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


The Capabilities Premium in M&A

The enhancement benefit that Walgreens can gain from acquisition was evident in its 2010 purchase of Duane Reade Inc., a signature New York City chain with some unique capabilities, including local marketing and the merchandising of fresh food and beauty products. Similarly, the recent acquisition of the online-only retailer will enable Walgreens to learn from a more experienced e-commerce player and to forge a multichannel strategy in a competitive sector where consumers increasingly want to shop online.

It takes a great deal of skill to be a successful serial acquirer; most companies fail at M&A more often than they succeed. When they look back at their unsuccessful deals, executives tend to blame timing or some financing blunder: “We paid too much; we took on too much debt.” To be sure, those factors make a difference. But behind every truly bad deal there is typically some fundamental mistake in capabilities assessment, or poor execution in integrating capabilities. Danaher, Li & Fung, and Walgreens avoid those errors because they understand their capabilities systems and design their deals accordingly, time and time again.

Beyond Arbitrage

Every few years, an approach to M&A emerges that confers competitive advantage to those who spot it early and become proficient at it. For a while, this type of M&A represents an arbitrage opportunity: Companies that practice it can buy properties, turn them around, and either run or sell them at a premium. In the 1980s, financial engineering (basically, using debt to finance acquisitions) was one such arbitrage opportunity. Then the private equity approach — slashing expenses and selling the company — became a second.

These two forms of M&A are well suited to financial players looking for short-term accretion. They have less value to strategic buyers looking for long-term uplift. M&A with a capabilities orientation is far more enduring because it puts assets, products, and services into the hands of companies that can make the most of them. It can therefore produce a more sustainable long-term return than arbitrage-oriented transactions can.

Although companies like Danaher, Li & Fung, and Walgreens have quietly practiced capabilities-oriented deal making for years, it is only now emerging as a visible alternative on Wall Street — not coincidentally, at a time when most “easy money” deal-making approaches have stopped working. We may be moving toward a time when companies gain advantage by articulating their own capabilities systems, showing a clear understanding of the handful of things they do that provide customers genuine value. Once companies have tangible answers — once they can settle on the capabilities system that differentiates them from rivals — they will have a reliable guide to enable them to make the right decisions about the deals that come to their attention.

If you are a strategy or corporate development executive, it might be an interesting exercise to go through the history of failed deals at your company — studying the video, as it were, and trying to spot the previously unseen capabilities gremlins. Of course, it would also be a bit of an academic exercise; what’s done is done. The important thing is to make sure that in the next deals you make, the capabilities logic is airtight and you follow our recommended first rule of M&A: Pay attention to your capabilities system. It will make a huge difference to your shareholders, and to you.


Our study looked at the 40 biggest deals during an eight-year period (2001–09) in each of eight industries: industrials, electric utilities, consumer staples, media, healthcare, chemicals, information technology, and retail. To measure the performance of these 320 deals, we took the acquiring company’s total shareholder return (TSR) CAGR — stock price plus dividends — two years after the acquisition was completed, and compared that with the TSR CAGR of the large-cap index in the acquiring company’s country. (For benchmark indexes, we used the S&P 500 in the U.S., the FTSE 100 in the U.K., the CAC 40 in France, and the DAX in Germany.) If the company didn’t pay dividends, the TSR was equivalent to the change in the company’s share price.

One part of the research required some judgment: the classification of deals’ intentions, and especially the deals’ fit from a capabilities perspective. To help with this, we examined corporate announcements, external press coverage, and SEC filings. For the fit classification, we ultimately relied on our judgment, analysis, and experience with clients to determine whether these were enhancement, leverage, or limited-fit deals.

Some deals appeared to have multiple goals — for example, they were intended as both a product and geographic adjacency, or they were expected to both leverage and enhance capabilities. We slotted those deals into the single main category that we believed they fit best.

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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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