Linking Innovation and Competition to Acquisitions

Innovation, competition, and acquisitions are closely interlinked. Innovation is the only way that has the potential to create an enormous amount of shareholder value. Once the firm profitably grows internally through innovation, it opens many opportunities for it to grow further externally through acquisitions and alliances. Most innovative companies today, such as Google, Apple, 3M, and others, have achieved horizontal growth internally, and expanded and grown externally also through acquisitions.

Technological innovation and change are linked to competitive advantage and industry structure. When an innovative product or service moves to the market, it diffuses on the supply side through competition. Competition restricts a firm’s ability to become profitable and generate a competitive advantage. To become successful, the innovation must create a competitive advantage through low cost, differentiation, or both. Tandy corporation failed to generate enough sales and profits from personal computers in the market because it had no effective business strategy. Innovation generates a temporary competitive advantage for the innovative company that should be utilized to build its market position on this advantage to remain successful. Therefore, to stay ahead of the competition, firms must continuously innovate with a robust innovation strategy, upgrade their resources and capabilities, and make imitation harder for competitors by developing slow cycle resources.

Most innovative companies are typically not satisfied with the initial slow internal growth they achieve through innovation. Faster growth can be achieved, but externally through mergers, acquisitions, and alliances. Therefore, with a desire to grow faster, most successful innovative companies prefer acquisition over other options, which is definitely the fastest way to grow. Unfortunately, most acquisitions fail, as they do not have clearly defined value-creating goals and a well-articulated acquisition strategy. Moreover, acquisitions are overpaid to the acquirees, as they capture most of the value in the transaction. Research indicates that most acquirers do not perform satisfactorily after the acquisitions, with respect to the internal growth they achieve through innovation. HP’s financial performance constantly declined after it acquired Compaq in 2001. HP’s stock was sold at $23.11 on September 3, 2001, the day before it announced the acquisition of Compaq. After three years, on September 21, 2004, shares were sold at $18.70.

An acquisition is the purchase of another company, in which an acquirer makes an offer for the common stock of the other company (the acquiree). An acquisition is not a strategy but a tool of corporate strategy. It is only when it combines with strategic objectives it becomes a viable acquisition strategy. When an innovative company desires to expand its scope and grow externally, it indulges in acquiring other companies to meet its strategic objectives. These strategic objectives of buying might include:

• to improve acquirees performance and capture value.
• to acquire resources and capabilities.
• to create economies of scale and scope and market power.
• to expand geographically.
• to diversify.
• to acquire high-growth potential firms early.
• to kill both innovation and competition.

To Improve Acquirees Performance and Capture value

Small innovative companies face difficulties in bringing new products to the market and expand which requires complementary resources: a diverse set of resources and capabilities to finance, manufacture, and market innovative products. These resources can be accessed through strategic alliances with other firms. But, when the innovative firm cannot access these complementary resources, it becomes a target of acquisition or takeover. When Chester Carlson invented xerography, he was unable to take his product to the market because he was deficient in complementary resources. Xerox acquired his patent rights and opened its first office copier in 1958.

To Acquire Resources and Capabilities

The most valuable resources and capabilities are embedded in the firm’s tacit knowledge, which is difficult to understand, transfer, and replicate. However, these resources and capabilities can be acquired faster through acquisitions. For example, in technology-based industries, well-established large firms frequently acquire small start-up firms with a motive to get access to new capabilities, technology, products, or innovation. From 2005 to 2011, Google acquired ninety-five small-technology-based companies to support its new product launches. Apple acquired many small start-ups to access technical and creative capabilities. Most recently Apple acquired Intel’s 5G modem technology platform with the goal of developing its own next-generation modems for its future iPhones.

To Create Economies of Scale and Scope and Market Power

Most successful acquisitions are driven by value-creating goals, such as increasing profitability, gaining through restructuring, or creating barriers to entry. The acquirer is most benefitted when the acquisition is within the same industry. This generates value-enhancing opportunities to get access to new geographic markets, creates massive economies of scale (in which total product cost is reduced by making large quantities of the same or similar products), and economies of scope (in which various activities of different products and services are combined to share a common value chain), and increase market power.

