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"Build vs. Buy" in M&A: A Guide for Investors

Updated: Feb 6



The strategic dilemma of "build vs. buy" is especially pertinent in the world of mergers and acquisitions (M&A). When companies decide to grow or diversify, they often face the decision of whether to internally expand their operations (build) or to acquire another business (buy). This choice can significantly impact an investor's returns, risk profile, and the overall trajectory of the investment. Let's dive deep into the build versus buy debate in the context of M&A, examining the advantages and potential pitfalls of each approach with examples to clarify the concepts.



Build: Organic Growth Through Internal Expansion


Advantages:


  • Control Over Process and Culture: When companies grow internally, they have more control over their processes, culture, and operations. Example: Google initially built its advertising and search capabilities in-house, ensuring it kept its unique culture and product quality.

  • Potential Cost Efficiency: Building can sometimes be less expensive than buying, especially when adjusting for integration costs and potential overvaluation in acquisitions. Example: Netflix, instead of acquiring content creators, initially chose to build its own content production capabilities.

  • Less Complex Risk Profile: When building, companies can control their rate of expansion and can pivot more easily if the market changes.


Pitfalls:


  • Time Consuming: Building can be slower than acquiring, potentially causing the company to miss out on timely market opportunities.

  • Operational Distractions: If not managed well, building can divert essential resources from the company's core operations.


Buy: Expansion Through Acquisitions


Advantages:


  • Rapid Market Entry: Acquiring allows companies to tap into new markets or sectors more quickly than if they were to build from scratch. Example: Facebook's acquisition of Instagram allowed immediate entry into the photo-sharing space.

  • Acquisition of Established Brands and Customer Bases: Instead of building customer trust from the ground up, buying can give immediate access to loyal customer bases. Example: When Microsoft acquired LinkedIn, it instantly gained access to a massive professional network and its user base.

  • Synergies: Companies can leverage shared resources, technologies, or distribution channels after an acquisition. Example: Disney's acquisition of Pixar not only brought in creative talent but also allowed sharing of animation technology and IP.


Pitfalls:


  • Integration Challenges: Merging two different corporate cultures and systems can lead to integration issues. Example: AOL and Time Warner's merger is often cited as a case where integration challenges led to a decline in value.

  • Overvaluation Risks: In the excitement of potential growth, companies might pay more than the intrinsic value of the acquired entity.

  • Potential Culture Clash: Companies with differing cultures might face employee dissatisfaction and attrition post-acquisition. Example: After HP's acquisition of Autonomy, disagreements and cultural differences led to controversies and write-downs.


Both building and buying come with their own sets of advantages and challenges. For investors, understanding the rationale behind a company's choice can offer insights into its strategic thinking, risk appetite, and future potential.


Stakeholder Implications of the Build vs. Buy Decision in M&A


Employees:


When a company chooses to grow organically, there are often exciting prospects for employees. This "build" strategy opens doors for internal growth and development. It's an era where existing employees get the chance to rise to new challenges, embracing new roles and responsibilities. However, this silver lining doesn't come without its clouds. The demand for expansion and development might overburden the workforce, especially if the company doesn't scale its human resources accordingly.


On the flip side, the acquisition or the "buy" strategy can bring a whirlwind of change. The fresh influx of talent and expertise can rejuvenate the company's operations. However, it's not always a smooth transition. Acquisitions frequently lead to overlap in roles and responsibilities. Take, for instance, Yahoo's acquisition of Tumblr. What seemed like a merger promising synergies led to significant redundancies and subsequent layoffs.


Build:

  • Pros: Opportunities for internal growth and development. Existing employees can take on new roles and responsibilities.

  • Cons: Potential for overwork or the stretching of resources if the company doesn't hire additional help.


Buy:

  • Pros: Influx of new talent and expertise.

  • Cons: Potential redundancies leading to layoffs, culture clashes, and integration challenges. Example: After an acquisition, there's often overlap in roles. Yahoo's purchase of Tumblr led to redundancies and eventual layoffs.


