Fortune has consistently found that CEOs are most worried about technology and upstarts disrupting their current market position.
They are right to be worried. Access to capital has never been easier, barriers to entry in many markets have never been lower, and buyers have more power than ever before. Customers continue to expect more, are continually armed with more choices, and change preferences fast — and, in order to stay relevant, companies are placing increased importance on their innovation strategies.
Disrupt or be disrupted. This is the mantra large enterprises must embrace, as successful ongoing innovation strategies will be the primary driver of not only staying relevant but also avoiding becoming the walking dead.
A common strategic priority has been innovation-by-acquisition — and it’s a big mistake. Actual innovation requires continuous innovation in core markets as well as experimentation to develop new lines of business. The latter is partially fulfilled by acquiring companies in non-core markets, but this strategy alone is strategically weak as it leaves your organization without the internal skills, resources, and organizational structure needed to foster continuous innovation on core-products.
Innovation strategies have two components: (1) the company’s own research and development (R&D) work (organic or internal innovation); or (2) from mergers and acquisitions (inorganic innovation). Both are necessary components of transformative innovation. However, one look at today’s market will show a clear trend towards a narrow focus on inorganic innovation — a strategy that ultimately leads companies to fall on the “be disrupted” side of the equation, because most acquisitions tend to be in non-core markets.
The Current Landscape
Disruption fear has been filling the coffers of innovation departments and expenditures in many industries. This valid fear has led to an increasing emphasis on innovation by acquisition to hedge risks. However, this inorganic innovation method means that said risks are by and large being hedged in non-core markets for the acquirer, leaving core-markets vulnerable.
Innovation by acquisition is a growth strategy that many large companies follow so they can continue to innovate without spending extra time and money on R&D, and/or increase risk in their core-market(s). Instead, their innovation is primarily sourced through M&A.
Isolated to tech no longer, the dominant innovation by acquisition strategy has entered the popular business zeitgeist. It runs rampant today in many industries, especially in CPG, food & beverage, and software. In 2015, companies collectively spent more than $5 trillion on acquisitions.
Of course, we would be remiss not to state that certain industries such as pharma, aerospace, and defense still heavily favor internal R&D for obvious reasons. However, the trend in software, technology, apps, consumer-packaged goods, food & beverage, big-agri, and more are increasingly showing an appetite for innovation by acquisition.
Inorganic innovation can be a successful part of a mature innovation strategy, with great competitive advantage. It accelerates innovation in the development of new products that often serve different customer segments and categories.
However, even when done correctly, it is important to note that the majority of M&A activity is occurring outside of companies’ non-core markets, presumably in an effort to hedge against new, emerging technologies.
Cisco was one of the first companies to lead the inorganic innovation trend. In 2009, it acquired Pure Digital, the creator of the flip camera — a product that was far removed from its core business of networking hardware and telecommunications equipment — to keep up with market changes and consumer trends. By 2011, the acquired unit was closed, the $590 million purchase price a complete write off.
More recent examples of this would include SAP acquiring Qualtrics, or Microsoft purchasing LinkedIn. This narrow, unstrategic focus will not lead to the kind of innovation needed to propel the kind of growth necessary to stay relevant.
Why The Current Landscape Is Suboptimal
Disrupt or be disrupted. Even if your organization acquires successful new lines of business, you’re missing a large blind spot: if you don’t innovate on your core-markets and sacred cows, someone else will. Blockbuster had the chance to buy Netflix early-on and laughed at the deal. The Netflix model would hurt their core business profit margin, so they stuck to their sacred cow. You know how that story ends.
In the technology sector, HP offers a great example of innovation by acquisition gone wrong. HP developed the necessary technology for the tablet long before Apple, choosing not to pursue it as they didn’t want to eat into their core market, instead focusing their innovation efforts in non-core categories. The same thing happened with Salesforces’ acquisition of Tableau.
Innovation by acquisition tends to promote a narrow focus of innovation towards non-core markets. When a firm pursues such a strategy to the detriment of internal R&D innovation, they begin to become laggards in their core business.
At the same time, acquisitions themselves vary in terms of success, hedging towards unsuccessful. The success of M&A relies heavily on how effectively the organizations in question are integrated (Kanter, 2011) — and the reality is that integration is rarely a smooth and effective practice.
For instance, companies that invested heavily in M&A in the 90s quickly realized making them pay off is a difficult achievement, due to challenges at the product, organization, and market levels — and, as a result, the trend came to a screeching halt (Chaudhuri, 2005). Even today, studies frequently find that the failure rate of acquisitions sits between 50% and 90%, with the majority reporting 70%+ failure rates (Source).
Acquisition fails for a wide range of reasons. Success rates are particularly low when the two companies in question have misaligned core competencies and company cultures (Price, 2012), when the acquisition was done for the wrong reasons, the ROI simply isn’t there, or the business model fails (Solomon, 2016).
Even when acquisitions do go well, if innovation budgets and strategies continue to be dominated by M&A/corporate development in non-core markets, there is a huge risk of leaving core markets — core products, segments, and categories — lacking continued innovation, leading to stagnation and decline.
Innovation by acquisition on its own is a weak innovation strategy, and not only because acquisition in general often fails to have a positive outcome. Along with the acquired product, the acquired innovation team tends to assimilate into the acquirer’s company culture, often causing that team to get frustrated and eventually quit. The acquirer’s culture is then at risk of imploding, becoming unrecognizable over time. Externally, competitors will eventually begin to adopt the same inorganic innovation model, so any possible competitive advantage is lost.
