Shopping for R&D

With today's economy moving at the speed of light, it's no wonder that companies are increasingly choosing to buy the ability to innovate, rather than to develop it in-house. But technology-grafting acquisitions are risky business. Although some provide a jump-start on the competition, others turn out to be costly mistakes.

Two recent studies shed light on the question of which technology-driven acquisitions are most likely to succeed. The results? Smaller acquisitions deliver more innovation than mergers of near equals. Furthermore, closely integrating the acquired company into the parent organization tends to drive stronger technological results.

One study, “Technological Acquisitions and the Innovation Performance of Acquiring Firms: A Longitudinal Study,” analyzed 72 acquirers and 283 technology-related acquisitions in the global chemicals industry between 1980 and 1991. Published in the March 2001 issue of Strategic Management Journal, it concludes that the size of the target's knowledge base — measured as the sum of the company's successful patent applications and the patents cited in those applications in the previous five years — had a positive effect on the number of patents granted to the acquirer in the four years following the acquisition. However, the closer in size that the knowledge base is to that of the acquiring company, the less beneficial the effect for the acquirer. In other words, it appears that small companies tend to get little value from technology-grafting acquisitions and even large acquirers do best when their targets are relatively small.

The authors — Gautam Ahuja, associate professor at the University of Michigan School of Business Administration, and Riitta Katila, assistant professor of management and organization at the University of Maryland — also report that the largest increases in innovation output occurred when there was a moderate degree of overlap (about 27% for the companies in their sample) between the knowledge bases of the acquirer and its target. Acquisitions that contribute highly similar knowledge deliver few benefits, the research suggests, whereas acquisitions that are too unrelated may not be easy to absorb.

These insights can help companies identify promising targets, but once the company is past the financial transaction, what's the best way for it to manage a new acquisition? A second study, the unpublished paper “The Management and Performance of Technology Grafting Acquisitions,” examines how closely acquisitions should be integrated into the parent company.

The paper analyzes 365 small technology-based acquisitions by 103 manufacturing companies in the computing, communication, semiconductor and pharmaceuticals industries from 1988 through 1998, revealing that high-integration acquirers technologically outperformed low-level integrators (which, for example, continued to report acquisitions as subsidiaries with their own names). One advantage of high integration, for instance, is a reduction in what the study calls “preservation costs”: the complexity and potential morale problems of managing units with different reporting and compensation policies. But tighter integration may have disadvantages, too, correlating with a higher departure rate of inventors from the target company and higher sales costs and general and administrative costs for the acquirer.

The author, Phanish Puranam, an assistant professor of strategy and information management at London Business School, cites additional field research in asserting that companies differ in their ability to manage the costs associated with different levels of integration. Consequently, the ideal level of integration for any particular acquisition depends on characteristics of both the target and the acquiring company.

The additional field research was conducted in partnership with Harbir Singh, chair of the management department at the Wharton School of the University of Pennsylvania, and Maurizio Zollo, an assistant professor of strategy and management at INSEAD.