Amazon Buys Goodreads

We learn today that Amazon has acquired Goodreads, a social network for people who love to read.  Goodreads has roughly 16 million members.  More than 30,000 book clubs use the site.  Many people see the move as a perfect fit for Amazon.   The company gets the opportunity to learn about people's likes and dislikes regarding books, and they have an opportunity to promote to this active book-loving community.  Moreover, they can use analytics to mine this tremendous amount of data about books that the social network will provide.  Early reports indicate that they intend to integrate Goodreads more closely with their Kindle reader devices as well. 

For me, this move clearly extends the powerful network effect that Amazon already benefits from in the book business.  The network effect means that the value for each Amazon user goes up as more people use the site.  That effect increases now with the addition of this powerful and broad social network.   Book lovers will derive even more value from Amazon, as the online marketplace enhances its ability to provide informative reviews and highly personalized recommendations to each customer. 

What's the downside?  Goodreads has cultivated an independent status up to this point.  Some Goodreads users will undoubtedly worry about the link with Amazon and the loss of that independent status.  Amazon will have to manage this tension, much as firms do any time they vertically integrate.  

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Acqui-Hires: Buying Teams of Engineers from Start-ups

The Wall Street Journal reports on the growth of an interesting phenomenon that has existed for some time in Silicon Valley. 

Established technology companies increasingly are buying—and then shutting down—early stage start-ups, mostly to acquire their software-engineering talent.  Investors, attorneys and others involved have dubbed these transactions acqui-hires.  The deals, which typically range in price from about $3 million to $6 million, started to become commonplace in Silicon Valley last year as demand for software engineers soared.

The paper reports that the deals come with some strings attached (naturally).   The employees may have to sign agreements to stay on board at the acquiring company for a few years.   They also may have to sign noncompete agreements that kick in if/when they leave for another firm. 

Even with these types of "strings" attached to a deal, I think these types of acquisitions come with some risk.  On the plus side, you are acquiring a team of engineers that is comfortable and experienced working together.  You are getting more than talent... you are getting a potentially terrific team.  On the downside, you are not much buying much other than the people.  Yes, you can stop them from walking away, or from going to a direct rival (although non-competes can be tough to enforce).  However, just keeping them there contractually does not insure that they will be productive.  You have to keep them happy.  If they have walked away from an entrepreneurial dream, then the task of keeping them engaged and fulfilled may not be easy.  

What do you have to provide for these folks?  It's more than good compensation.  You have to provide them interesting projects on which to work - fulfilling, meaningful work.  You have to make them feel like they are contributing to something bigger than themselves.  You want them to feel ownership of the product or service on which they are working.  It's a tough task, but it's critical if firms wish to make these types of acquisitions successful. 

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Should Coke Acquire Monster?

The Wall Street Journal reports that Coca-Cola explored a possible acquisition of Monster, the energy drink company.   Coca-Cola apparently backed away due to the hefty price tag.  Some investors reportedly balked at the premium that would be paid for Monster, and they made their concerns known to management.

I found one particular note in the story quite interesting.  It reads: "Coca-Cola already has an agreement with Monster to distribute some of its drinks, and that could diminish the potential synergies from any deal—and thus Coke's willingness to pay a large premium."   When I teach strategy, I always reinforce the idea that companies need to consider whether a merger is actually required to achieve the benefits of cooperation.  I draw on Williamson's transaction cost theory, and I argue that we have this "markets vs. firms" choice to make.  Do we organize the activity inside the firm (merger), or do we transact with another party through the market (with a contract or alliance)?   In this case, Coke has been working quite effectively with Monster through the market for some time.  The question is:  What additional synergistic benefits will come if they move from this relationship to a merger?   What can they NOT accomplish through their current relationship?  That's the key question in this case.