Customers:


From a customer's viewpoint, a company's decision to build can be both reassuring and testing. There's comfort in consistency—knowing that the product or service they've come to love remains unaffected. However, this very consistency may sometimes come at the cost of innovation, as changes and improvements are rolled out at a more incremental pace.


However, when a company chooses to buy, customers are often on the edge of their seats. There's the tantalizing possibility of rapid feature introductions or entirely new services. But this quick evolution isn't devoid of risks. Consider the apprehensions of long-time Slack users when Salesforce acquired the platform. The fear of potential disruptions or alterations to the beloved product's quality and direction was palpable.


Build:

  • Pros: Consistency in product or service quality. No disruptions as changes are incremental.

  • Cons: Slower introduction of new features or improvements.

Buy:

  • Pros: Rapid introduction of new features or services.

  • Cons: Potential disruptions in service or changes in product quality. Example: When a larger company acquires a beloved start-up, long-time customers may worry about changes in the quality or direction of the product, as seen with concerns from Slack users after Salesforce's acquisition.


Shareholders and Investors:


For shareholders and investors, the build strategy often signals a company's confidence in its internal capabilities. It's perceived as a calculated move, especially if the return on investment (ROI) on internal ventures promises to surpass acquisition costs. Yet, there's an element of patience required. Returns can be slow to realize, and there's always the looming risk of high initial R&D expenditures without assured success.


Contrarily, acquisitions present a tantalizing prospect of quick wins. The allure of immediate access to new markets, avant-garde technologies, or fresh revenue streams is hard to resist. But the journey isn't without its bumps. Over-enthusiasm can lead to overvaluation and rash acquisitions. A case in point is Microsoft's tryst with Nokia's phone business, which, despite high hopes, didn't yield the anticipated synergies and led to sizable write-downs.


Build:

  • Pros: Can be seen as a prudent use of capital if the ROI on internal development is higher than acquisition costs.

  • Cons: Return on investment might be slower. High initial R&D costs with no guaranteed success.

Buy:

  • Pros: Immediate access to new markets, technologies, or revenue streams. Potentially faster ROI.

  • Cons: Risk of overpaying, potential for write-downs if the acquisition doesn't deliver expected value. Example: Microsoft's acquisition of Nokia's phone business did not yield the expected synergies, leading to significant write-downs.


Competitors:


In the competitive arena, a company's decision to build can be a double-edged sword. By choosing to innovate internally, companies can carve out unique niches, offering products or services that competitors might not have. But this insular approach might give competitors, who opt for acquisitions, a head start.


Choosing to buy, especially for larger corporations, can solidify market dominance rapidly. Acquiring potential competitors or complementary businesses can amplify market presence. Google's M&A strategy exemplifies this approach. Their acquisitions of potential rivals, like YouTube and Android, didn't just eliminate competition but fortified Google's market dominance across sectors. Yet, these aggressive moves often come under the regulatory microscope, and there's always the risk of overpaying, especially in heated bidding scenarios.


Build:

  • Pros: Can lead to unique products or services that competitors don't offer.

  • Cons: Competitors might have a head start if they choose to buy.

Buy:

  • Pros: Immediate market presence and potential elimination of a competitor.

  • Cons: May attract regulatory scrutiny. Potential to overpay in a bidding war. Example: Google's acquisition strategy, buying out potential competitors like YouTube and Android, solidified its market dominance in multiple sectors.


The "build vs. buy" conundrum in the M&A landscape underscores the intricate balance companies must strike between organic growth and strategic acquisitions. Both paths offer their own sets of opportunities and challenges, affecting not just financial bottom lines but also stakeholders ranging from employees to customers, shareholders, and even competitors. While building emphasizes control, cultural cohesion, and gradual expansion, buying offers rapid market access, instant scale, and the acquisition of established assets. However, with these benefits come potential pitfalls like integration woes, cultural mismatches, and overvaluation risks. For investors, understanding this strategic tug-of-war is pivotal. It offers a lens through which the company's vision, agility, and foresight can be gauged. Ultimately, whether a company chooses to build or buy, it's the effective execution of that choice and its alignment with the broader business strategy that determines success in the dynamic world of mergers and acquisitions.

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