STRATEGY & INNOVATION ARTICLES

Companies constantly seek new growth opportunities, but organic new growth is far from a sure bet. While business model innovation is a powerful path to sustained, robust growth, new businesses can take years to mature. The skills needed to conceive and incubate them present a unique set of challenges that many companies find difficult to overcome. “A large enterprise has trouble making an investment in innovation,” says Brad Anderson, the recently retired CEO of electronics retailer Best Buy. “It’s in part because Wall Street has trouble imagining a new way to operate but, more important, because people inside the company can’t see the value of a new idea and so won’t allocate the resources and support the new initiative needs to succeed.”

But organic growth is not the only option available to companies seeking transformational growth. Though most of my book Seizing the White Space: Business Model Innovation for Growth and Renewalis dedicated to developing new business models within incumbent organizations, I don’t mean to imply that incumbents shouldn’t seek to achieve transformative growth and exploit opportunities in their white space through mergers and acquisition. Incumbent companies can and should seek out opportunities to grow by mergers and acquisitions.

Some companies are legendary for their acquisitive prowess. For a time, GE acquired dozens of companies a year. Cisco has made more than one hundred acquisitions in its 26-year history. Acquisitions can be a way to quickly spur sales and develop reputations. They can allow mature organizations to brand an emerging company as “most likely to succeed” or steadily pursue sound strategic growth. And they can spur robust growth through business model transformation. When Anderson took over Best Buy, in fact, he led the company through a series of strategic acquisitions that helped it grow beyond a pure retail sales model.

But it’s no news to point out that acquisitions, at the best of times, are tricky. Study after study finds that acquisitions tend to disappoint, variously estimating that half to as many as 80 percent fail to create value. The high-profile struggle of AOL after its $180 billion acquisition of Time Warner is one obvious example of an acquisition gone bad. But there are others: Daimler/Chrysler, Sprint/Nextel, and Quaker Oats/Snapple, to name only a few. Quaker Oats paid $1.7 billion for the Snapple brand in 1994 but sold it to Triarc three years later for a mere $300 million.

I believe many M&A disappointments stem from a failure to understand the fundamentals of business model development. Companies often acquire other companies without fully understanding what they’re buying. The new company’s resources can be folded into the core of the acquiring company, but new business models resist such integration. Consequently, successful acquisitions tend to fall into one of two camps. An acquirer can buy a company solely for its resources, which it would then fold into its own model, while jettisoning the rest. The bulk of Cisco’s acquisitions follow that pattern. Alternatively, a company can seek to acquire another company’s business model, which it then needs to keep separate, but can strengthen by injecting into it its own resources. That’s that Best Buy did with Geek Squad. Trying to integrate in ways other than these that don’t allow a way for two very distinct business models to integrate is a recipe for a failed acquisition.

What they’re buying, essentially, is the other company’s business model, which as I explain in more detail in Seizing the White Space, consists of a value proposition customers want, delivered through a coherent profit formula by employing certain key resources effectively through certain key processes.

Johnson & Johnson has understood this, buying business models at an early stage and then keeping them separate. For example, its Medical Devices and Diagnostics division bought three business models that were fundamentally new to its respective markets: Vistakon (disposable contact lenses), LifeScan (at-home diabetes monitoring), and Cordis (artery stents used in angioplasty procedures). J&J bought these companies young and incubated them into the larger enterprise, where they became the growth engine of the MD&D division for many years.

All too often attempts to fold an acquired business into the core can kill what made it unique in the first place. Video game maker Electronic Arts (EA) learned this the hard way. Propelled by investor expectations, rising development costs, and an industry consolidation trend, EA aggressively bought up small companies led by creative teams that had found success in the market. To profit from anticipated economies of scale, it built up a standardized technical infrastructure and imposed streamlined production processes on its new acquisitions.

The results were abysmal. EA fell into a pattern of producing mediocre products based on movie licenses and sports franchises, which were updated each year. “EA is a strong brand, but a predictable one,” says Dan Hsu, former longtime editor-in-chief of Electronic Gaming Monthly. “Gamers know what they’re getting into: something with high production value and solid but not spectacular game play.”

Forcing creative teams to follow core processes was killing their innovative spirit. Luckily, CEO John Riccitiello saw the writing on the wall. “Where our industry has made mistake after mistake,” he says, “is forcing those technologies down the throats of development teams who know what works . . . It’s leading to creative failure . . . We’re getting less-creative, less-innovative products.”

Then he announced a sea change in EA’s operations: independent creative studios would operate as “city-states” within the EA corporate structure. “[Riccitiello] fell on his virtual sword and admitted that his company had squandered its leadership position in the market by trying to reduce the creative process to a cell on a spreadsheet,” reported the New York Times. “He said his company had lost its way by trying to homogenize and manage its creative process much like the consumer products companies (Häagen-Dazs, PepsiCo, Clorox) he used to work for . . . ‘Frankly, the core of our business, like in any creative business, are the guys and women who are actually making the product,’ Mr. Riccitiello said. ‘You can’t just buy people and attempt to apply some business-school synergy to them. It just doesn’t work. The companies that succeed are those that provide a stage for their best people and let them do what they do best, and it’s taken us some time to understand that. In our business the accountant, the guy in the green eyeshade, is like the guy in the alien movie that eventually gets eaten. If you let him run your business, it is neither inspiring nor effective.’ ”

Most of the same principles that govern the incubation, acceleration, and transition of homegrown new business models apply to acquired ones as well. Equally important is leadership’s ability to allow a newly acquired business model to pull what it needs from the core, rather than having elements of the core model pushed onto it. Best Buy’s Brad Anderson expressed this idea succinctly when asked about the company’s acquisition of Geek Squad, an in-home computer services and support company. “Geek Squad bought Best Buy,” he said, “not the other way around.” Anderson knew that the synergy would produce growth and transformation for the company, but he also knew that the low-margin, high-volume, retail mentality of Best Buy could easily suffocate the high-touch, high-margin service orientation of Geek Squad. He let Geek Squad pull from Best Buy what it needed to thrive. At the time of acquisition, Geek Squad had 60 employees and was booking $3 million in annual revenue. Today, working out of 700 Best Buy locations across North America, Geek Squad’s 12,000 service agents clock nearly $1 billion in services and return some $280 million to the retailer’s bottom line.

As Vijay Govindarajan and Chris Trimble noted in Ten Rules for Strategic Innovators, a newly acquired business based on a model distinct from the core should decide what it can borrow from the parent, what it should forget (or forget about), and what it will do or learn that is completely new. The key to understanding what to forget and what to learn lies in the business model. You must understand both your own business model and the new company’s model completely, so you won’t throw away the most valuable thing you bought – the very thing that will help your company grow.