Saturday, April 21, 2018

Is acquisition of tech startups beneficial for large companies ?

I was reading through this latest article in Harvard Business review of April '18 on how innovation really works in organisations.  I found it quite interesting and it shook away away some of my earlier perceptions on why organisations acquire small organisations to benefit on research and development efforts.

We all have been led to believe that it is better for large companies to acquire young and small new tech startups than invest in Research and Development (R&D) independently. A glaring example of this is Google. Starting as a search engine, Alphabet, Google's parent company has now grown inorganically to include almost 215 acquisitions as of March 2018.

But does this hold good in general in the technology ecosystem ? It is a major question we need to understand.

Why are large companies afraid to invest in R & D, and why do large companies acquire small companies ?
First and foremost, it is the commercial interest. To join hands together and use the synergies of both the companies to become a large entity and grow in business volumes.

Secondly, when a hostile takeover happens, the intention of the large company is to finish off the acquired company, otherwise called predatory acquisition. 

A third reason why a major group acquires other companies is to get rights over the Intellectual Property the small acquired company may hold. Google acquired Motorola Mobility on 15 August 2011 for $12.5 billion and got rights to almost 20,000 patents which Motorola had. This helped Google be the undisputed leader of the mobile industry world over, challenging Samsung. Later on in March of 2014, Google sold off Motorola to Lenovo for $2.91 billion, less the IP.
A fourth reason of acquisitions is to have a thriving research and development ecosystem, and not to kill it, as Google did with Motorola. The parent company would want research and development to be taken up by the acquired entity leaving the acquirer free to use its IP
The fifth reason is that star employees of the large company investing in research and development are more likely to leave the large company and set up their own companies. This hurts the interests of the large company forcing I to go slow on research.
Because of these reasons, large organisations would want instead to take over small high-tech research oriented companies, in the process save time, money, effort and importantly star employees.

But contrary to expectations, it has been now shown through research that acquisitions of small tech companies by large companies need not necessarily improve the Research Quotient, on the other hand, it can kill the research benefits. 

Over a three year study conducted in the US on the acquisition intensity (ie. dollars spent on the acquisitions divided by the acquirer's revenues) is said to correspond with a significant decrease of the acquiring company's Research Quotient (a measure of the return on research and development investments). It is really interesting to understand how this has been found to apply in general to the industry, but has escaped Google, the biggest acquirer in the past twenty years on planet earth. 

     ie. the acquisition intensity is found to be inversely proportional to the research quotient.

It is found that of all startup innovations only 25% came from research by startups, 52 % came from experience of the promoters in an earlier industry and 14% came from suppliers to the industry.

It is also found that
  • the average rate of new firm creation in any industry is just 0.06% 
  • employees leaving their companies to start new startups is just one percent. There is a growing tendency among educated employees to stay back with major companies and hesitate to take the huge risks associated with starting new organisations. 
  • as tenure of employees in an organisation increases, the tendency to stay back with the same company is high
  • as employees are treated well, their tendency to stay back is high
  • as employees are paid well, they tend to stay back (till about $5.2 million annual compensation)
It is found that companies with 500 plus employees do 5.75 times more research than small companies and they are 13% more productive in research and development than small companies. This brings us to the stark reality that big companies are the real harbingers of development through research than small companies.

Large companies cannot acquire good companies that do good research and development and expect the trend to continue, instead, it kills the small company's research and development efforts too. Innovations often credited to small companies actually did originate from ideas which originated in the large companies when the innovator was working with them and preferred to quit and develop independently, as he found the environment in large organisation a bit stifling. Mostly these ideas were what the large company over time found impractical and unworthy to carry forward.

The takeaway thus is, let us not discount large organisations as still the furnaces of great ideas that is transforming the world.  The contribution of research and development that originates in large organisation is really driving the world forward.

george

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