As capital remains cheap and competition increases, more and more corporate finance strategists are willing to take on transformational deals. Unlike absorption deals, in which companies acquire businesses that complement their existing operations, transformational deals involve acquiring new markets, channels, products, or processes in a way that requires significant operational integration. In fact, successful integration is key to realizing the potential value of these deals.
Between 2010 and 2013, the percentage of transformational deals increased from 29 percent to 44 percent, according to PwC’s annual survey of senior management of Fortune 1000 companies that had completed mergers or acquisitions in the previous three years (see Exhibit). During the same time period that transformational deals grew, respondents reported that absorption deals declined from 40 percent to 29 percent. Although transformational and absorption deals accounted for most of the M&A activity, respondents also reported a small number of tuck-in deals, which involve integrating small companies, and stand-alone deals, which keep the acquired entity operationally separate from the rest of the organization (see “M&A Integration: Looking Beyond the Here and Now,” PwC’s 2014 M&A Integration Survey Report).
What’s driving this shift? Our analysis suggests that more companies are seeking to fundamentally change their business model or the scale of their enterprise. In many industries, the obvious absorption targets were snapped up during the years following the 2007–09 recession. Now, companies are seeking growth outside their core competencies in an environment that’s being reshaped by disruptive technologies, evolving regulation, and changing customer expectations.
Transformational deals need not be big; their hallmark is that they fundamentally reinvent operations and maybe even change the dynamics of the industry. In healthcare, for example, payors are buying providers and creating new shared risk–bearing health networks. In telecommunications, mergers between major Internet and cable television companies could create new, innovative models of content creation and distribution. In retail, companies are pursuing deals to transform their operations, including supply chains, as they try to get products to consumers more cheaply and quickly than their competitors do. Amazon is busy building physical warehouses throughout the country, while also seeking greater automation and higher productivity through its $775 million acquisition of Kiva Systems, a robotics startup that services warehouses. Meanwhile, Walmart is turning its formidable network of bricks-and-mortar retail outlets into e-commerce assets from which it can quickly fulfill online orders. The company has been on a buying spree to acquire tech startups in social software, mobile apps, and cloud infrastructure, with the goal of reaching consumers in an omnichannel environment: stores, online, and mobile.
The Integration Challenge
Transformational deals have become desirable, but business leaders agree that they are the most difficult transactions in M&A today. Half of the respondents to PwC’s 2014 M&A survey said that their company had the core competency to integrate absorption deals, but fewer than a quarter said the same thing about transformational deals. Respondents also noted how difficult it is to make these deals work. Whereas 65 percent characterized their recent deals, many of which were transformational, as a significant strategic success (i.e., the deal was concluded and the businesses began working together as planned), fewer than half reported success in achieving financial goals, and only 35 percent said they had realized their operational objectives.
The most desirable but difficult deals in M&A today are those that transform the business.
The success rate of financial goals tends to be higher than that of operational goals because most companies focus on financial synergies right away to achieve quick wins. Operational goals—such as supply chain integration, business process and systems integration, and the meshing of two different innovation capabilities—are tougher to realize because they require a sustained commitment to integration completion over the long term.