Beyond that, though, we also have to consider the following:  What are the costs of inaction?  Will Pepsi acquire Monster, and therefore, Coke would lose its current relationship altogether with this leading energy drink firm?  We have seen that story before, in fact.  Coke once considered acquiring Gatorade, and investors (specifically Warren Buffett) balked at the price tag.  Pepsi swooped in and acquired Gatorade instead.  Coke has been a laggard in the sports drink business ever since that time.  So, Coke must consider the question about whether additional synergies exist above and beyond their current relationship, but they also must consider whether that relationship could get disrupted by a rival's purchase of Monster.

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The Facebook-Instagram Deal

Wow! What else can you say?  Facebook pays $1 billion for a company with 12 employees and no revenue.   I'd love to see the discounted cash flow model that my students could come up with to determine that valuation! 

What's going on with this acquisition?  First and foremost, we have to remember that photo-sharing is a crucial element of the Facebook experience.  As my former colleague Mikolaj Jan Piskorski likes to say, Facebook made it socially acceptable for all of us to become exhibitionists and voyeurs to some degree!   In that sense, Instagram has emerged as a major threat to Facebook.  As people spend more time sharing their photos via Instagram's mobile app, they are likely to spend less time on Facebook.   That reduced time on Facebook will cost the social media heavyweight a significant amount of advertising revenue.  Moreover, rumors of a possible link-up between Twitter and Instagram (or perhaps even Google and Instagram) surely made Mark Zuckerberg more than a bit nervous.

What challenges will Facebook face with this acquisition?   Zuckerberg has announced that he intends to continue operating Instagram as an independent company with relationships to other social media platforms such as Twitter.  Users will still be able to post photos on other social media services, follower users outside of Facebook, and can choose not to share photos on the Facebook platform.   In some sense, this move is a type of vertical integration.  When that happens, firms also face the challenge of competing with their customers.  Instagram will now be competing with its customers - i.e. Twitter and Google Plus compete with Facebook.  Will that cause friction?  Will it cause Instagram competitors such as Hipstagram and PicYou to steal away users?  Facebook will have to be quite careful as it manages those relationships.

Some experts have wondered why Facebook could not have achieved some of the same benefits without having to acquire Instagram. Could they have formed an alliance or partnership with Instagram?  Perhaps they could have.  However, such an arrangement may have made it more difficult to engage in the type of close coordination required to integrate Instagram more deeply into the Facebook platform moving forward.  If Instagram simply were to remain an independent company, then an alliance might have made more sense.  However, I think more intense coordination and integration is coming... and a merger probably makes more sense in that instance. 

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Are Risky Personal Behaviors Associated with Risky Business Decisions?

Bob Sutton's blog has pointed me to a terrific article by New York Times writer Steven Davidoff.  The piece is titled, "A Mirror Can Be a Dangerous Tool for Some CEOs."   Davidoff examines the effects of CEO personality on business actions and performance, drawing on some interesting academic research. Here is an excerpt:

Arijit Chatterjee and Donald C. Hambrick said in a 2006 paper that narcissism among chief executives encouraged more volatile company performance. In a study of 111 chief executives in the technology industry, the authors found that indicators of narcissism correlated not only with company performance but also with the pursuit of deals.  The study was criticized for overstating the power a chief executive has over a company. But additional research has shown that a top executive’s personality can have powerful effects on how a corporation is operated.  For example, Henrik Cronqvist, Anil K. Makhija and Scott E. Yonker found that the level of debt for a company was related to how much a chief executive was willing to borrow to buy a house. Matthew Cain and Stephen B. McKeon looked at chief executives who had pilot licenses. Flying small planes is viewed as thrill-seeking behavior. Professors Cain and McKeon found that chief executives with pilot licenses were more prone to engage in acquisitions, with the theory that takeovers are risky, yet exciting ventures.

