Many companies believe that collaboration decisions are internal matters. They don't take into account external factors before picking strategies—and invariably fall victim to market forces. Companies should consider exogenous factors, like market uncertainty and competition, even if they can't control them.
Degrees of uncertainty. Executives know that collaborations between companies are inherently risky, but don't realize that they've become downright uncertain in a fast-changing world. Risk exists when companies can assess the probability distribution of future payoffs; the wider the distribution, the higher the risk. Uncertainty exists when it isn't possible to assess future payoffs. Companies are forced to decide how to team up with other firms, especially small ones, without knowing whether there will be payoffs, what they might be, and when the benefits might come their way.
Before entering into an acquisition or alliance, companies should break down the uncertainty that surrounds the collaboration's outcome into two components. First, managers must evaluate the uncertainty associated with the technology or product it is discussing with the potential partner. Can we tell if the widget will work? Is it technically superior to existing and potential rivals? Second, the company should assess if consumers will use the technology, product, or service and how much time it will take to gain widespread acceptance. Based on the answers—or lack thereof—the company can estimate if the degree of uncertainty that clouds the collaboration's end result is low, high, or somewhere in between.
When a company estimates that a collaboration's outcome is highly or moderately uncertain, it should enter into a nonequity or equity alliance rather than acquire the would-be partner. An alliance will limit the firm's exposure since it has to invest less money and time than it would in an acquisition. Besides, the company can sink more into the partnership if it starts showing results, and, if necessary, buy the firm eventually. If the collaboration doesn't yield results, the company can withdraw from the alliance. It may lose money and prestige, but that will be nowhere near the costs of a failed acquisition.
| If there are several suitors, a company may have no choice but to buy a firm in order to preempt the competition. |
That isn't exactly rocket science, but our research shows that few companies are disciplined enough to adhere to those rules. For instance, Hoffmann-La Roche spent $2.1 billion in June 1999 to acquire Genentech, which had developed a clot-busting drug, TPA, but hadn't completed effectiveness studies or sought FDA approval. Roche thought it could help the start-up get clearances for the drug quickly and then push it through its global distribution network. Six months later, a study found that TPA, which Roche had priced at $2,200 per dose, was only as effective at clearing clots as Hoechst's streptokinase, which sold at $200 a dose. That dashed Roche's hopes. TPA grew into a respectable $200-million-per-annum drug, but it never became the blockbuster Roche paid for. Given the high technical uncertainty in the drug development process, Roche should not have bought Genentech.
Not every company makes such mistakes. Bristol-Myers Squibb invested $1 billion to pick up a 20 percent equity stake in ImClone in September 2001 rather than buying the firm. In return, it bagged the marketing rights to ImClone's cancer-fighting drug, Erbitux, as well as 40 percent of annual profits. According to the deal, Bristol-Myers Squibb would invest $800 million more after ImClone got past key milestones in the drug approval process. In December 2001, when the FDA declined to review Erbitux due to "severely deficient" data, ImClone's share price plunged from over $60 to $25 within two weeks (and shook up offices on Wall Street and suburban homes in the U.S. in the process). The companies immediately renegotiated the alliance, and the giant will invest less in ImClone in the future. Had it chosen to acquire ImClone for the asking price of $5 billion, rather than allying with it, Bristol-Myers Squibb would have been gazing out of a $3.5 billion hole in its books instead of a $650 million one.
Forces of competition. There's a well-developed market for M&A in the world, so companies would be wise to check if they have rivals for potential partners before pursuing a deal. If there are several suitors, a company may have no choice but to buy a firm in order to preempt the competition. Still, companies should avoid taking over other firms when the degree of business uncertainty is very high. Instead, the company should negotiate an alliance that will let it pick up a majority stake at a future date after some of the uncertainty has receded.
Take, for instance, the manner in which Pfizer used an alliance with Warner-Lambert as a gateway to an acquisition. In June 1996, Pfizer offered to collaborate in the marketing of Lipitor, a new cholesterol-reducing drug that Warner-Lambert had developed. Lipitor was technically superior to competing products in some ways, but it was a late entrant in the market. Doctors and consumers were used to four other products in that category, and it wasn't clear if they would accept Lipitor immediately. Given the high technological and market uncertainty, Pfizer rightly believed that a contractual alliance made the most sense. Partly due to Pfizer's marketing acumen and distribution system, Lipitor's sales crossed $1 billion in its very first year, and by 1999, it had become a blockbuster drug with an annual turnover of $3 billion.
| A company's experience in managing acquisitions or alliances is bound to influence its choices. |
Even as Pfizer was exploring the possibility of working more closely with Warner-Lambert, archrival American Home Products and Warner-Lambert announced a surprise $72 billion merger in November 1999. The next day, Pfizer made an $80 billion counteroffer for its partner. Procter & Gamble jumped into the fray with a plan to acquire both AHP and Warner-Lambert but withdrew after investors reacted angrily. The battle between AHP and Pfizer for Warner-Lambert raged on for weeks, but it was a foregone conclusion. Pfizer's alliance with Warner-Lambert to market Lipitor, the cost-cutting opportunities it had spotted, and the possibility that Pfizer could combine one of its drugs, Norvasc, with Lipitor together gave Pfizer a distinct edge over American Home Products. By February 2000, Pfizer had won the battle for Warner-Lambert with a $100 billion bid.
Collaboration capabilities
A company's experience in managing acquisitions or alliances is bound to influence its choices. Some businesses have developed abilities to manage acquisitions or alliances over the years and regard them as core competencies. They've created special teams to act as repositories of knowledge and institutionalized processes to identify targets, bid or negotiate with them, handle due diligence, and tackle issues that arise after a deal is made. They've learned the dos and don'ts from experience and created templates that help executives manage specific acquisition- or alliance-related tasks. In addition, they've developed formal and informal training programs that sharpen managers' deal-related skills. GE Capital, Symantec, and Bank One, among others, have created acquisition competencies, while Hewlett-Packard, Siebel, and Eli Lilly, for example, have systematically built alliance capabilities.
It's tempting to say that companies should use the strategy that they are good at because it does improve their chances of making collaborations work. However, specialization poses a problem because companies with hammers tend to see everything as nails. Since most firms have developed either alliance or acquisition skills, they often become committed to what they're good at. They stick to pet strategies even if they aren't appropriate and make poor choices.
Smart companies prevent such mistakes by developing skills to handle both acquisitions and alliances. That isn't as easy as it sounds. Take Corning. For decades, it had cultivated the ability to manage alliances. In the 1990s, however, the company used acquisitions to expand in the telecommunications business. Corning faced several challenges and much criticism because it had little experience in handling takeovers. While Corning made many mistakes, the company may have been on the right track when it tried not to let habit determine its choices. In fact, our research shows that companies that use both acquisitions and alliances grow faster than rivals do—as companies like Cisco have amply demonstrated. 