Four Reasons for M&A in Technology Companies

We constantly hear of companies acquiring other firms. Google's parent firm, Alphabet has bought 227 companies in the last 18+ years. That's over 1 company every month! It's not just the big tech giants either. Finnish industrial firm Ensto (of some 270M€ in turnover) has bought firms steadily: Alppilux in 2014, Tridelta in 2016 and Elwia Systems in 2017 being the most recent ones. Even smaller companies shop around: Finnish consultancy firm Eficode bought Big Data consultancy Videnhuset in 2014, Design firm Adage in 2017 and Devops house Pragma in 2019.

Regardless of the size and industry of your employer, it may happen that you are tasked with evaluating a potential M&A target. Understanding the motivation behind the arrangement allows you to focus on evaluating the right things.

For the purposes of the technologist, we can split the strategic motivations to four categories

Growth motivated M&A

Growth motivated M&A is relatively easy to deal with from a technology standpoint: the focus of technology evaluation should be in risk management. The acquisition will happen regardless of the technologist's opinion, unless an unmitigable risk with high value is uncovered in the due diligence. The technologists focus should be to...

1. Find these risks if they exists
2. Find other weaknesses, which could hinder joint operations down the line and come up with a mitigation roadmap
3. Plan integration of products and toolchains (if the intent is to integrate the two companies).

Existential technology risks for the growth motivated M&A might be

• A shift in the market makes the company's products obsolete due to insufficient R&D investment. This may show up as competitors driving price erosion, components (hardware or software) becoming unavailable or competent personnel being unavailable due to the aging technology.
• The growth is intended to arise from cross-selling of the companies' products in each others markets, but the products are not compatible with the market's regulations, culture or other products they need to work with.
• An intellectual property risk ties up resources or prevents sales of the product in the target markets
• Regulatory approvals, such as product certifications or permits are missing. This is usually only a risk with acquiring small companies as bigger ones tend to have them covered.

The risk management part of technology due diligence should always be done. To understand whether these risks jeopardize the entire enterprise, the mitigation costs and risk probabilities need to be evaluated and reflected against the expected upside from the deal.

Competition Removal M&A

When buying a company to eliminate competition, the focus of the technology due diligence depends on the intended fate of the acquired product lines. This in itself is a technology question, as products will need to be compared on feature- and profitability metrics. A replacement path will need to be designed for the discontinued products and the remaining items should be dealt similarly to a growth motivated M&A case.

Migrating existing customers to new products may incur costs, which should be incorporated in the business case calculation.

Operational Synergies M&A

Operational synergies are significantly more complicated to evaluate than growth motivated cases. All key products need to be evaluated for features, components, supply chain, channels, sales models and personnel competence. It is also not enough to know the new company well, but also have an in-depth understanding of your own firm's solutions.

The most important operational synergies are:

• Sourcing synergies can be achieved if the same supplier can provide components or services to both of the companies' products.
• R&D synergies can be achieved if one development project can support both companies products. This approach entails sharing some hardware or software components across product lines. It is rarely the case that two companies would use identical hardware or software from the get-go and consolidating can end up being costly so it is very important to evaluate
• Solution synergies arise when products of two companies can be combined in some way to provide additional value to the customer.

New Capabilities M&A

An M&A action taken to expand competence or acquire new technology. In essence, this is a make-or-buy decision: most technology and competence could be built in-house. The question is, how much would it cost to do so? To answer this question, answer the following supporting questions:

• What are the key assets, including competencies and technologies of the target company, and how do they differ from your own firms assets?
• What do you intend to do with the new assets?
• Which parts of their assets are critical in achieving your goals?
• What is missing from their assets? How much will it cost to develop them to the point where your needs are satisfied?
• How much has the company spent to get to this point (considering only the critical parts of their assets)?
• Given a good team and present day technology, could you do what they do more efficiently? How long would it take?
• How long would it take to recruit the needed team?
• Considering the development time, how much profit would be lost due to time-to-market?

Cost of development + Cost of delay give you the price tag for the make option.

Investment + Cost of Integration + Cost of additional development give you the price tag for the buy option.

You will obviously need to also evaluate the risks inherent in both, especially if the difference in costs is small,