I think the latter two studies are truly fascinating.  One of our Bryant honors students (now finishing his MBA at Duke) completed a senior thesis examining similar relationships.  He analyzed people who enjoyed sky-diving , and likewise, he found that those individuals tended to exhibit riskier choices in other parts of their lives as well.  What is the implication of such studies?  I believe it suggest that we should be taking a look at signals that suggest an executive may have a high propensity to take risk or strive for the public spotlight, and we should search broadly for those signals.  However, we have to be careful.  These studies demonstrate a pattern that emerges, on average, from the data.  That does not mean every thrill-seeker will be advocating risky corporate acquisitions.

These studies do make a broader point as well about acquisitions.  They re-emphasize the fact that many CEOs do deals for reasons beyond the impact on shareholder value.   Many individuals find deal-making to be exciting and satisfying.  They derive much personal utility from such deals.   However, that "thrill-seeking" may be to the detriment of shareholders, customers, and employees.  

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Will Facebook Acquire Zynga?

The Wall Street Journal has a good article describing the co-dependency that has evolved between Facebook and Zynga.  The paper reports the following statistics about the two firms:

"Facebook, based in Menlo Park, Calif., derived 12% of last year's $3.71 billion in revenue from Zynga, according to the social network's IPO prospectus released Wednesday.  Meanwhile, Zynga, the San Francisco-based social gaming company that makes many games that are played on Facebook, received 93% of its revenue last year from virtual goods it sells on the social network."

Economic theory suggests that the two firms may be headed for a merger.  Why?  Oliver Williamson, the Nobel-prizing winning economist, has argued that companies consider transaction costs when determining how to organize themselves.  Put simply, firms compare the efficacy of using the market to organize economic activity to the efficacy of organizing such activity within the firm.  Often, companies establish contracts, strategic partnerships, or formal alliances with other firms if the arrangement provides value to both parties.  However, these market-based transactions sometimes become problematic.  Why? One reason is that the potential for opportunism and hold-up occurs.  That is, the firms may try to take advantage of each other.  Such holdup tends to occur in situations of co-dependency. 

Let's take a classic example from Williamson's work.  Imagine an oil refinery adjacent to a pipeline, each owned by separate parties.  What if the refinery and the pipeline each had no alternative uses.  That is, the only way to ship the oil from the refinery was from the pipeline, and the only use of the pipeline was to ship that refinery's output.  In that situation, each party would be beholden to the other, and they might find it hard to work together amicably via contract or alliance.  Merger tends to be an outcome in such circumstances.

We had a similar situation in the entertainment business recently.  Disney and Pixar had worked together through a contractual relationship for many years.  Then, Disney and Pixar entered into contract renewal negotiations in 2005, and the relationship became strained.   Why?   I would argue that the two firms had become co-dependent over time.  Disney needed Pixar, because its own animation studios had fallen on hard times.  Meanwhile, Pixar needed Disney because the original contract had given Disney certain rights even if Pixar terminated their relationship.  Disney could continue using the characters from the early Pixar movies, and they could make sequels to those movies, even if Pixar partnered with someone else in 2006.  Pixar really didn't want to see that happen to their beloved characters.  Not surprisingly, Disney acquired Pixar in 2006, thereby choosing horizontal integration over a market-based relationship - just as Williamson's theory would predict.

Now, we could have a similar co-dependency emerging between Facebook and Zynga.  Could a merger be in the cards?  It's certainly something to watch.  On the other hand, Zynga has been working to diversify its revenue base lately.  That may lessen the co-dependency over time.

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Narcissistic CEOs: Impact on Acquisitions?

Nihat Aktas, Eric de Bodt, Helen Bollaert, and Richard Roll have written a thought-provoking paper that examines how CEO narcissism affects the acquisition process.   Here is an excerpt from their abstract, which summarizes their findings:

More narcissistic acquiring CEOs are more likely to be the initiator of the transaction. Compared to their less narcissistic peers, they also tend to negotiate faster during the private part of the process, and they are more likely to complete the transaction. Additional analyses show that target CEO narcissism is associated with higher bid premiums and lower acquirer abnormal returns. Our results make a strong case for the impact of CEO psychological characteristics on many dimensions of the takeover process.

