Thursday, April 18, 2024

The case for buying a new growth engine

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As they face macroeconomic uncertainty in their industries, most business leaders acknowledge that it’s more vital than ever to develop and accelerate an alternative engine of growth for the future. We refer to these new businesses within existing companies that use the scale benefits of the core business to grow faster than an independent startup could as “Engine 2.” And downturns are the times when companies make the bold moves that enable them to emerge stronger than their competitors.

While it can be tempting to build a new business from the ground up, our new research strongly supports the case for buying. We looked at hundreds of Engine 2 businesses over the past 25 years, and of the 58 most successful, 40 used mergers and acquisitions (M&A) as a significant part of their scaling plans. It’s an important finding at a time when lower valuations and less competition for deals make it a buyer’s market.

Building a team organically can take years longer than buying, which may put the company behind in a fast-moving competitive environment, allowing others to secure a strategic edge. Without in-house expertise for the new business, a company could be set back by several mistakes along the scaling journey. M&A comes with costs, for sure, but higher premiums are required to lure critical talent away individually. Building a business also often comes with costs associated with false starts, reorganizations, and executive interventions.

The key to successfully buying and scaling an Engine 2 starts with understanding that the unique assets of the target and the scaling journey of the acquirer will vary. Most, however, will generally fall into one of three common archetypes—and each requires tailored priorities and areas of focus. We’ll look at these archetypes one by one.

Rolling up businesses with similar cores

In these cases, an acquirer typically has some experience in the desired Engine 2 business and is looking to build scale rapidly through multiple acquisitions of existing players. To succeed, the buyer needs to be especially strong in diligence, confirming the strength of the business and how well the asset fits with the new engine. It’s also critical to emphasize integrating the new asset into the larger engine with minimal IT dis-synergies and minimal losses of customers and key talent.

Atlas Copco was interested in moving beyond its core of compressors with a new Engine 2 in vacuum technique. It knew from experience in similar industries that the market was poised for growth and that there would be great value in scale leadership. To build out quickly, the company acquired Edwards Group, and the subsequent success reinforced its conviction. Atlas Copco added verticals and geographic coverage to the engine with acquisitions of Leybold, CSK, Brooks Automation’s semiconductor cryogenics business, and more than 10 service and distribution assets over the past three years.

Success came as a result of a combination of the right strategic plan and outstanding execution, including extensive due diligence and efficient integration to scale up the new engine and build a leadership position in a growing market.

Buying capabilities to create a new core

In these situations, the M&A target is strategically attractive for capabilities or assets that will expand a new growth engine the company has in mind. The target may have critical talent, data, infrastructure, or domain knowledge that the acquirer lacks and that can be applied to existing or future new growth engines. The most skilled practitioners apply lessons from these acquisitions across multiple engines and business units, creating new value in unpredictable ways. Running this strategy successfully requires excellent talent retention, culture integration, and a patient board willing to wait out a possible multiyear journey with twists and turns.

Consider the route taken by Disney when it envisioned the potential for streaming content as a new growth engine. Its direct-to-consumer ambitions were greatly accelerated with its 2017 acquisition of BAMTech, a technology service and video streaming company previously formed by Major League Baseball. The BAMTech acquisition gave Disney several vital elements for what would eventually become Disney+, including robust back-end technology, insights into customer needs, and essential talent to tie together the value proposition with the new technology.

Buying the new core already at scale

In these deals, a company makes a single, major acquisition of an Engine 2 business that it plans to grow aggressively. China’s TCL ran this motion successfully when it bought Zhonghuan Semiconductor to add a large-scale Engine 2 of solar materials and modules with runway to grow even larger under the consumer electronics leader’s direction. 

Using this strategy, the acquirer must feel confident that it can rely on its existing resources and capabilities to grow the new business in ways that make the high acquisition costs worthwhile. That’s typically achieved by adding value that wasn’t possible when the target was on its own. For example, the acquirer may have sales relationships, R&D resources, unique assets, access to data or users, or operational excellence that can be used to bring the target to new heights. While this approach usually is the fastest path to a scaling a new Engine 2, it also can be the most expensive, incurring the largest acquisition premiums. Additionally, it requires the highest degree of integration difficulty because of the complexities of large-scale transactions and change.

Dell’s purchase of EMC in 2016 set the standard for large-scale Engine 2 acquisitions, and it still stands as one of the most successful in history. Dell knew the market was moving toward connected storage and servers, but it struggled to get traction with its organically developed storage products. EMC was the market leader not only in storage and virtualization (with VMWare) but also with enterprise customers, which Dell wanted so that it could make more of a push. Among many potential integration priorities, Dell started with cross-selling and moved rapidly to enable its sales team to bring EMC’s storage and VMware’s solutions into Dell accounts (and vice versa), turbocharging both Dell’s traditional core and the acquired businesses. Dell achieved synergy targets in half the expected time, hastening the company’s ability to realize its Engine 2 ambitions in a fast-moving and highly competitive environment.

Companies that are most successful when buying a new growth engine at scale test specific value creation theses with potential customers to confirm the magnitude of the potential benefit. They also build an operating model and management system that enable the right points of overlap to deliver new Engine 2 value while retaining the unique elements that made the asset valuable in the first place.

4 fundamental steps to successful execution

These archetypes for buying versus building are all viable approaches to accelerating a new growth engine. What separates the success stories from the also-rans is execution. Many companies have learned that the priorities and choices that work for core businesses do not always translate to establishing and scaling a new business. Regardless of the archetype a company chooses, we see four fundamental steps that no acquirer should overlook.

  • Start with a laser-focused due diligence that tests the asset’s fit with the elements that will be most important to your scaling.
  • Draft a clear integration thesis, and perform the integration with the aim of preserving the unique assets and capabilities that made the target desirable.
  • Design the integration plan to focus on the pivotal decisions that unlock customer value for the new engine, not just for the fastest path to day one.
  • Go beyond merely financial incentives for the critical talent you identified in the integration.

As more companies opt to buy to speed Engine 2 growth, more success stories are emerging—and the details that contribute to that success are coming into sharper focus. Winning companies will be those that take these lessons to heart as they make bold moves in the downturn. They’ll take advantage of lower premiums and less competition for deals to accelerate their new growth engine, outpacing competitors more effectively and for less total cost.

Alexandra Ramanathan and Vincent Vandierendonck are partners with Bain & Company. Mikaela Boyd is a partner and head of strategy practice for the Americas at Bain & Company. Scott Nancarrow is practice director for mergers and acquisitions at Bain & Company. Bain & Company is a partner of Fortune’s Breakthrough series.

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