Laurence Capron on Build, Borrow or Buy

Laurence Capron, the Paul Desmarais Chaired Professor of Partnership and Active Ownership at INSEAD in France, is the author (with Will Mitchell of Toronto University’s Rotman School of Management) of Build, Borrow or Buy (2012). Drawing on their research and teaching, Capron and Mitchell propose the Resource Pathways Framework. This is built around three strategic questions:

Build: Are your existing internal resources relevant for developing internally the new resources that you have targeted for growth?
Borrow: Could you obtain the targeted resources via an effective relationship with a resource partner through licensing or alliances?
Buy: Do you need broad and deep relationships with your resource provider and need to take majority control?

Stuart Crainer talked to Laurence Capron at INSEAD’s Fontainebleau campus on the outskirts of Paris, and began by asking what first ignited her interest in the subject in the first place:

The starting point was my dissertation on mergers and acquisitions (M&As) and how often they destroyed value. This was not only from a shareholder standpoint but also for employees and they also could hurt a firm’s capabilities. My initial interest was the extent to which acquisitions could help firms to acquire new capabilities to continue to grow and to survive, and how often they ended up not being successful.

I started to develop executive programs on M&As at INSEAD. It became clear to me that executives — heads of M&As, corporate development and so on — came to the course with the idea that M&As were the strategy of their company and they just needed to make it happen. Instead of being a tool in a toolkit, M&As were the strategy. They tended not to think whether they needed M&As in the first place to accomplish what they needed to accomplish; when it makes sense to make an M&A; or about alternatives — what about a joint venture, a licensing agreement, internal development or corporate entrepreneurship?

Part of the course increasingly became about when not to make an acquisition and the alternative tools. And then of course the question became: when should I make an acquisition instead of using other tools?

Then, following the likes of Penrose, Prahalad and Hamel, I tried to better understand how a firm can grow their set of resources and really deploy them successfully. I was really attracted to that resource-based stream of research. I found it extremely insightful to look at a corporation as a set of core resources. I really liked the idea in CK Prahalad’s initial work of these resources being trapped in their business unit, and how even corporations had difficulties in accessing their own resources, their internal innovation and to move resources around.

There have been lots of questions marks raised about M&As for a long time, about them destroying value rather than building it and the egos involved and people being blind to the other opportunities. It’s amazing that companies’ enthusiasm for M&As persists.

If you look at the entire process from due diligence, assessment, portfolio fit, pricing, post-merger integration, and then potentially learning and codification and putting in good templates, we all know that through the process it’s very easy to stumble. What has been more interesting for me as I’ve developed cases on companies like Cisco, Monsanto and so on, is that even good acquirers can stumble. They have developed M&A best practice, but at some point the organization becomes geared towards making acquisitions again and again, to some extent losing sight of the role of internal innovation, or how important it is to build organic growth as well as acquiring businesses, or how they should balance alliances, acquisitions, and organic growth.

Because I really do believe — and it’s the key thesis developed in Build, Borrow or Buy which I wrote with Will Mitchell — that firms that select their growth modes based on the circumstances they face, tend to perform better and to survive than firms which specialize in one mode.

What it means is that even if you are an M&A specialist, a firm that becomes extremely good at making acquisition deals and relies on that acquisition growth, then at some point you will hit the wall and will have to step back to stop, to sequence and to build back organic growth or to access new capabilities through licencing or alliances… Because not every valuable external partner wants to be bought. They may want to engage in some flexible collaborative agreement. So, again in order to access the different valuable sources of innovation it’s really important to tap into the different modes.

Isn’t the trouble that the build and borrow options are quite dull, whereas buying is exciting?

Yes, buying is exciting; we know that. So, for a CEO it’s very tempting to go for buying. And so we know that firms and their leaders need the strong corporate discipline to keep their hubris in check and avoid being carried away in the M&A process… And even value creating M&As need to be complemented with internal innovation and require over time to blend effectively internal skills and talents with those of external people.

But the importance of balance is a difficult message, isn’t it?