I found these results fascinating.   I understand completely how narcissistic acquiring CEOs might be deal happy.  After all, one could imagine them enjoying the spotlight associated with making acquisitions, and deriving satisfaction from growing the size of their empire.   The more surprising results concern the impact of  narcissism on bid premiums and acquirer returns.  I would have thought acquiring CEO narcissism would have the significant impact there, but in fact, it's the target CEO's narcissism that creates higher bid premiums and lower abnormal returns.  The scholars explain the finding by arguing that, "Manipulative narcissistic acquiring CEOs may be able to browbeat their less narcissistic counterparts during talks."  It's an interesting potential explanation.  Is the lesson that we shouldn't try to do deals with narcissists?   Perhaps it is!

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SAB Miller Seeks to Acquire Foster's

We should not be surprised that a major beer company has made a bid for Foster's.  After all, once Foster's spun off its wine business, it became far more attractive as an acquisition target.  Major brewers such as Inbev and SAB Miller would not have been interested in acquiring Foster's when it had a struggling wine portfolio.  Now, however, Foster's offers a solid set of brands, with a strong position in the Australian market and export potential beyond even what the firm has achieved to date.  I would not be surprised if other brewers perhaps take a look at offering a higher bid. 

It will be interesting to see an acquirer discovers that opportunities to invest and grow the business have remained untapped in recent years at Foster's.  After all, the firm treated its beer business as the cash cow which fueled the growth in the wine sector.  While the Australian beer market is mature, the opportunities globally can be attractive for a firm with strong brands and distribution capabilities.   Did the firm under-invest in the beer business while on a spending spree in wine?  It's possible.  That surely is what an acquirer will seek to determine as soon as possible. 

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P&G's Organic Growth Strategy

Business Week reports on new P&G CEO Bob McDonald's strategic push to emphasize organic growth over acquisitions, particularly growth in emerging markets.   I must say that I applaud any CEO who is willing to put a priority on organic growth vs. acquisitions.  I think too many chief executives fall in love with doing deals, rather than doing the hard work required to grow existing brands.   Moreover, too many firms pay an overly high price tag for deals.

Having said that, the P&G organic growth strategy has some risks.   First, a company of that size must generate a ton of new growth simply to "move the needle" - i.e. to grow the overall top line by a small percentage.  Second and perhaps more importantly, P&G must take care not to diminish its brand equity in various product lines as it tries to grow in emerging markets.  Under McDonald's predecessor, A.G. Lafley, P&G definitely shed many of its lower-priced brands and focused instead on premium positioning of its products.  That strategy proved very successful.   Now, however, to grow in emerging markets, P&G will face pressure to offer lower-priced versions of its products.  The question is this:  Can P&G effectively maintain its premium strategy in the developed world while catering to lower income customers in emerging markets?  In an increasingly global economy, might that strategy dilute certain brands?  In the past, it may have been easier to position brands differently in different countries.  That has become a bit more difficult with globalization, increased international travel, and the like. 

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Does Your Board Conduct After-Action Reviews for Acquisitions?

I learned yesterday that the Board of Directors of one major industrial firm in the US does regular after-action reviews on major acquisitions.  What a great practice!  What does this systematic practice achieve? First and foremost, we all know that acquisition proposals and valuations involve many assumptions (about things such as the amount of synergies, the discount rate, etc.).  Moreover, the valuations turn out to be HIGHLY SENSITIVE for some of those assumptions.  We also know that many deals don't turn out as advertised.  The after-action reviews not only allow the firm to reflect on past actions and adapt plans moving forward.  They also provide a measure of accountability that is desperately needed when it comes to pitching deals and capital investments.  Because managers know that the Board will revisit the deal pitch in the future, they will tend to be more "intellectually honest" when it comes to their assumptions about synergies and the like.  Hopefully, that accuracy will lead to better deals and more appropriate valuations.

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