A couple of ROKC enthusiasts have approached us about applying ROKC to Merger & Acquisition so we decided to post an article with our thoughts on the subject.
Let’s start with a quick review of the ROKC approach:
- A business has a key component, an asset it owns or controls that gives it a competitive advantage in the markets in which it operates.
- The competitive advantage is sufficient robust over a foreseeable period of time that the opportunity to build a business out of the key component presents itself.
- The business owner can now set out to use the key component in the production of a product for a given market segment and packs it with features that will appeal to that same market segment.
- The product must help the consumer reduce the uncertainty of their life in some perceivable fashion.
- A certain amount of time and energy will also be employed to communicate the product’s value to the market segment so that they want to buy it, in some instances buying it as many times as possible in others just once.
- The above must generate enough residual value to allow the business to identify, monitor and mitigate risks to the key component and the competitive advantage it bestows, to the transformational processes by which it produces the product and incites the consumer to acquire the product, and to the overall business risks related to operating in that market.
- There must be enough value generated from the above to cover the cost of capital and return money to investors, and still reinvest in the business’s future before the key component’s competitive advantage disappears.
- Once the key component has lost enough of its competitive advantage the business owner will have either found a new one or the business will close.
It is from this standpoint that we look at how mergers & acquisitions make sense for a company by asking the question: “How does a merger or an acquisition help the business maximize the Return on Key Component within its perceived lifetime?”
The simplest M&A example is acquiring marketshare. The ability of any business to scale only through organic growth is limited. It requires going through successive cycles of buying and selling until it has accumulated enough capital to penetrate new markets. This is a slow process which can ultimately cut into the key component’s market effectiveness leading to a loss of competitive advantage before fully exploiting its economic potential. Think of the short lifetime for a patent before it falls into the public domain; you have to get a return on all the monies invested to file the patent before it expires or a competing technology comes along. Consequently, buying companies, nationally and internationally, is a way to greatly accelerate the scaling process.
Another reason for M&A activity is to kill off a competing technology. In this instance, the acquisition target will be a direct competitor who is bought with the objective of acquiring their key component and quashing it. This allows the acquiring company to reduce the risk to its own key component while at the same time getting access to the target’s clients.
In other cases, the target company’s key component will enhance the buyer’s key component. Facebook acquired Instagram because Instagram’s level of user engagement to share photos was so much better than Facebook’s. Facebook’s key component is valuable only if there is user engagement.
More recently there is the phenomenon of “acqui-hiring” in which a company buys another business to gain access to their talent. It seems this is case for Yahoo’s acquisition of Tumblr whereby it got access to David Karp, the company’s CEO. Marisa Meyer, CEO of Yahoo, not only bought the Tumblr business with all that it entails but also hopes Mr. Karp with help her revive Yahoo.
As with many large companies that are good at doing one thing on a very large scale it is very difficult for the behemoth to change direction. Consequently, a portfolio approach allows the holding company to manage the risks associated with a loss of competitive advantage by acquiring new high growth companies in which it can invest while milking the declining business for the cash with which to do it. Once the declining business reaches a certain level of returns it is sold off and the newer growing business becomes the face of the business.
These are just some of the ways in which a business can engage in M&A to maximize its Return On Key Component. Certainly there are other more complex scenarios but this is enough to give you an appreciation for how the ROKC method is applied to M&A. We are happy to learn about others. Feel free to share.