The NCCUSL and the American Law Institute (ALI), whose joint approval is necessary for uniform laws to be placed within the Uniform Commercial Code (UCC), discussed and debated UCC Article 2B, the predecessor to the UCITA, over the past eight years. UCC Article 2B was originally intended to be placed along with UCC Article 2 related to the sale of goods and UCC Article 2A related to the lease of goods. However, UCC Article 2B was changed to the UCITA, because the ALI was not ready to adopt UCC Article 2B until Spring 2000 or even later while the NCCUSL was ready to adopt the UCC Article 2B at its annual meeting in July 1999. The NCCUSL also expressed a desire to deviate from the constraints of harmonizing UCC Article 2B with the rest of the UCC. So, the NCCUSL changed the name, adopted the UCITA, and will submit the UCITA to the legislatures for debate and adoption by January 2000 once the Reporter’s Notes are finalized.

The UCITA applies to computer information transactions, which are generally defined as “an agreement or the performance of it to create, modify, transfer, or license computer information or informational rights in computer information.” Computer information is defined as “information in electronic form which is obtained from or through the use of a computer or which is in a form capable of being processed by a computer.” Information is defined as “data, text, images, sounds, mask works, or computer programs, including collections and compilations of them”. So, for example, the UCITA would apply to all software, online publications and other online text, digital multimedia works, access contracts via the Internet, and other similar transactions for computer information.

The UCITA fills a gap in the United States uniform contract laws created by the invention and development of the computer and the Internet. The existing contract laws divide the world into a contract for the sale or lease of goods, or for services. Understanding the nature of software is necessary to understand why the current contract laws are insufficient to address computer information transactions. With the creation of computer software, the information industry was created where the item being contracted for was not a tangible good and was not an individual service. The item being sought is the right to use an intangible property that performs certain functions when run inside of a computer, i.e., software. The nature of software does not require that the software exist in a tangible form. Further, software is not an individual service provided to a particular person; instead, most software is made generally available to the public without any individual service being offered. Thus, software exists in a separate world that does not clearly fit into the category of a good, or a service.

The existing uniform contract laws in the United States also fail to expressly recognize licensing and the nature of the rights transferred with licensing. Due to the nature of the intellectual property rights behind software, a practice has developed in the software industry where the software is not sold to the end user. A software company is simply granting the end user the right to make certain uses of the software but with certain restrictions applied to the end user in order to protect the underlying intellectual property rights. A license has become a form of a contract. Even though courts in the United States have applied UCC Article 2 to license agreements, Article 2 does not recognize or address the unique issues related to software licensing and protecting intellectual property.

Software and the Internet also have created gaps in the uniform contract laws in the United States, because of the electronic nature of the medium. Contracts are being negotiated and concluded between computers without the signature of or even final approval of a person. Further, rules for the delivery, conformance, breach obligations, and other provisions related to the sale of goods provide little guidance to the parties when dealing with computer information transactions. For example, a licensor’s (seller’s) remedies under UCC Article 2 or the CISG for a licensee (buyer) breaching a software or access contract are meaningless when the licensee (buyer) has already benefited from access to the software or the information and also may easily retain a copy of the software or the information.

The UCITA was created to recognize the unique nature of computer information, and attempts to codify the existing practices in the software and Internet industries. On the international level and within most if the not all countries, the above issues have not been adequately addressed. With the eventual adoption of the UCITA and the dominance of United States companies in the software and Internet industries, the international community should be familiar with the UCITA, because a United States software company will likely choose the UCITA as the applicable law.

For more information on the UCITA including a link to the text of the UCITA, please see: www.2bguide.com.

Published in the MAA News Bulletin, 1999

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