Despite odds that favor failure, the most successful companies in the high-tech industry are active dealmakers. To explain this anomaly, we assessed the performance of the 485 largest high-tech companies as reckoned by market capitalization. We broke them into four groups based on market value created and on the growth of market capitalization; then we studied the transaction activity of each group. Our analysis established that while the average merger or acquisition destroys value for the acquirer, deals carried out by companies that undertake them strategically and often actually do create value.
How then do top performers manage their transactions? For a deeper look at this question, we used 30 case studies and interviews with 30 senior practitioners to augment our research. Although there is no single best way to carry out these transactions, our study suggests that there are patterns and principles that separate top performers from the pack.
For two reasons, the stars of high-tech consider dealmaking to be as inevitable and perennial as product development or marketing. First, the pace of technological change in the industry is extraordinary and thus forces companies to manage their assets aggressively. In 1993, for example, the typical company in the high-tech top 100 stayed there for seven years; by the end of the decade, the average tenure had dropped to three years. At the peak of the Internet market, in 1998 and 1999, 32 of the top 100 companies fell off the list. A similar turnover in market leadership continues today. In markets that move more rapidly than most companies can, many players become fodder for deals.
Second, high-tech is a "winner-takes-all" industry. Just 2 percent of the companies in the software sector, for instance, have contributed 63 percent of the appreciation in market capitalization since 1989. Transactions and consolidations can often fill holes in a product line, open new markets and create new capabilities in less time than it would take to build businesses internally. Such moves may be prerequisites to achieving a dominant position.
So it is no coincidence that most "gold-standard" companies in our survey--those averaging more than 39 percent annual growth in total returns to shareholders since 1989--undertake almost twice as many acquisitions and form up to ten times as many alliances as do their competitors. The sheer volume of deals gold-standard companies undertake has made them as good as they are at extracting value from these transactions. Despite having different products, services and customers, the high performers we studied--including Corning, IBM, Intel, Microsoft, Qualcomm and Sun Microsystems--appear to have mastered four areas essential to success in transactions: They develop clear strategic goals for the company as a whole; they undertake only those transactions that can advance those goals; and they know how to get transactions done quickly, and with the least possible stress to their acquisitions or themselves. Finally, they weave these transactional capabilities into their operational fabric.
Keeping it simple
Most companies manage acquisitions and other transactions as occasional, major events involving one or two obvious targets. By contrast, every gold-standard company we studied takes a programmatic approach. Each maintains a steady flow of deals and has clear management processes to identify and extract value from them. Seldom do these companies try to chase a blockbuster deal. Indeed, the transactions they undertake tend to be small compared with their own market value: On average, gold-standard companies pay less than 1 percent of their market capitalization for an acquisition. Most of their acquisition programs included a few larger transactions, but deals in which the purchase price of the target was 50 percent or more of the acquirer's market capitalization were rare. And although gold-standard companies are significantly larger than the average in the high-tech universe, the deals they completed had an average value of $400 million--well below the $700 million average for the rest of the industry.
The bias against big deals is well-founded. Smaller transactions lend themselves to simpler, more disciplined structuring and integration, thereby minimizing the negotiations and infighting that, in larger deals, can defeat the logic of the original plan.
Moreover, the companies we studied view dealmaking much as they do their R&D programs: The risk of failure is never allowed to call into question the essential nature of the enterprise. Likewise, for gold-standard companies and other well-respected companies in the sector, the problem is not whether to transact deals but how to do so in ways that raise the odds of overall success.
The S-curve describes three stages of market evolution: emergence, development and maturity. Each brings unique challenges and opportunities. In the emergent stage, we found, two main strategic issues confront businesses: proving the value of their technologies and quickly building a critical mass of customers. In the development stage that follows, businesses must decide how to sustain and to profit from rapid growth. Most of the companies we studied at this stage can choose from four broad strategies: increasing their scale of operations, managing the customer relationship more satisfactorily, controlling the market for a technical platform, and promoting product innovation.
Finally, as markets mature and the growth curve flattens, other strategic choices appear: Economies of scale become more important, as do the expansion and integration of a company's sales and distribution channels. Even such crucial questions as pricing, asset management and market segmentation are subordinate to this handful of broad strategic choices. The choice of strategy will in turn dictate a particular program of transactions.
Gold-standard companies understand that if transactions are to support larger strategies, 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 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 technology, 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, ten 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 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.
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. It first rolled up a series of small distributors. 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.
Finding their place
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 occupies, whether it wants to remain there, and the kinds of strategic acquisitions 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, non-core 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 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. All three moves were initially orchestrated by the corporate center.
Intel, Microsoft, 3Com and other companies have pursued similar strategies. IBM 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. 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.
Frequent, focused dealmaking 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 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 they need to make 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.
In the top-performing companies we studied, the decision to undertake transactions rests in the hands of four or five people. In the case of large transactions, the board too is involved. Yet the people making transaction decisions stay close to the action in the line organizations. To review corporate strategy, assess the needs of business units and vet possible opportunities, for example, business-development executives at one leading semiconductor company schedule quarterly two-day meetings with the CEO, the CFO, key managers of functional departments, and the general managers of business units.
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.
Braving a volatile market
The market correction of 2000 and 2001 has brought dealmaking 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.
Gold-standard companies know that execution is at least as important as strategy in any kind of market environment. Their executives focus on the real value drivers of a deal throughout each stage of evaluation, negotiation and integration. They are also aware that most of the value of a deal is realized during the post-deal integration phase. Sustaining revenue growth as people decide to depart, product delivery schedules slip, and sales-force cultures clash is the most difficult challenge managers face. That is why some of the best companies, far from starting to lay off the sales staff during a transition, actually build it up.
In addition, the best dealmakers nail down as many terms as they can before a deal closes, so as to minimize the haggling that is otherwise bound to distract managers from their fundamental task of creating value without interruption. To that end, the acquirer also establishes a number of links with the target before a deal closes. But to act with this kind of foresight, managers must be offered incentives tied to their success at advancing the integration process.
In an industry that requires companies to do deals, the most successful companies make transactions almost routine. Indeed, it is the routine nature of the dealmaking that helps guarantee its success. But skill in execution goes only so far. Before the first telephone call to the target is made, a gold-standard company has figured out how its acquisition will build on earlier ones and serve its longer-term goals.
Editor's note: McKinsey has served as an adviser to Hewlett-Packard in its bid to acquire Compaq Computer.
For more insight, go to the McKinsey Quarterly Web site.
Copyright © 1992-2002 McKinsey & Company, Inc.