Why are Industrial Companies Acquiring Tech Startups?

Mergers and acquisitions used to be fairly straightforward in the yesteryears. This is because companies would only make acquisitions within their own industry. This meant that if a technology-based startup were up for grabs, the list of potential suitors would only include companies like Google and Microsoft. This has completely changed now. Traditional companies like General Electric and Wal-Mart have made several technology-based acquisitions. This has come as a surprise to many people given that these firms do not have the competence required to manage a tech firm. However, the trend is clear. In fact, in the year 2017, more non-tech firms acquired tech-based startups than the usual big tech firms buying small firms.

In this article, we will have a closer look at some of the reasons behind this increase in inter-industry acquisitions.

Reasons Behind the Increase in Inter-Industry Acquisitions:

• All Business Is Technology Business: In the 21st century, all businesses are going mobile. Right from buying books to buying cars, some part of the buying process is done online. As such, there are no companies which do not have an online presence. Even industrial age companies need to have a digital footprint. This is where the acquisitions come in handy. Large companies like Wal-Mart buy small online retailers who have developed some specific technology. This technology can then be leveraged by Wal-Mart to increase its online presence by leaps and bounds. This is the reason why many technology-based startups in industries such as Fintech and e-commerce are more valuable to traditional companies and banks than they are to other tech companies. Since they are more valuable and provide synergy to the overall business model, industrial age companies are willing to pay more. This is the reason behind the increase in the number of inter-industry acquisitions. To the untrained observer, they might appear to be unrelated. However, the fact of the matter is that such acquisitions provide synergy and create value.
• Leapfrogging To The Front: Traditional companies do not have the workforce to develop and maintain high-end technology products. However, that is the only source of competitive advantage these days. This is the reason why industrial age companies are trying to build their own digital departments. However, many have found out that it can be very time consuming as well as counterproductive. This is the reason why acquisitions make sense. Acquisitions allow companies to leapfrog ahead of the competition. When General Electric buys a technology startup, they drastically reduce their chances of being made redundant by them.
• Cost Reduction: The subscription to technology products can be painstakingly expensive. This is the reason why technology companies are some of the most profitable businesses in the world. These subscriptions add to up a substantial amount. As a result, many companies want to eliminate these subscription costs. If a company finds a start-up which has created a product which they need to use extensively, many times they may be better off just buying off the company rather than paying annual subscriptions. Not only does this strategy lower costs but also improves the profitability of the company by allowing it to generate additional revenue sources.
• Access to More Resources and Clients: The number one reason why startups sell to bigger companies is that they get access to deep pockets. Most startups fail in their formative years due to lack of cash. Acquisition by a giant industrial age corporation guarantees that the lack of cash will not really be a problem. This allows promoters to stop worrying about their immediate cash flow and instead focus on the product design and other issues which prove to be important in the long term.

These companies have thousands of users. As such, the start-up finds a fixed user base. Also, these companies may refer the startup to other sister companies. As such, the startup gains because of the number of clients as well as the resources allocated to the product increase exponentially.

Disadvantages of Inter-Industry Acquisitions

• The speed of Decision Making: The speed of startups is very important for their growth. This is truer of technology-based startups. The first one to provide a more technologically advanced product to the market usually wins. The problem is that when industrial age companies acquire tech startups, they convert it into a bureaucracy. The number of people involved in decision making is very large. Many people are consulted before a decision is taken. This takes away the speed which is essential for the success of a startup. The workaround is to let the start-up work as an independent company under the aegis of the larger company.
• Focus on Immediate Profitability: Technology-based start-ups are known to be loss-making for the first few years of their operations. Only when the number of users reaches a critical mass does the company even break even. However, this cash burn is a natural part of the process. If there is too much focus on profitability early on, then it is likely that the start-up will not survive very long. Industrial and digital business models are fundamentally different. This is the reason why policies which are considered to be prudent in an industrial company ends up wreaking havoc in a digital firm.

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The article is Written By “Prachi Juneja” and Reviewed By Management Study Guide Content Team. MSG Content Team comprises experienced Faculty Member, Professionals and Subject Matter Experts. To Know more, click on About Us. The use of this material is free for learning and education purpose. Please reference authorship of content used, including link(s) to ManagementStudyGuide.com and the content page url.