Innovation is tough. It takes a long time. It is expensive. There are no guarantees. Others may have better ideas. When your business is faced with this reality, what can you do?
McKinsey and others call it “M&A as R&D.” In short, it argues for using an acquisition engine to fill in technical gaps in your product offerings. Two places where this is prevalent are the technology and pharmaceuticals industries.
Acquisitions in the tech industry
Microsoft is a leader in this practice, with over 50 acquisitions since 2005. Some of these were household names, such as Skype, Great Plains and Visio, but most were smaller companies with compelling IP, such as AVIcode, which was a leader in .NET application performance monitoring that improved Microsoft’s System Center product.
Amazon.com is another example. Since 1999, Amazon has purchased or invested in over 40 companies. Many of these were vertical online retailers, like Drugstore.com, Homegrocer.com or Pets.com. But others provided core technologies that enabled growth across the firm, such as Junglee and Alexa.
Pricing on these acquisitions tends to be quite high from a normal price-to-sales or price-to-earnings ratio. That is because these deals are not valued merely based on the standalone firm, but how important the technology is to the acquirer’s strategic objectives and how much revenue or profitability can be driven following integration. In some cases, the acquisition is done as a defensive measure to keep a competitor from acquiring the technology. Some have argued that Microsoft’s recent purchase of Skype was done as much as a defensive move against Google and Apple, as an offensive move in the mobile communications space.
So where’s the value? The primary synergy drivers for M&A as R&D are:
- The ability to integrate the acquired firm’s technologies into the acquiring firm’s products
- The ability of the acquiring firm to drive the acquired firm’s products through their channels
To realize this value, acquiring firms must be very careful when engaging in this strategy. First, they have to do significant due diligence to make sure the acquisition brings the technology capabilities desired AND those capabilities can be integrated into core products in a reasonable amount of time and effort. Second, key engineers and other staff need to be retained to avoid “brain drain” and ensure the technical integration is done well. Third, integration must be done quickly. Integration teams must be skilled to perform the combinations, and usually these acquirers have well codified processes to move quickly and efficiently.
Acquisition in the pharmaceutical industry
The largest pharmaceutical firms in the world today face enormous challenges. The myriad of drug breakthroughs in the ‘80s and ‘90s generated a worldwide revenue stream in the hundreds of billions of dollars. However, the patent protections on many of these drugs are now ending, and the revenue potential for these medicines is becoming quite limited as generics quickly emerge to undercut the margin and market share of the incumbent medicine. Some analysts believe that by 2016, drugs that today generate $255 Billion in global sales will lose their patent protection and will be at significant risk to generics.
This loss of key revenue sources demands that these firms find replacements. However, developing a new drug from scratch can take up to 10 years and $2B and there is no guarantee of success. These firms simply don’t have the capital to invest in dozens of drug developments directly.
So what do they do? They create R&D investments with smaller biotech firms by combining their capital, VC investments and other private investments to create portfolios of equity (JV) investments at a fraction of the cost. These investments work for the bio-tech firms because it provides them with access to capital and a ready manufacturing and distribution channel when their treatments have been approved.
Pfizer, the largest world’s largest pharmaceutical company, invests $50M per year in a variety of healthcare related areas, including therapeutics, drug delivery and drug discovery. They currently manage almost two dozen investments globally.
GSK, the 4th largest pharmaceuticals company in the world, today has over 40 treatments or compounds under development with alliances or third parties. These investments represent about half of its pipeline.
So how do they do it? By creating internal capabilities to identify, negotiate and manage a basket of investments quickly and with more predicable outcomes. What are most important are to:
- Develop a strategic framework: Many firms have defined frameworks for which research areas are needed and how they will fit in with the rest of the treatment portfolio.
- Develop a rigorous screening process: Due diligence is critical in evaluating investment risk; quality of management and researchers; and quality of treatment pipeline.
- Utilize dedicated alliance teams to manage performance: Alliance teams must be able to represent both parties well and work to drive the alliance to success.
- Make decisions carefully and deliberately, but quickly: Strong governance must be in place to determine when investments should be increased, decreased or when to exit an investment.
R&D investments are a critical component to most of the major pharmaceutical’s growth strategy. They can mitigate capital risk, acquire new technical capabilities and increase the number of development projects.
When done well, using acquisitions to fuel an innovation engine is effective, fast and value producing. The keys are understanding what you need to buy and how to unlock the value of the acquisition.