The current contractionary monetary policy and geopolitical disruptions have slowed down mergers & acquisitions (M&A) for companies. However, many are now adopting the “co-creation” approach for their acquisition investments. When executed correctly, this investment strategy can reduce the risk of investment returns due to demand instability, eliminate the need for spending time and money to achieve synergies, and benefit both the buyer and the seller.
Market Context
The technology sector has transformed and shaped businesses, as demonstrated once again during COVID-19 when companies that had advanced digital adoption capabilities were the ones that thrived. Moreover, the emergence of the “phygital” business operating model has created unprecedented demand for cloud and digital technologies.
In today’s market, companies are rewarded for holding cash on their balance sheet rather than investing in acquisitions. Additionally, regulatory bodies have become more stringent. For example, in 2019, the FTC (Federal Trade Commission) undid a completed purchase of Grindr, citing a breach of national security. Furthermore, recent deals like Microsoft & Activision Blizzard and Adobe & Figma are being scrutinized by competition commissions of various countries.
All in all, it’s becoming an uphill task for company boards.
Co-Creation
Given the current context, a co-creation-based technology transformation partnership is emerging as a promising way forward. This partnership involves a contract between both parties to deliver business outcomes, as well as an equity purchase by the buyer (who is also the supplier) and the seller (who is also the client). For the seller, the invested cash would fund its transformation, while for the buyer, this represents a committed revenue stream, protecting their investments from market volatility.
Recent deals share a commonality: the buyer is often a technology player, while the seller is a major industry sector company undergoing a transformation journey. Notable companies in the financial services, automobile, life sciences, and healthcare sectors have chosen this path to achieve their business goals. For example, Google, Microsoft, and AWS have formed equity investment-driven partnerships with clients such as CME Group, LSEG, and NASDAQ.
Deal Construct
For the seller, this involves an equity sale in exchange for the incoming investment instead of budgeting a separate margin-impacting Capex or Opex. The cash inflow from the investment will fund the first two to three years of work, which is the project incubation window while keeping existing operations running smoothly.
Most importantly, it ensures no negative impact on margins during this phase of dual expense. By the end of the third year, the accrued savings should provide a cash outlay to fund the transformation expense for the following years, resulting in margin expansion.
For the buyer, this translates into a steady revenue stream. For both the buyer and seller, it provides a robust framework for assured investment returns and business growth.
Success Drivers
The success of this model depends on the following key factors:
Investor Credentials
This inorganic growth model requires a thorough understanding of the client’s business and established capabilities. Big tech companies have been very active in this space because they have advanced technology and tools in cloud computing, digital solutions, cybersecurity, AI, and data analytics that can drive significant changes and help shape an organization’s competitive advantage. Furthermore, their deep pockets provide the necessary financial support to make such investments.
Relationship Between Parties
Multi-billion dollar deals, where the lines between customer and supplier become blurred, require a high level of trust between the parties involved. Google, Microsoft, and AWS, with their well-established brands, state-of-the-art products, public cloud (IaaS) solutions, and large customer bases, are frontrunners in this space, and not surprisingly so.
Operating Model and Business Goals
The tri-party model has been prevalent in past deals, in which a big four firm has joined the partnership to bring in program management and change capabilities. The three parties involved need to break down the business outcomes into simple and measurable project goals, with clear lines of accountability.
Attention to minor details is crucial given the nature of the model, which involves creating “skin in the game” within the existing legal entity constructs, rather than creating a separate joint venture. Lastly, having the right skilled project team is critical for delivering the agreed-upon outcomes.
Commitment to Leadership
A partnership like this requires leadership commitment to focus on both day-to-day operational issues and strategic material decisions, given the high stakes involved. The governance model must include an empowered group of leaders from the client’s business systems and transformation unit, as well as senior engagement leaders from both the tech investor and the big four firm. Additionally, a matrix should define the decision-making rights across various engagement matters, spanning all three parties.
Key Takeaways
“Co-creation” is not a minority investment, which has been prevalent in the past and is more financially motivated. Instead, it is a partnership that aims to deliver business outcomes, and the trust between the parties enables them to operate in tandem.
While big tech has taken the first leap in this business model, many more global technology players can grow and expand their market share by following suit. Furthermore, their long-standing relationships with several clients, deep understanding of their business, and established networks will put them on firm ground to pursue this growth path.
Disclaimer: This article was originally written by Ramendra Rout.