On March 16, 2000, it was the end of the road: within only six years of the takeover and with costs of around four and a half billion euros, BMW finally sold the automobile manufacturer Rover to a British investor group for a symbolic price of five pounds – just one example in a long list of failed company takeovers. Companies grow stronger and more secure if they focus on innovations instead of many large-scale takeovers. This is what a study by Georg von Krogh, ETH-Zurich Professor of Strategic Management and Innovation, and Sebastian Raisch, Assistant Professor of Strategic Management at the University of St. Gallen, recently published in the Harvard Business Review has shown.

The authors analyzed the corporate growth of the Fortune Global 500, an annually published ranking of the top 500 corporations in terms of turnover. The study revealed that the companies that grew on the back of product or service innovations achieved better results in the long run. This group of the corporations examined even managed to generate almost twice the return for its shareholders compared to companies that primarily achieved their revenue growth through acquisitions.

Detailed study

The scientists analyzed the financial data of 500 companies and conducted interviews with numerous managers. Amongst other issues, they were interested in finding out why company acquisitions are not as successful as expected. Their work showed a variety of reasons. For instance, there is often a bidding war for the company up for sale in the run-up to the acquisition. “This pushes up the price of the acquisition candidate. The buyer won’t know whether the investment has really paid off until later”, explains Georg von Krogh. Every acquisition entails integration costs, which result in excessive burdens in the years following the takeover.

Moreover, the buyer also pays for unnecessary parts of the company that cannot be incorporated into his or her own business. These parts may be individual products, but also full technological systems. Then there is the problem that the positive goodwill and immaterial assets, such as confidence in the organization or quality guarantees, which have taken years to build up are often lost. “Every company has development departments or sales teams that have their own culture. After the merger or acquisition, a dispute erupts as to which of the two teams will take the front seat, which consumes a lot of time and resources. It takes a long time to regain the innovative strength in these areas for the core business”, stresses Sebastian Raisch.

Innovation from within

Innovations from inside the company are far more profitable, the scientists discovered. These innovations could cover new products, services or processes. In the best companies, the improvements in productivity are around six percent per annum. “Companies may achieve this by using technologies more effectively, not by laying people off”, says Georg von Krogh. The successful companies in the sample primarily buy up smaller companies that complement or boost their existing products and technologies.

The money saved through internal improvements can be used to fund product innovation , for instance. Such was the case with Nestlé: the increase in operational efficiency meant that the budget for the research and development department could be doubled in recent years. One result was the Nespresso system, which went on to pioneer the portioned coffee market.

Selection of the best ideas

There are still certain rules that need to be followed in innovation, however, and the policy of “more is more” is not the answer. The key seems to be a selection of the right innovations. “It’s better to focus on a few innovations than to fritter away one’s energies”, says Sebastian Raisch. In the case of General Electric (GE), of 2000 original initiatives only the 80 most innovative projects deemed important for the company and its customers were pursued. This generated a growth of over 7.5 billion US dollars in the space of three years. Product ideas that create or fulfill the needs of the customers, such as the affordable portable ultrasound scanner GE developed in India, especially open up new markets and make it possible for a company to realign itself on the market.

No rapid takeovers

It is not only the type of growth in itself that is important, but also the rate of growth. The scientists had already developed the model of a growth corridor in an earlier study study that shows whether companies are growing too fast. In the current economic climate, the two authors are afraid that many managers will go on a shopping spree: “Many companies are going cheap at the moment. This increases the risk that expansion strategies that aim for acquisitions rather than internal innovation might be used in the upswing”, says von Krogh. The current indicators predict an economic recovery for the coming year. This may also mean an increased risk of rapid takeovers. “Before you buy up a company, we strongly recommend you consider very carefully whether it is really necessary and whether it can achieve real innovation for your own company. If the answer is yes, it is crucial that you generate sustainable growth within the boundaries of the growth corridor.”