Sunday, September 30, 2007

Howdy Partner!

Once upon a time, there were two nearly identical companies in the same industry, called Alpha Company and Beta Company. Both companies wanted to grow, and both realized that if they increased their power throughout the entire supply chain, it would help their growth. However, both companies took a different strategic approach to reach this goal.

Alpha Company decided to reach its goal primarily through acquisitions. It started to use its resources to buy up companies in other parts of the supply chain. The logic was simple: the more companies they owned throughout the supply chain, supposedly the more power they would have within the entire supply chain.

Beta Company decided to reach its goal primarily through strategic alliances and partnerships. Beta used its resources to create superiority within the one area of the supply chain where it already operated. It then used that superiority as a bargaining chip to convince others in the rest of the supply chain to form preferential partnerships.

The results for Alpha Company were as follows:

1) Alpha could only acquire companies which were willing to sell to them. Usually, the companies who were the very best in their sector were strong enough that they did not see the need to sell their company to Alpha. Either that, or they asked for so much money that Alpha could not afford them.

2) Alpha ran out of resources before completing the acquisition of an entire supply chain network. They had more of the pieces of the puzzle than before, but the network still had many holes in it.

3) Rather than spending time improving their core business, their time was spent trying to integrate the acquisitions. This always seems to be more difficult, more time consuming and more expensive than originally anticipated. And while they were doing this, other companies—like Beta—were improving their core business. This was reducing the competitiveness of Alpha’s core business.

4) Because Alpha always demanded that its divisions work exclusively with each other, they were not always able to use the best partner in every situation. This weakened their position in the marketplace and lowered the sales in the acquired companies.

5) Many of the rest of the businesses in the supply chain no longer saw Alpha’s core business as an ideal partner, because Alpha had acquired one of their direct competitors. Therefore, the business they used to give to Alpha went to others who did not own businesses in their sector. This lowered Alpha’s sales in the core business.

6) With the lowered sales in the core as well as the new businesses, Alpha was forced to cut some costs in an attempt to save profitability. However this only served to weaken the quality of their offerings, making them even weaker in the marketplace.

The results for Beta Company were a bit different:

1) Because they had invested in making their core business superior to competition, Beta became a sought-after partner. Beta was able to use this clout to create preferential partnership deals with the best players in the rest of the supply chain. It had deals with great players throughout the entire supply chain network.

2) The preferential partnerships became more profitable than the former way of conducting business. Much of the added profitability from the preferential partnerships was plowed into the core business to make it an even stronger competitor/partner.

3) Even though Beta had preferential partnerships, it refrained from creating very many “exclusive” partnerships. Therefore, it could still work with others in the network if it made more sense for its customers.

4) Although the companies which had not formed partnerships with Beta were a little angry with them, most were pragmatic enough to understand that Beta had become so superior in its field that it still made sense to deal with them, in spite of their own anger. In addition, they felt that at least Beta had not become a traitor by buying one of their direct competitors, so they liked dealing with Beta more than Alpha.

In the end, Beta kept getting stronger within the entire supply chain, while Alpha kept getting weaker. Eventually, Alpha filed for bankruptcy while Beta became the darling of Wall Street.

One of the key issues addressed in strategic planning is the concept of growth. Nearly all of a company’s stakeholders want to increase the growth of the company. Acquisitions are often seen as a “sexy” way to achieve that growth. Just spend a little money and—BAM!—you are instantly larger than before. It’s a lot faster than trying to diversify as a start-up. In addition, you eliminate some diversification risks versus start-ups, because you are purchasing known competencies (that you do not currently have) which are already established in the marketplace.

The problem is that although acquisitions may at first seem to be the best way to diversify and grow, they are fraught with problems of their own. As we saw in the story above, Alpha was worse off than before due to its acquisition strategy.

In today’s rapidly changing economy, it is often better to grow via partnerships, alliances and preferential agreements rather than through acquisition. This was the successful approach of Beta in the story above.

Therefore, when developing growth strategies, always make sure you consider the partnership approach.

The principle here is that “control” is not the same thing as “ownership.” Often, we rush to the conclusion that the more we own, the more we control. Therefore, we try to own a lot of things.

In reality, ownership can often weaken one’s control. In the story above, Alpha’s power in controlling the supply chain was less after their acquisitions than before. It lost power as follows:

1) It lost the power of dealing with the best people in the industry. Part of this was internal because they were now limiting themselves to using the companies they acquired, which were not always the best choice for every situation. Part of this was external, because now others were less willing to work with them because they did not want to work with a firm which owned one of their direct competitors.

2) It lost power in their core business. This was due to multiple factors, including having less time and money to invest in the core, as well as a loss in productivity due to the loss in customers who did not want to deal with them any longer because of the baggage of having to deal with their other divisions.

Often times, more power can be gained through partnerships than through acquisitions. Partnerships can give you a great deal of control over how the entire ecosystem works without tying up all of your capital. Think of the medical profession, which thrives on referrals. Partnerships are a way to get a disproportional amount of “referrals” at a preferred rate.

In the story above, Beta gained power in several ways:

1) It became more powerful in its core business, because it was able to concentrate more resources on improving its performance. This made it a more desirable partner.

2) It became more powerful in determining how the profits in the entire ecosystem were divvied up. Through its negotiations, Beta obtained a preferred status, which allowed it to negotiate more favorable terms for itself. As a result, Beta tapped into a larger share of the entire ecosystem’s profit pool without having to invest in more of the ecosystem. This makes for a great return on investment. By contrast, when Alpha acquired other companies in the ecosystem, it had to pay a premium to get the deal done. Hence, the company who sold the business to Alpha extracted a great deal of the profitability through the premium price, leaving less for Alpha.

Now some of you may be saying that acquisitions are better because they bring more synergies. Perhaps this is true, but acquisitions also bring more dis-synergies from people who no longer want to work with a company who bought a direct competitor. Often times, the net synergistic benefit is higher with the partnership, because you are more likely working with a better mix of partners.

Although growth is often a very good thing, not all attempts at creating growth are equally beneficial. In many cases, partnering is a better way to grow than acquisitions. Ironically, partnering usually creates greater control than ownership. And in the end, control is what typically leads to greater profitability.

People who volunteer to do a job usually do a better job than those who are forced into it. In a sense, acquisitions are like forced labor, whereas partnerships are more voluntary.

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