Yes, it’s very difficult because usually CEOs or the top management team don’t question their mode of growth. If you have always grown with a specific mode and you have been rather successful you just go on. If firms are successful with their first acquisitions they keep going on, without really assessing that at some point they are going to run out of integration skills, their people are going to be tired of screening, buying and integrating new firms.

This balance is very important. Again, it’s very difficult — not at an intellectual level because the “Build-Borrow-Buy” framework is very simple — but at a behavioral, political and emotional level for firms to consider all their options on an equal footing. CEOs, for instance, if they have an engineering background will tend to emphasize the engineering part and internal innovation; if they come more from a financial background they will focus more on deal making as a solution. So, background is very important.

There are also pressures. CEOs and top management teams suffer from internal and external pressures when it comes to making deals. So, it’s very difficult in terms of behavior to consider the different options you have.

What we still see in organizations is that the different functions tend to be located at different levels. For instance, the M&A team is usually very close to the CEO and the corporate development team. But the licensing team or the alliance team tend to be folded at a much lower level within the organization. So, it’s really up to the CEO to consider all these options equally, to have the discipline to say when it makes sense to make an alliance rather than going through a potentially value destroying acquisition.

So, if they’re interested in longer-term stability and development of the company they need to seek out balance?

Yes, the short-term pressures are in favor of pursuing instinctive implementation excellence of a favorite mode of growth–what we call “implementation trap” instead of reviewing the alternative modes of growth options available in light of the company’s knowledge base and values, the nature of the targeted resources, the resource market characteristics and the nature of desired relationship with external partner. Often companies specialize in one mode (“one-trick pony”) for short-term efficiency, but long term when you look at it, companies go through cycles of “build-borrow-buy” — more defensively than proactively.

If you think of firms like Nokia, BlackBerry, Dell and so on, we know that all firms at some point face a tension between exploration and exploitation: exploiting the core versus exploring and stretching the core. It’s very easy when you think of exploration to jump on acquisitions as the solution to your problems. When their core business is under threat, the tendency for companies is to keep on investing in R&D, because it’s hard to cut back R&D programs; to restructure internally; and, at the same time, to embark on a series of unrelated acquisitions so they end up with a very fragmented portfolio of projects. What you have are very contradictory pressures.

Where does a company like Apple fit into the build, borrow or buy framework?

What is interesting with Apple is that they started focusing on internal innovation. They’re very proud of their products and their internal culture. The company was driven by innovation and the culture was all about great products and being proud of them. What is amazing about Apple, in spite of their strong preferences for internal innovation, is that they managed to build a strong network of outside partners, and they have also combined that with focused educational acquisitions in some domains like computer software, mobile advertising, mapping services — usually these have not been very visible because they’re not big transformational acquisitions. So, Apple has been very good in combining the three elements.

Who else does this well, do you think?

We have Cisco as an example in the book. Cisco became an M&A machine in the late 1990s. But, after 70 acquisitions, they ran out of integration skills, people were demotivated and so on. Cisco completely restructured to put more weight on intrapreneurship and to balance the three modes. So, if you look at Cisco in terms of corporate strategy they have alliances, acquisitions and intrapreneurship is also really important.

Or look at L’Oréal. Out of its 28 major brands 25 were acquired. But what is really interesting about L’Oréal is that they managed to build organic growth once they acquired the companies.

Does the framework work globally?

Of course, in some parts of the world, like the Middle East, alliances between business groups and families are more important than the buy mode. It depends how developed the market for corporate control is. If you are in the Boston area where there is a strong market for VCs, for collaborations between start-ups and incumbents and so on, it might be easier to trade IP and to go for contractual arrangements first.

Also there are some regulatory barriers. For entry into some markets you may need to have a local partner. Those are the contextual factors that will influence the framework.

No matter where you are, the starting point is our assumption that CEOs have clarified their strategy. The gap we try to close is really about the selection and the balance of the mode.

In your experience do CEOs have a strategy?

