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strategy and business
 / Spring 2012 / Issue 66(originally published by Booz & Company)


The Capabilities Premium in M&A

Before completing a deal, Danaher will often visit the target company’s plants to determine how much process improvement — and margin improvement — it can expect. No activity is too small for Danaher’s attention; the company uses process mapping and kaizen techniques to improve every aspect of production: the way products move between stages, the management of parts, and even the way individual workers handle tools. Within months of buying Sybron Dental Specialties in 2006, Danaher’s process specialists figured out a way to reduce the time needed to make a clear ceramic orthodontic bracket from 24 days to six, and to reduce Sybron’s manufacturing floor space by 30 percent.

The 31 transactions (worth 72 percent of its market capitalization) that Danaher has conducted between 1995 and 2011 are almost all leverage deals, in which the company applies its capabilities system to a new or adjacent product or service area. Danaher’s M&A program has helped raise the company’s share price by a factor of 15 over that time period, a performance far superior to that of the S&P 500 and many of Danaher’s competitors.

• Li & Fung Ltd. Based in Hong Kong, this sourcing company designs and transports products for manufacturers, including many apparel and durable goods makers in the United States. Li & Fung’s capabilities system — which includes the management of a network of suppliers, seasoned skills for negotiating both price and quality of delivered goods, and a highly refined distribution network in North America and Europe — has made it the world’s largest supplier of toys and clothes to retailers. The company showed a 25-fold rise in total shareholder return between 1995 and 2010. (This was offset somewhat by a 45 percent drop in 2011, which led to a management shake-up; however, most observers agree that the cause was the global recession and flagging consumer sentiment, and prospects for the company remain strong.)

Although sourcing might not seem like a fertile sector for acquisition, Li & Fung has spent about $5 billion, more than one-fifth of its current market capitalization, to buy 24 smaller competitors. All of its deals broaden and deepen its sourcing network, already one of the most extensive in the world. These acquisitions bring Li & Fung additional revenue and new manufacturing customers, and sometimes allow it to add expertise in a new product area. In 2010 and 2011, for instance, Li & Fung bought leading suppliers of leather goods, health and beauty products, denim products, and toys, along with onshore sourcing companies in the U.S. and western Europe. In an interview in June 2011 with Bloomberg News, company chairman William Fung said rising wages in China may also prompt the company to look for deals in other developing markets, such as Vietnam, Bangladesh, and India. In all these acquisitions, the capabilities-oriented logic remains constant.

• Walgreen Company. The largest drug retail chain in the U.S. has more than 7,700 stores in the United States, many of which it opened organically. But it also has a track record of acquiring companies that contribute to share performance, and the company is noteworthy for making both leverage and enhancement deals. In its leverage deals, Walgreens typically buys regional drugstore chains, such as Happy Harry’s (founded in Delaware) and ApothecaryRx (which has 18 pharmacies in five Midwestern states). It rapidly converts all incoming retail properties to the Walgreens format (its counterpart to the Danaher business system), minimizing store downtime during integration. In addition, by bringing rigorous pharmacy management capabilities to its acquired stores, Walgreens drives up its productivity (as measured by prescriptions sold and same-store sales) and reduces operating costs.

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  1. Gerald Adolph and Justin Pettit, Merge Ahead: Mastering the Five Enduring Trends of Artful M&A (McGraw-Hill, 2009): Describes some of the trends affecting mergers and acquisitions and the concepts and methods of strategically oriented M&A practice.
  2. Bharat N. Anand, David J. Collis, and Sophie Hood, Danaher Corporation, Harvard Business School Case Study No. 708445-PDF-ENG, February 12, 2008: Spells out the portfolio strategy and use of the Danaher business system by this extremely successful M&A “Pac-Man” company.
  3. Paul Leinwand and Cesare Mainardi, The Essential Advantage: How to Win with a Capabilities-Driven Strategy (Harvard Business Review Press, 2011): Broader insight into the value and role of distinctive capabilities and coherence, and guidance for developing a strategy accordingly.
  4. Paul Leinwand and Cesare Mainardi, “The Coherence Premium,” Harvard Business Review, June 2010: Similar analysis of returns for companies that align their capabilities systems with their go-to-market strategy and lineup of products and services.
  5. The Capabilities Premium in M&A by sector:
  6. For more on this topic, see the s+b website at:
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