One only has to look at recent examples of innovation by acquisition gone wrong to see how an inorganic innovation-focused strategy can be damaging:
Salesforce <> Tableau
Salesforce has been diversifying its acquisitions for a couple of years now. In 2018 alone, it spent more than $7 billion acquiring companies both in and outside its core market, its biggest purchase being integration platform MuleSoft.
Just this year (in June 2019), CRM leader Salesforce announced it would acquire Tableau, a popular data visualization software, for $15.8 billion. As pointed out by Patrick Moorhead, this suspiciously looks like Salesforce has given up on R&D innovation, opting to absorb business intelligence software that threaten their core offering instead of developing their own solutions.
By shifting away from their core offering and the promise on which their business is built — an entirely SaaS-focused stack of products that now, with their recent acquisition, includings a hybrid cloud product — Salesforce appears to be bowing to external pressure. Their response to the “disrupt or be disrupted” problem is to change their business model to adapt, rather than innovating to grow and challenge their industry. While this could work in their favor, it could also make them completely lose their foothold in the market.
Since 2015, General Mills has been prioritizing innovation through acquisition by using its venture capital fund, 301 Inc., to support consumer food startups with (for the most part) the goal of eventually acquiring. As with many acquisition strategies, this not only involves bringing the acquired products into their existing offering but also bringing those startup founders onboard.
In the last three years, many of the acquisitions secured through this strategy have seen General Mills absorb non-core products — cottage cheese snacks, sauerkraut, kimchi, and plant-based meals. Of course, these non-core products also come with competing, non-core, long-established operations, marketing, and customer bases.
When General Mills acquired Epic Provisions, a producer of meat-based protein bars, in 2016, the startup’s small team of 12 employees pushed back against their company culture being assimilated into the larger organization, jeopardizing the $100m investment. The original owners of Epic also became unhappy with many of the changes General Mills was making to the product line and bristled against their corporate focus on numbers and fast growth. Each time the grain titan takes on a new acquisition, it must face similar issues in bringing not just the products but also the teams together.
At the same time, General Mills runs the risk of their own culture and core product line imploding, particularly as they begin to replace older products and sub-brands with new acquisitions. Not to mention the fact that this inorganic acquisition strategy sees them putting less focus on the open innovation that propelled much of their success in the first place.
It’s no news that Coca Cola has been prioritizing innovation through acquisition for a while now, showing no qualms about changing its core brand to adapt to market demand. In recent years, to keep its market share (and avoid being disrupted) while consumers shift away from sugary soft drinks, Coca Cola has dipped out of its core offering to focus on healthier alternatives like vitamin water, smoothies, and kombucha.
More recently, however, Coca Cola has made some acquisitions that sit even further outside its core market. Their purchase of British coffee chain Costa Coffee in 2018 goes beyond expanding its beverage product line — it also means the company is entering the real estate market, something it has no experience in.
Around the same time, Coca Cola announced the acquisition of Moxie, a small soda brand with low sugar content that has a cult following in New England. Though it may also be called “soda”, this is evidently a product and target customer that sit far outside Coca Cola’s core.
As beverage consultant Bill Sipper points out, many of Coca Cola’s latest acquisitions are tactical — allowing them to ‘take out’ competitive players, even if they’re operating on a much smaller scale or offer starkly different products — to try to retain their market share. However, what these acquisitions lack is strategic direction, as many of these acquired brands are far removed from the company’s prevailing (and long-successful) marketing strategies and customer focus. That’s not to mention the fact that they are acquiring products, like Moxie, with consumer bases that might be turned off the product altogether once they catch wind that it’s linked to a big conglomerate.
In response to such staggering growth in its M&A, Coca Cola has created a new division: Global Ventures, specifically designed to help acquired brands get ready for the market exposure that comes from being under the Coca Cola umbrella. At the same time, CEO James Quincey has said the company will step back from aggressive M&A activity to focus on its recent acquisitions. Only time will tell if this will be enough to solve the many issues that come from an inorganic acquisition-led strategy.
How we can do better
Your organization’s innovation strategy must be more than a project thought up in a boardroom. For many organizations, it’s the lifeblood of relevancy. To maintain your foothold on the market — to disrupt rather than to be disrupted — innovation needs to be an ongoing strategy, often of small changes and discoveries.
Many modern companies suffer from what Rajesh K. Chandy and Gerard J. Tellis call “The Incumbent’s Curse.” Incumbents protect their successful current products, focus on the present (especially the perennial crises that crop up in the lives of massive corporations, as we saw with HP), and are averse to risk.
To effectively innovate internally and in core lines of business, however, companies must develop a culture and organizational structure to combat the incumbent’s curse.
Innovation is never finished, and companies that fail to adopt a diverse acquisition strategy — one that combines inorganic with organic innovation — will ultimately be out-innovated. To truly disrupt the market, and to stay relevant as consumer tastes and technologies evolve, it is crucial to develop and nurture strong internal innovation capabilities and organizational structures, not merely absorb new products and companies in an effort to hedge against inevitable change.
Innovation by acquisition can be a successful growth strategy for more mature companies. However, when faced with the reality that many (if not most) acquisitions fail and that the majority of acquisitions occur outside a companies’ non-core market, inorganic acquisition quite simply cannot be the only option. Otherwise, companies run the risk of neglecting their core business and focusing narrowly on the present instead of looking to the future to ‘stay relevant.’
So you have a choice — disrupt yourself or be disrupted. It’s a choice every company will eventually have to make. The delta on how long you can delay this choice is variable, but indecision will render your choice for you: you will be disrupted. And the fight to stay relevant won’t be pretty.