What’s going on here? It seems that each day brings another announcement of a major new merger or acquisition. A few days ago, the newspapers reported a potential global alliance taking shape in the automobile industry, bringing together GM, Nissan and Renault. In the past few weeks, we have seen Mittal Steel’s acquisition bid for Arcelor, Phelps Dodge’s acquisition of both Inco Ltd. And Falconbridge Ltd in the mining industry, and Johnson & Johnson’s acquisition of the consumer brands division of Pfizer, Inc.
I wrote a widely quoted article in Harvard Business Review back in 1999 entitled “Unbundling the Corporation” (purchase required) – how do I reconcile that perspective with the recent wave of merger and acquisition activity on a global scale? In fact, if we probe beneath the headlines, we see an interesting paradox: mergers and acquisitions are accelerating at the same time that a systematic unbundling of the corporation plays out.
The current wave of M&A is a direct response to intensifying global competition at two levels – in both product and financial markets. In product markets, product life cycles are compressing, margins are eroding and market fragmentation makes it more and more difficult to make this all up on volume. In financial markets, investors are becoming increasingly demanding, seeking not only near-term profitability but attractive growth prospects as well.
What’s a CEO to do? Well, judging by the recent pattern of M&A activity, CEOs are increasingly looking for mergers and acquisitions within the same industry, often across national boundaries. This is a marked improvement over previous waves of M&A activity that were more purely growth focused and often led companies into diversification strategies that destroyed value rather than creating it.
These consolidation strategies seem to have two primary drivers. First, executives pursue opportunities to squeeze additional cost savings by leveraging economies of scale. Second, they seek to expand their product brand portfolio as a way to pump up revenue growth. There’s a third factor in play as M&A activity increases – CEOs face a choice of either embarking on an aggressive acquisition strategy of their own or risk becoming an acquisition target of someone else.
In the face of growing competitive and financial pressure, these are reasonable motivations. The question is whether they go far enough. Like the stock buybacks that I discussed in an earlier posting, these initiatives may reflect a more serious shortcoming: an institutional inability to internally generate profitable sources of growth. In fact, these initiatives may significantly distract executive (and investor) attention from the pressing need to restructure enterprises to create sustainable growth platforms. The turmoil at Kraft Foods, where the CEO was recently replaced, illustrates this risk. After embarking on an aggressive acquisition program to add new brands to its portfolio, Kraft has underperformed in terms of creating new brands of its own or generating more value from its existing brand portfolio.
The core message of my article on “Unbundling the Corporation” was ultimately a growth message – unbundling is a pre-requisite to sustainable and profitable growth. Unbundling does not lead to smaller enterprises, but instead creates powerful growth platforms. In a nutshell, the article argued that most enterprises today are an unnatural bundle of three very different kinds of businesses – infrastructure management businesses, product innovation and commercialization businesses and customer relationship businesses. By trying to manage the inherently conflicting demands of these three businesses within a single enterprise, executives undermine the potential for profitable growth.
In fact, this unbundling is already taking place across many industries around the world. Over the past several decades, we have seen the rapid growth of many forms of outsourcing – including logistics, contract manufacturing and call center operations. In effect, these outsourcing operations have grown as enterprises systematically make choices to strip out their infrastructure management businesses – high volume, routine processing operations – and turn them over to more focused companies. And the leaders within the outsourcing business, whether we are talking about Federal Express and UPS in logistics or leading companies in contract manufacturing and call center operation, are enjoying significant growth as they leverage the scale economies that shape most infrastructure management businesses.
This first wave of unbundling is already well under way. We are only in the earliest stages of the next wave of unbundling – separating product innovation and commercialization businesses from customer relationship businesses. This next wave is beginning to play out in some industries like pharmaceuticals where biotech companies focused on product innovation and commercialization are developing complementary relationships with established pharma companies that have deep relationships with “customers” (in this case, doctors and health care institutions). As I have suggested in another posting, this next wave of unbundling will also shape the future evolution of the media industry as it grapples with the challenges and opportunity of digital networks.
So what are the implications of all of this for CEOs? First, be wary of aggressive M&A campaigns until your management team has engaged with, and aligned around, the most basic question of all: what business are we really in? Every management team faces difficult choices in terms of which of the three businesses to focus on, yet few companies have explicitly engaged on this question. Until these choices have been made, M&A programs run the risk of complicating business operations – this is one reason why anticipated synergies rarely surface and why M&A transactions more often than not destroy economic value, rather than creating it.
Second, once these choices have been made, pursue aggressive growth strategies consistent with the economics of the business chosen. Each of the three business types has very different growth opportunities and sustainable growth will depend on pursuing consistent growth strategies. M&A will certainly play a role in these growth strategies, but the real opportunity will lie in harnessing the internal growth potential that is made possible by operating a focused business. The paradox is that unbundling is a pre-requisite for profitable and sustainable rebundling.