In the latest McKinsey Quarterly article, titled “The elusive goal of corporate outperformance”, its authors reviewed the performance of over 1000 global companies with more than $5Bn in revenues trying to understand the common characteristics of the ones that outperformed their peers both in Top Line and Bottom Line growth. They used a very sophisticated modeling approach called non-parametric analysis that avoids the traps of averages and medians, and provides very specific outputs on individual performance, and came up with 9 companies out of the 1,077. Through their research they reached a similar conclusion my partners and I, and similarly minded operations executives, have agreed upon a long time ago: “Until you have operations that run smoothly and enable profitable organic growth other strategies have a lower chance of success.” This is how the McKinsey people said it: ”First, the top nine performers strongly preferred organic growth: they made few acquisitions and divestitures when compared with other companies in their industries. Further, none of the deals these companies made were transformational; that is, no divestiture or acquisition had a value exceeding 30 percent of their market capitalization in the year before the deal (Exhibit 2). By contrast, 37 percent of the companies enjoying either strong revenue growth or profitability—but not both—attempted some type of transformational deal.”
Over the years, I have experienced clients and, when I was an executive, other executives who insisted they could work their way out of a troubled operation through acquisitions or by implementing the latest fad in sales initiatives. Even though invariably they succeeded in their singular objective, more often than not, they failed the most important objective of any operating company, that of profitable top line growth.
Unless the acquisition strategy is one of a holding company, or a portfolio investment, pursuing acquisitions in an operating company without addressing the operational integrity issues is an irresponsible activity by senior management to say the least and a violation of their fiduciary responsibility to say the worse. Just like a boat that creates a wake behind it, acquisitions create a backlog of intergration challenges and operational integrity issues that only get worse as the number of acquisitions increases. And just like the backwash created by the wake can catch up and sink a boat that slows down below a certain speed, so does the task of integration eventually catch up and can sink companies that have to, at some point, slow down and integrate their acquisitions.
In one company I was involved with a few years back, organic growth was running at less than 1% but with a string of acquisitions masking the actual performance, it appeared as if the company was growing at substantially higher rates. Investors were happy and the management team (we were young and inexperienced at the time) did not recognize the problem. The non-sustainable ponzi scheme of acquisitions lasted for about three years and then the wheels came off the wagon. Needless to say, it came as a surprise to those of us who at the time believed in the message of the CEO of growth through acquisition and did not dig into the actual operating performance of the company. Imagine our shock when the company was sold to a “distressed asset buyer” for $0.40 on the dollar. It was an expensive lesson to learn for me and my partners, but a valuable lesson nevertheless. Unfortunately, the lesson did not spread widely and I have seen the same patern repeat itself in more recent times in other companies.
If you are an operator, please consider taking a basic financial analysis course, understand the financial aspects of any acquisition and compare that to the current operating environment. If the acquisition is “making the numbers look good” but adds little or no value to the current operating strategy, take a closer look at the long-term viability of the company.