I hope so! They can be driven by opportunities and so on. But at big companies they have processes in place to review their strategy and so on. So, at least we know that companies are equipped with strategic planning processes. And then do they follow them closely or not? It’s case by case.

We found that when CEOs have clarified where they want to go and the activity they need to survive, usually they jump to their favorite mode. What we tried to accomplish in the build, borrow, buy framework is this idea to step back and say: before you jump to your favorite mode, whether it’s internal or alliances or acquisition, make sure you think carefully about the best way to grow and avoid the main traps.

What are the main traps you found?

The first is in most cases there is a strong preference for internal development. So, companies will usually first try experimenting internally; and it’s only once they have failed that they go externally. But if the gap is too big, the organization is not appropriate to develop what you need and you should go externally much more quickly.

The second trap is that once companies have figured that internal development is not fast enough nor appropriate and have decided to look externally, instead of considering the full range of external options — from licensing to alliances to JVs and so on — they jump to acquisition. They think they have already wasted too much time, and jump to acquisitions with the idea that acquisitions are a quick fix, the shortcut.

Another misleading assumption is that if you get full control you will get full access to the capabilities. Mostly it’s not true. People walk away and full control doesn’t necessarily give you easy access to capabilities. In the study we did on 162 telecom firms, 27 percent of the acquiring firms managed to extract the value of the target’s firm capabilities — while 80 percent chose acquisitions over alliances to get exclusive access to the targeted capabilities. Access to external capabilities hinges upon the willingness of people to collaborate. By creating a trauma, full control through M&A can in fact be an impediment to collaborative behavior.

The third trap is not considering post acquisition issues and particularly the motivation of people.

Where does this research lead to now?

Now I’m working on applying Build, Borrow, Buy to young companies. With a colleague in the US, Asli Arikan, we are tracking the population of firms that went for an IPO. So, we’re looking at about 4,000 firms and what happened to them and their likelihood of delisting. It’s interesting because by the end of the fifth following their IPO, 55 percent of firms are delisted. So, we are trying to re-examine the relationship between the type of corporate development program they have been following and their likelihood of being delisted.

We are finding that young companies which do too many acquisitions or too many alliances in the five years following their IPO are more likely to be delisted. Most likely they run out of resources to integrate properly what they buy.

But we also find that firms that only stick with internal development are also more likely to be delisted. So, if you only rely on internal development it can also penalize a young IPO firm. Similarly, a young IPO firm needs to find their optimal path between relying too much on internal development, which most likely is going to be too slow for them to scale up their organization and speed up their innovation; and at the same time too much openness, too many acquisitions which can also hurt them because they don’t have the competent and skills to embark on such an aggressive program just after IPO. Knowing that most of them when they go IPO they don’t have acquisition experience; they tend to be young and with little corporate development function.

So, young firms still need to engage in affiliation, partnership, maybe do some focused acquisition in addition to their internal development.

With a doctoral student from INSEAD, Aline Gatignon, we are examining how domestic firms in Brazil, which are not affiliated to a business group, develop leading edge capabilities, with the prominent role of the “Borrow” mode reflected in the cross-sector multilateral alliances forged among key players in the ecosystem.

What about the field of strategy generally? When you first entered the field of strategy in the 1990s there were lots of interesting people involved in strategy. Now it seems slightly unfashionable.

Yes. I see two different environments. In the practitioner environment interest in strategy and corporate development is huge. When it comes to M&As, alliances and corporate development these topics are important for every firm, because they face digitalization, want to be more socially conscious and so on. Achieving a competitive advantage is still the core of practitioners’ interest.

The academic market is structured around publications and there is a shortage of scholars in what we call pure strategy. To some extent in the academic environment people want to be embedded into a discipline like sociology, economics and so on. The business education market asks for more relevance. So, a school like INSEAD has to try and live with those kinds of contradictory forces — providing relevant teaching and research for their different stakeholders; but also paying attention to rigor and remaining open to different streams of research, including the discipline-based type of approach.

Stuart Crainer is co-founder of the Thinkers50.