Most firms are motivated to consider M&A as an extension of their growth strategy as a way to fill gaps in their portfolio or to bring relationships and competencies that would otherwise take years to develop. Successful pairings also have the potential to help create a game-changing competitive position through technology or other assets. Yet there are many examples of acquisitions that have failed to reward shareholders with a positive return on their investment, demonstrating that acquisition decisions are significantly challenging and could benefit from a more thorough and multifaceted approach.

Fortifying the Acquisition Decision-Making Process

Most corporations have established processes for evaluating acquisition candidates, spanning a wide spectrum of economic, legal, and other factors. In the implementation of these processes, there is an intense focus on the firm targeted to ensure that its market position is solid, its assets secure, and its financial structure sound.

Such assessments are a core part of the decision-making process, but a strategic assessment should not stop there. There are three additional key elements that should be evaluated: the potential for disruption, customer experience, and competitive response.

1. The Potential for Disruption

A key insight emerging from our analysis of successful acquisitions is that a strategic assessment must look beyond the targeted firm. You should also examine the overall market in which your acquisition candidate operates and then consider what capabilities your firm can bring to the relationship.

In assessing a prospective acquisition’s potential for disruption in the business environment, most firms start by answering a standard set of questions that include:

• Is this a good business to be in?
• Do the firms in this business make money, and does the forecast look promising?
• Does the business create value for its customers, and is this value recognized?
• Are the firms in this industry that create value for their customers rewarded for their contributions, or are the businesses characterized by aggressive price-buying?
  

As negative answers to such questions tend to raise red flags, it’s imperative to take your strategic assessment one step further. Even when the answers are encouraging and the forecast seems promising, it makes sense to develop scenarios that are disruptive. To start, ask your acquisition team and available experts this question: “If this industry looks totally different five years from now, can you give me a scenario as to how that might have happened?”

The answers you hear can trigger ideas about opportunities to create value and generate rewards for your firm. You may identify a strategy through which you can gain far more than you anticipated by becoming an industry change agent. For example, a disruptive scenario might involve:

• Changes that are taking place in the business environment, such as technology innovations, new regulations, changes in demand patterns, and distress situations involving current players in the market
• A participant from within or outside the industry implementing a strategy that creates value in a new way, through rolling up smaller firms and creating economies of scale, or through some technology foundation that provides an advantage
• Changes that undermine the current foundations for industry profitability, like new competitors that overcome barriers to entry or who offer an almost-as-good product at a dramatically lower price point
• Growth through the industry’s expansion into new global markets or adjacency businesses

Whichever the case, if you’re able to identify a disruptive strategy that creates a sustainable “leadership position” for your firm, take it as a serious possibility. Whether the disruptive scenario is one involving a great upside or a significant downside risk, it needs to be included in the acquisition evaluation and plan. And that must start with self-examination:

• Are we the “right firm” to implement such a strategy?
• Are there reasons why our firm may be better positioned for success than others?
  • For example, expertise in the market, synergy through existing operations, core competencies that are transferable, and assets that can be leveraged
• Are the required business model changes practical in terms of the demands on our resources?
  • These include financial resources and human resources

Additionally, assume that competitors will react. Ask yourself if competitors’ reactions can be thwarted in order to ensure that the pro forma forecasts associated with the strategy are realized.

What’s more, keep in mind that far too often, the acquisition decisions and business case assume a “steady-on-course” future for the acquired company, when the reality there is significant change, disruption, and requirements for investment of time, money, and expertise.

Identifying a disruptive scenario need not derail the decision to go forward with an acquisition, especially if the scenario can be characterized as a low-probability event—as they are in many instances. The attractiveness of the acquisition under more likely forecasts should be the primary driver of decisions. Yet, it is still critical to identify the “killer variables” that will determine whether the plan succeeds or fails. Your integration team should develop a monitoring plan that allows them to forecast whether the base case forecast is unfolding or whether one of the disruptive scenarios is beginning to develop.