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Two dices, stacked on each other.

Mergers and aquisitions are a risky gamble, but it's not all about luck. U prof Rajesh Chandy has identified three rules for success.

High-tech marriages

Published on June 1, 2005

Nary a day goes by when news of an acquisition or merger is absent from the press, especially in high-tech industries, where firms must innovate to grow. Many wealthy suitors seek unions with glamorous, dynamic firms with hot new products and see such unions as a means to reinvigorate themselves, and create the next generation of innovations.

While managers exchange trillions of dollars in such unions each year, academics have long held that mergers and acquisitions are in fact bad for innovation. Once the knot has been tied, researchers suggest, many companies fail to give birth to the next generation of drugs, technical gadgets, or life-saving devices. Indeed, acquisitions can be time-consuming, expensive, and distracting, and overall hurt, not help, a company's ability to create innovations. But they don't need to be that way.

"If you haven't done your own research and development work, you won't have the knowledge to identify good from bad targets," Chandy says. "You won't be able to tell the lemons from the diamonds in the rough."

Carlson School Professor of Marketing Rajesh Chandy and his colleagues look at corporate acquisitions in the context of the pharmaceutical industry and extend their findings to all high-tech mergers and acquisitions, where innovation and patent creation are major goals.

"Researchers generally ask the question: Are acquisitions good or bad for innovation?" says Chandy. "In the high-stakes game of drug company acquisitions, a more useful question is: Why are some firms better at innovating from acquisitions than others?"

This is the question that Chandy and his co-authors Jaideep Prabhu of Imperial College London and Mark Ellis of Harvard Business School address in a recent study, "The Impact of Acquisitions on Innovation: Poison Pill, Placebo, or Tonic?" They researched 35 drug manufacturers over a nine-year period that had acquired a total of 157 companies. The researchers went beyond looking at research and development budgets, or the number of patents developed, to address the impact of acquisitions on product innovation in the drug development process.

Lessons from high-tech unions "Some unions led to few innovations, but many were in fact very fruitful," says Chandy. By comparing those that succeeded with those that failed, we were able to identify three principles for success."

1) Develop yourself before you marry Hoping to capitalize on the research and development that they've failed to undertake, many high-tech companies go seeking innovators who have already done the work for them. "This is faulty logic. Marriages made in desperation or for the sake of convenience are unlikely to work out," says Chandy.

"It's not that it's bad to buy another company because of its ability to innovate: indeed that is a great reason to buy," adds Chandy. "But unless you have already invested in innovation of your own, you are likely to botch up the innovation that is happening in the company you buy. You just won't know what makes your new partner tick."

You're also less likely to choose targets that have invested in innovation. "If you haven't done your own research and development work, you won't have the knowledge to identify good from bad targets," Chandy says. "You won't be able to tell the lemons from the diamonds in the rough."

Also, the best targets will likely resist overtures from a suitor they see as being incapable or over the hill. "Xerox Corporation is a good example of a company that didn't build before it went buying," Chandy says. In the 1960s, Xerox, the copier company, wanted to join the digital revolution and decided the best way to do this was through acquisition. "Xerox approached everyone it could think of, essentially begging to get married. In a last ditch effort out of sheer desperation; the company bought Scientific Data Systems (SDS), which was the largest acquisition at the time. SDS had little to offer Xerox, but Xerox didn't know any better."

2) Grow as individuals in order to grow as a couple Chandy and his colleagues found that buyers must have the right internal know-how, so they can absorb and integrate new information from the companies they acquire for the purpose of creating new innovations. But what is the right know-how?

"It's having both technical depth and breadth," says Chandy. "In the pharmaceutical industry, we measure depth by the number of patents a company holds in a particular technology area and breadth by the number of technology areas in which a company holds patents."

Having depth of knowledge is important, because it allows companies to better choose the most promising targets to acquire and to produce new knowledge in those fields. In addition, having breadth, and thus being knowledgeable about a number of areas is even more advantageous. "Breadth allows for happy accidental discoveries, because companies are able to apply their knowledge from one field creatively to another field," Chandy says.

3) Clones and opposites don't attract Don't seek companies that look and feel just like you or that don't look anything like you. "It may seem like common sense to want to buy a company with knowledge that is very similar to yours, or to look for a company that has knowledge that you don't have," Chandy says, "but the failures resulting from these types of acquisitions are widespread."

"Having too much similar technical knowledge won't be good for the acquiring company, because there will be little new knowledge to absorb," Chandy adds. This will result in developing more overlapping technologies and redundant research. There will be few knowledge synergies and therefore few opportunities for combining different types of knowledge in creative ways.

"In contrast, if the two firms' knowledge is very dissimilar, the external knowledge will be too difficult for the acquirer to absorb, and the company won't be able to use it to create new knowledge," says Chandy.

The bottom line for companies seeking to merge and acquire for the purpose of creating new technologies is this: Make sure you are ready to be married, and seek partners with moderately similar traits to your own. Innovation will follow in the form of new products and technologies.