Tuesday, April 4, 2017

To Build or Not to Build: That Is the Question

From the perspective of business executives, there are two ways to grow an enterprise: build or buy.

They ask whether it is appropriate to build a new business idea, product or service from scratch.  Or should the company buy an existing corporation that already provides the desired product or service?

The answer to that question: it depends. Either way, the solution is never simple.

Often, purchasing another organization is an
expensive way to grow. To start, buyers need to conduct due diligence, scrutinizing the minute details of financial and operational efficiencies. They investigate questions like, is the enterprise profitable?  Does it own real estate?  If not, is it paying too much for a lease?  When does the lease end?  Is there a union?  Is the union friendly or antagonistic?  What terms has the union negotiated?  Does the business entity have debt?  How expensive is the debt?  Does it have shareholders?  How efficient is operations?  How strong is the management team?  Does the company own intellectual property?  Is the geographic location ideal? This is a comparably short list of items that need to be assessed before buyers consider purchasing a firm.

Money is also a large factor during this due diligence process. If the research highlights a number of concerns, the buyer may opt to back out, even after investing funds into researching the acquisition.  Then again, a troubled company can be an opportunity for it allows buyers to acquire a problematic company at a discount. If the buyer has the resources to fix it, the acquisition can provide many rewards. These benefits can range from geographic location, patents, client base, real estate, plant and equipment or talent. 

Assuming the financial and operational due diligence is attractive, there has to be an agreement on the purchase price and how the money is paid to the owner and/or shareholders. This is a critical step as there are owners who possess 100% of the company’s stock.  If he or she is paid a lump sum, (for example $20 million), it may incentivize the owner to relax and decrease productivity. Without the need to work as hard as before, the buyer may expect lower company performance and/or a decrease in the purchased firm’s value.

The other risk factor in acquisition is corporate culture. Firms like GE have a philosophy: when we buy you, you will do things the GE way. Often like GE, the acquirer attempts to integrate two cultures into one organization. However, the process can be the most expensive part of a merger or acquisition. The Harvard Business Report says 70%-90% of mergers and acquisitions fail or never fully realize their intended value.  In some cases when the acquisition fails, the buyer sells the acquired company for less than what it was purchased. 

With that said, there are times when building rather than buying is appropriate. Bob Weissman,the former Chairman & CEO of Dunn & Bradstreet (D&B) is a prime example. During his tenure, he spun off a number of subsidiaries from D&B, like Nielson Ratings. In addition, he started companies from scratch, like IMS Health and Cognizant Technology. Back in 1994, he started Cognizant with 42 people from inside D&B. Today, it employs over 200,000 people and trades on the NASDAQ stock exchange as a spin off from D&B. IMS Health was also spun off and trades on the NYSE. 

While not every opportunity to build will be as successful as the D&B stories, the idea of growing it at home allows for more control.  Notwithstanding, it is imperative that the homegrown enterprise is managed well by a strong team of executives.  Without sufficient resources to hire top talent and make capital infusions, the idea of building can be a long process with mediocre success. Moreover, new ideas within an existing company can be overshadowed by current business. In many cases, there is a struggle to innovate in large corporations as employees will kill the new initiative.

As you can see, the question of build or buy is not a simple one. Buying is like instant mix and stir. You buy a company that is already doing what you want, except the challenge is post integration.  Building avoids the need for an integration process.  The parent company becomes like a private equity firm that funds internal projects that can possibly be spun off.  To do this, you need talent, great organization, capital and a huge commitment from the CEO that says this initiative is important.  Which would you choose?   

What do you think? I would love to hear your feedback and I’m open to ideas. Or if you want to write me about a specific topic, let me know.

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