In 1964, the Beatles released their hit single “Can’t Buy Me Love.” The song reminds us that there are certain things in life—like health, happiness and of course love – that just can’t be bought, no matter how much money you spend. I would like to add innovation to this list. It’s become a common strategy for large enterprises to essentially outsource innovation ideas to smaller, entrepreneurial firms through partnerships, licensing deals and even outright acquisition. In essence, they are betting that they can buy innovation.
It’s easy to understand why companies pursue this strategy. They are told, after all, that as large behemoths they can’t possibly be as innovative or nimble as startups and that it’s more efficient to just buy innovation ideas from the outside. On the surface, this “stick to your knitting” type logic seems reasonable. After all, aren’t companies supposed to focus on their so-called “core competencies” and exploit markets for the rest? On closer examination, though, the logic behind this strategy is deeply flawed for two reasons.
The first flaw in the logic is that it assumes you can buy an innovation or even the whole innovative company at an attractive price (i.e., a price that is below its true value). But remember, if you can buy something, so can your competitors. If an entrepreneurial firm has a great technology or capacity to innovate, it will likely draw the attention of many would-be suitors. And this will be especially true if everyone is following the “buy innovation ideas from the outside” strategy. Econ 101 teaches us that competition among bidders for an asset will cause the price to increase. Intense bidding among suitors can drive the price of acquisitions or licensing deals sky high. For instance, some biotech companies with just a single marketed drug have been purchased for above $20 billion (in comparison, the best estimates of the total cost of developing a drug is less than $3 billion). In short, competitive bidding can drive prices well past the point where the deal in question is financially attractive. In economics this is called the “winner’s curse”—the winning bidder, by definition, was the one who paid above what everyone else thought the asset was worth. A number of studies back up the idea that companies often fall victim to the winner’s curse. Acquisitions tend not to create value for the shareholders of acquiring firms (they do, however, pay off nicely for the shareholders of acquired firms). Of course, everyone who does these deals thinks they can spot the “diamond in the rough” and beat the dismal odds. You don’t have to be a mathematician to figure out the flaw in this logic.
The second fallacy in this argument is that it assumes the acquiring company has the ability to create and capture value from the innovation or innovator it acquires. But think about a corporation that lacks its own internal capacity for innovation ideas. It doesn’t have a clear innovation strategy; its systems are not geared toward spotting and nurturing transformational opportunities; and its organizational culture stifles the kind of behaviors (like risk-taking, experimentation and rapid decision making) required for innovation ideas. How well do you think such an organization will be able to exploit the fruits of its acquisition? In general, the record on acquisitions of small entrepreneurial firms by large corporations that lack their own innovation capacity is quite poor. As you might expect, these companies generally squash the innovative spirit of the companies they acquire by imposing their bureaucracy and culture. Frustrated, the really talented and entrepreneurial people leave (once their retention bonuses are paid).
This doesn’t mean that acquisitions can’t be part of an effective innovation strategy. They certainly can be. Apple acquired Steve Jobs’ NEXT and not only got Steve Jobs back, but also acquired key software that became part of new Mac operating system. Google, Amazon and Facebook have all made acquisitions of startups or embraced technology partnerships. Some of these have generated amazing value (think of Google’s acquisition of YouTube for just $1.65 billion). But acquisitions have not been the core of these companies’ innovation strategies. Instead, they have used acquisitions and technology partnerships as complementary pieces of deep internal capabilities and as part of broader innovation strategies.
Here are few basic principles for using external sources of innovation ideas:
- Use external sources of technology and innovation as complements to—not substitutes for—internal capabilities. If you have deep expertise, you will be a smarter shopper for external sources of innovation ideas. You will be much better able to evaluate which technologies are worth it, and which ones are “lemons.” And your expertise will also help you absorb and exploit those technologies once the deal is done.
- Look for strategically complementary technologies or capabilities. The best way to get a good deal is to be the only one interested in buying. This is more likely to be the case when your company and a potential partner have unique complementary capabilities that cannot be replicated by any other firm. Chasing after the same partners as everyone else is a recipe for overpaying.
- Fix your own cultural problems first. When a corporation known for being bureaucratic, risk averse and lethargic buys a startup known for innovation and creativity, it is usually the former which keeps its reputation intact. Acquisitions can solve some problems, but they rarely solve cultural problems.
Building a capacity and culture for innovation is tough (as I will discuss in a later blog). If being innovative was as easy as writing a check, innovation would not be a strategic capability. Organizations with innovative capabilities and cultures are rare, and that’s what makes them so valuable. You can’t buy love, and you can’t buy innovation.