Build or buy?
That's the issue discussed in a recent Wall Street Journal article "Bosses Prefer Buying Businesses To Building Them", 2/17/2005). The author sees the following points about the current merger boom:
- Many big companies are flush with cash right now. Many have used that money to pay down debts, buy back stock, and increase dividends. The next logical place to put that money is into acquiring new companies.
- While the world economy is doing better than it was after the Internet bubble burst, the actual growth in capital spending is increasing at a modest speed, and that looks likely to be an upcoming trend. Therefore, expanding through internal growth is getting harder.
- Corporate heads are more optimistic than ever about mergers and acquisitions, in spite of the relatively high valuation of suitable targets. But the key is investors. In contrast to some of the thinking before, investors have been rewarding a number of skillful acquirers with high stock prices. Since execs get highly compensated (options, shares, incentives) when stock prices go up significantly, there's a good reason. (Of course, we often see executives get highly rewarded when stock prices go down, so that may not be the sole motivator.)
But the WSJ article misses out on some of the key issues. First, big companies are pretty bad at real innovation. In the end, it is easier to buy innovation than try to develop it internally. No matter how high the R&D budget, it is vary hard for established companies to do more than upgrade and add features to existing products. The cost of failure is so high in big companies that most new products that make it through the approval process are simple imitations of what already exists. Such variations can be and often are profitable, but they don't have the same effect as "the next big thing."
The other reason is ease. Acquiring a new company is a lot easier than improving operations at your own. Exploiting a product that someone else has made by giving it the big company treatment in marketing, sales, and distribution is a lot less painful than finding ways to make serious and effective internal changes For all the talk of reengineering the company, most companies would rather just buy another one. That move is high-concept, ego-gratifying, and relatively straightforward. Rethinking a corporation is complex, painstaking, and often tedious.
3:19:45 PM 
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