To Expand Geographically

Large established innovative companies have extensively used acquisitions in recent history as a means to grow by expanding the company’s activities into both domestic and foreign markets. This acquisition strategy allows the firm to achieve horizontal growth faster externally. Firms that grow horizontally through acquisitions in the same industry also have a higher survival rate. 3M, a conglomerate, with its capabilities in R&D, has expanded globally through internal development and externally through acquisitions in related as well as unrelated industries into products such as adhesive tapes, audio, and videotapes, floppy disks, and household products.

To Diversify

Corporate diversification is driven by three major objectives: (1) desire for growth, (2) risk reduction, and (3) to create shareholder value. A firm can diversify into related (concentric) and/or unrelated (conglomerate) businesses through acquisitions. The acquisition is a well-known way of diversification for an innovative company when it desires to grow faster or needs a transformational change due to declining performance. Growth through concentric (related) diversification is a viable corporate strategy if an innovative company desires to expand its activities into related areas where it can secure a strategic fit in a new industry and use its existing product knowledge, manufacturing capabilities, and marketing skills. IBM, an innovative multinational in a transformational effort from hardware to software and a service-based company, acquired 115 companies between 2000 and 2011, such as PwC Consulting, Rational Software Corp., Cognos, and SPSS Inc. Likewise, with a desire to grow faster, Microsoft entered the video games business with the introduction of Xbox in 2001 and to support the development of video games it acquired many small companies, such as Exos (video game controllers), RenderMorphics (3-D graphics software) and video game software developers (Electric Gravity, FASA Interactive, and NetGames).

To Acquire High Growth Potential Firms Early

This strategy involves predicting technology-based company winners early in their life cycle and acquiring them at a lower cost before other players recognize their value potential and future importance. This acquisition strategy can also be viewed in terms of option valuation as buying real options: growth and flexible options-which allow a firm to make small investments in several future business opportunities without entirely committing to them and introducing decision points at intermediate stages of investment projects, respectively. Johnson & Johnson followed this strategy in 1998 when it acquired an orthopedic device manufacturer, DePuy, which had $900 million in annual sales. J&J used its resources and capabilities to nurture and grow this company. By 2010, DePuy’s revenues grew to $5.6 billion.

To Kill both Innovation and Competition

In some instances, acquisitions can kill both innovation and competition. Consolidation in any industry can give rise to acquisitions and out of which some of them could be hostile takeovers. Killer acquisitions harm consumers because they eliminate both products and competition, but they benefit the incumbent firm-the acquirer. Questcor, a US-based pharmaceutical company in the year 2000, held its monopoly over a drug called Acthar. During that year, Acthar was selling at around $40 a vial. However, in the same year, Novartis started developing Synacthen, a synthetic version of Acthar. In 2013, Questcor acquired the production rights of Synacthen with the primary motive of reducing competition and raising prices. Shortly after the acquisition, Questcor shut down the development of the drug. Today, Acthar costs $39,000 a vial, a ninety-seven thousand times increase in prices over 19 years.

References and Further Reading

1. R. M. Grant, Contemporary Strategy Analysis (United Kingdom: John Wiley & Sons, Ltd., 2013), Chapters 2, 5, 9, 13, and 15.
2. M. E. Porter, Competitive Advantage (NY: The Free Press, 1985), Chapter 5.
3. T. L. Wheelen & J. D. Hunger, Strategic Management & Business Policy (New Jersey: Prentice Hall, 2000), Chapters 5 and 6.
4. T. L. Wheelen, J. D. Hunger, Alan N. Hoffman, and Charles E. Bamford, Strategic Management & Business Policy (United Kingdom: Pearson Education Ltd., 2018), Chapter 7.
5. Scott B. Smart, William L. Megginson and Lawrence J. Gitman, Corporate Finance (Ohio: Thompson South-Western, 2004), Chapter 24.
6. Marc Goedhart, Tim Koller, and David Wessels, The six types of successful acquisitions, Mckinsey & Company: Strategy and Corporate Finance, May 2017.
7. Raksha Kopparam, Killer acquisitions lead to decreased innovation in the prescription drug market, Washington Center for Equitable Growth, September 25, 2019.