Why Do Corporations Make Acquisitions? Buy vs. Build

When large corporations look to expand or innovate, they face a critical decision: should they build new capabilities internally or buy an existing company that already has these capabilities? This decision, often referred to as the “buy versus build” dilemma, is influenced by various strategic and financial considerations. Let’s explore why corporations frequently choose to acquire rather than develop from scratch, and what factors they weigh in making this decision.

Introduction to Corporate Acquisitions

Corporate acquisitions differ significantly from private equity acquisitions. While private equity firms often focus on aggregating and consolidating businesses to achieve multiple expansions and short-term ownership, corporations typically aim to integrate new acquisitions into their existing operations for long-term strategic growth. Corporations seek fundamentally sound and often profit-generating entities that can provide access to new markets, innovative capabilities, or intellectual property.

Buy vs. Build: A Hypothetical Scenario

Consider a large telecom company like Verizon or AT&T that wants to enter the device-to-device communication market, such as the Internet of Things (IoT) for security cameras. At the executive level, these companies would analyze how to become players in this space and gain a competitive edge. The analysis boils down to a decision of whether to buy an existing company with the desired capabilities or build those capabilities internally.

Advantages of Buying Over Building

Building a new capability from scratch is akin to “Prometheus Starting Fire.” The initial stages of developing a new business are the most challenging and resource-intensive. In contrast, acquiring an existing business, even a small one that generates a modest profit, can save significant time and resources. Large corporations often find it advantageous to buy rather than build for several reasons:

1. Resource Savings: Starting a new business requires substantial time, effort, and capital. By acquiring an existing company, corporations can bypass the most challenging stages of business development.
2. Speed: Acquisitions allow corporations to quickly enter new markets and gain capabilities without the delays associated with internal development.
3. Expertise and Innovation: Acquiring a nimble and innovative company can provide not only the desired technology or product but also the expertise and innovative culture that comes with it.

Why Corporations Prefer Acquisitions

A common question is why corporations don’t simply develop new capabilities internally. The answer lies in the efficiency and cost-effectiveness of acquisitions. Even if corporations pay a premium, acquiring a company is often cheaper and faster than assembling the necessary resources and talent to build from scratch. Additionally, time is a crucial factor. Gaining a competitive advantage quickly can be worth the higher acquisition cost compared to the slower process of internal development.

Valuation and Strategic Fit

When corporations evaluate potential acquisitions, they look beyond the immediate financial metrics. They consider how well the acquisition fits into their overall strategy and operational needs. This involves understanding the broader industry landscape and identifying where the acquired company fits within it. The valuation of an acquisition is often based on the strategic benefits it provides, such as avoiding certain operational pains or gaining a significant competitive advantage.

For example, if a corporation can acquire a company that fills a critical gap in its product line or market presence, the strategic value of that acquisition can be substantial. This approach to valuation considers not just the standalone worth of the company but its worth within the context of the acquiring corporation’s strategic goals.

Summary and Conclusion

The “buy versus build” decision is a fundamental consideration for corporations looking to expand their capabilities. Acquisitions offer numerous advantages over internal development, including faster market entry, resource savings, and the acquisition of innovation and expertise. By strategically evaluating potential acquisitions based on their fit within the larger corporate strategy and the specific advantages they offer, corporations can make informed decisions that drive long-term growth and competitive advantage.

In summary, corporations often find it more beneficial to acquire existing businesses rather than building capabilities from scratch due to the efficiency, speed, and strategic fit that acquisitions provide. Understanding these dynamics helps in appreciating why large companies frequently opt for acquisitions as a primary growth strategy.