nnovating is always a good thing… right?
Not quite. A new study by Abhishek Borah of the University of Washington Foster School of Business finds that the financial markets, on average, react negatively when firms innovate through the acquisition of another company. By comparison, innovations produced in-house or through alliances tend to be greeted positively by investors.
In their analysis of three alternative paths to innovation—denoted in the paper as “make,” “buy,” and “ally”—Borah and co-author Gerard J. Tellis of USC learned that buying innovation is the most prevalent of the three strategies in business today, despite its sketchy track record.
The reasons? The study reveals that firms often choose to buy after periods of little commercialization, when they are desperate to innovate. Senior executives may have incentives to buy. And, perhaps most surprisingly, they simply fail to learn from past acquisitions.
“You’d expect that firms would use prior returns as the basis for future choices,” says Borah. “But they don’t appear to do so before purchasing another firm’s innovations. They buy as a quick fix for a deeper strategic problem. And they are not learning from prior experience. That is why attempts to buy innovations falter.”
Innovation is the lifeblood of firms, an activity essential to survival, growth and success in today’s globally competitive marketplace.
But there are different routes to innovation. To produce new products and services, companies produce their own (make), partner with other firms (ally), or acquire firms (buy). And they spend billions of dollars each year implementing these three strategies.
To find out what works best (and worst), Borah and Tellis analyzed the market’s response to 3,522 announcements of innovations by 192 firms across 108 industries over 5 years. Their sophisticated model controlled for many different factors in the economy, industry and firm in order to isolate investors’ reaction to each innovation announced.
They found that “buy” is the most prevalent method of innovating, followed by “make” and “ally.” Despite this, “make” and “ally” generate a significantly positive and much higher payoff than “buy,” which leads to a significantly negative payoff.
According to Borah, the short-term reaction is indicative of future performance. “We follow the efficient-market hypothesis which states that a share price today incorporates the future value of the information,” he says. “We expect that the future value of the innovation is already present in the price just after its announcement.”
In other words, if investors sell shares on news of an innovation acquisition, that strategy is destined to fail.
And failure is a hard reality. The success rate of acquisitions languishes around 17 percent, according to a report by the firm KPMG. Recent high-profile flops include HP’s $11 billion acquisition of Autonomy, eBay’s $2.6 billion acquisition of Skype and Microsoft’s $6.3 billion acquisition of aQuantive (and its recent purchase of Nokia been met with little optimism).
Borah explains that acquisition innovations tend to go wrong for several reasons. They are less flexible and reversible than those produced in-house or in partnerships. They are suspect to culture clashes, challenges integrating financials, and layoffs or employee defections.
But corporate acquisitions can produce positive innovations, too. Intel has a good track record of buys, as does Google and YouTube. How do they do it?
If the study has a silver lining, it’s that the negative returns that plague “buy” innovations can be mitigated. Borah says that successful acquisitions require experience, attention, and resulting innovations that complement the firm’s core strengths and give customers a real benefit.
“Before buying, managers should know the process, have procedures in place, document past acquisitions,” he says. “And when they buy, it should be to create innovations that are related to the firm’s current capabilities, and that offer real benefits to customers.
“An organization needs to learn from its past.”
“Make, Buy, or Ally? Choice of and Payoff to Announcements of Alternate Routes to Innovations” is forthcoming in Marketing Science.