This post was co-authored with Matthew P. Manary, Ph.D. Candidate, Fuqua School of Business, Duke University.
In addition to studying product-market strategies for company growth, I have also been asking CMOs how they use a set of “firm boundary” strategies to grow. In response to the question to “Allocate 100 points to reflect how your firm will grow during the next 12 months,” The CMO Survey™ (August-2012) reports that the majority (68.9%) of growth is expected to be organic or from within the firm’s own boundary, 12.9% from partnerships (ranging from alliances to joint ventures), 12.2% from acquisitions, and 6.1% from licensing arrangements. Organic growth gives the firm more control because growth activities happen within the firm boundaries. It does not go to the “market” for goods or services and therefore does not have to manage a partnership or licensing agreement. It also does not extend the firm’s boundary (sometimes called a “hierarchy”) to include a new firm which gives more control, but is also more expensive and may dilute the firm’s focus. At the same time, organic growth is potentially more costly because the firm must learn to do things that potential partners or acquisition targets have already mastered.
Results show that organic, partnership, and licensing growth activities have not changed significantly in the last four years of The CMO Survey™, despite minor fluctuations. The use of acquisitions as a growth strategy, however, has steadily increased. Figure 1 shows this progression from 8.8% in February 2009 to 12.2% in August 2012. There may be many reasons for this—companies have cash on hand or can get low-cost loans to make acquisitions, acquisition targets are cheaper, or firms are engaging in riskier growth (new markets and new offerings). The latter appears to be true based on data from The CMO Survey™ as I noted in an earlier blog.
Figure 1. Company Use of Acquisition Strategies Over Time
These speculations are trumped by one important fact that lies deeper in this trend data. Specifically, when examining the use of acquisitions as a growth strategy I find that the overall momentum observed in Figure 1 is driven in large part by technology-centric firms. Figure 2 compares the by-sector use of acquisition growth strategies for August 2009 versus August 2012. Although, according to casino utan svensk licens, all sectors other than Banking/Finance/Insurance posted an increasing reliance on acquisition growth strategies, the bellwether of growth is the tech sector. The use of acquisitions to fuel growth more than doubled for technology firms from 8.6% to 18.5% in just 3 years!
Figure 2. Sector Differences in the Use of Acquisition Strategies Over Time
Why are tech firms on an acquisition bender? Certainly growth aspirations are important. However, the thesis I want to advance in this blog is that the acquisition strategy surge within tech appears to have coincided with an increasing focus on intellectual property (IP). This IP focus is not necessarily about growth, though. Instead it appears that the dictum “The best offense is a good defense” is at play. Specifically, companies are protecting options and creating barriers to entry for competitors.
Growth by IP is therefore fundamentally a defensive strategy as it appears to be playing out in the tech trenches. Some of the largest recent tech acquisitions have involved either the sale of just patents, or of firms that come with massive IP portfolios. For example, after losing a bidding war to a group of firms headed by Apple and Microsoft for bankrupt Nortel’s nearly 6000 coveted wireless patents, Google acquired Motorola Mobility and its almost 25,000 patents and applications.
Unfortunately, at least so far, most of these patents are not ending up in products, but instead in the courtroom. Take for instance a set of patents Microsoft purchased from America Online in April, that Microsoft two weeks later sold to Facebook, who in turn used them to sue Mitel for patent infringement. Google’s Senior Vice President and General Counsel Kent Walker noted this shift last year saying, “The tech world has recently seen an explosion in patent litigation …. Some of these lawsuits have been filed by people or companies that have never actually created anything; others are motivated by a desire to block competing products or profit from the success of a rival’s new technology.” And not having IP protection can be expensive; consider the recent $1B verdict handed down against Samsung in its fight with Apple (which now spans 6 countries on 3 continents).
Why this strategy? Why now? A combination of three factors appears to be driving this shift: fuzzy product-market boundaries, litigation as strategy, and mountains of cash.
Fuzzy product-market boundaries. A decade ago technology firms operated in relatively defined fields. Apple made personal computers, Amazon sold books online, Google developed search engine software, Intel made PC chips, Microsoft made operating systems, and so forth. Today, all of these titans in some way compete in an increasingly crowded product-market landscape. For example, Apple, Microsoft, and Amazon all sell their own tablet devices, a product category that was non-existent just three years ago. And as technologies converge, traditional product categories have blurred. Tablets and smart-phones are functioning increasingly like computing devices. Laptops are less than an inch thick and touch-enabled, making them both a computing device and tablet.
Litigation as strategy. With increased competition, firms are aggressively defending their stakes in the market, and the weapon de jour is patent litigation. Recent patent litigation has pitted some of the world’s largest tech companies against each other—Microsoft vs. Motorola, Apple vs. Nokia, Apple vs. HTC, Google vs. Apple, Oracle vs. Google, Sony vs. LG, and Apple vs. Samsung—to name just a few. Here is an interesting example: Facebook, with only 56 patents at its disposal at the beginning of this year, found itself sued for patent infringement from Yahoo!, who is backed by a war-chest of over 1,000 patents. Facebook has since acquired IP from Microsoft, IBM, Friendster, Walker Digital, and HP, and now just 9 months later has a collection of over 1,400 patents. And just as it did with Mitel, Facebook allegedly is using acquired patents to subsequently counter-sue Yahoo!. Facebook is not alone, though. Google, Microsoft, Apple, Ericsson, EMC, Sony, RIM, Intel, Oracle, and EMC have collectively spent billions to purchase tens-of-thousands of patents over the past two years. And acquiring IP has become so prevalent that firms are even hiring executive level positions to lead their patent acquisition strategies, such as Amazon’s currently open Patent Acquisitions Executive position.
Mountains of cash. In addition to blurred product markets and increased IP litigation, cash has fueled the acquisition frenzy. Based on 2011 financial statements, the top 10 cash positions for tech firms totaled almost $300B. With the need for patents to enter new product spaces (or to keep competitors out), acquiring patents has become an increasingly attractive and necessary, but expensive, investment. Google recently paid for Motorola Mobility and its nearly 25,000 patents and applications. Microsoft paid over $1B for over 1,100 America Online patents and licenses (Facebook then purchased 650 of the patents from Microsoft for ), while Intel spent $375M on 1,700 InterDigital patents. And two consortiums of tech giants recently paid over $5B for the roughly 7,000 patents held by Nortel and Novell. But the combination of cash-in-hand purchasers and the need for product protection has had an impact on the market. Prices of patents in high tech are increasing at an alarming rate. Recent patent acquisitions have been running as much as $750K per patent—quadruple the price from just a few years earlier.
Will the current strategy shift to building protective IP fortresses stymie innovation in new product categories? If so, we may eventually see the acquisition trend for technology firms reverse as the market reaches a new equilibrium of a few dominant—and untouchable—players. Or will the defensive strategy backfire and leave the door open for new entrants to out-innovate the current incumbents? History may very well repeat itself, fueling future tech acquisition frenzies as tomorrow’s innovators feast on the IP remains of today’s litigants.