Printer Friendly

An Overview of Information-Age Trends and Their Impact on Telecom Managers.

Within the past two years, once-iconoclastic IBM has affiliated with such diverse partners as Sankyo-Seiko, Sears, Merrill Lynch, CBS, Rolm, Intel and Stratus. AT&T has struck deals with United Technologies, N.V. Philips, EDS, Convergent Technologies, Olivetti, Ricoh and Japan ENS, and GM has acquired EDS. In just one year, from 1982 to 1983, information-industry (I.sup.2.) acquisitions zoomed 31 percent, versus an all-other industry average of four percent. Going information technology (IT) alone is out; getting IT on with others is in.

The underlying rationale is compelling. (I.sup.2.) corporate planners are seeking sustainably higher returns on their shareholders' equity (ROE). They have come to realize that the underlying tradeoffs to growing ROE have tilted away from internal development and towards external development.

True, internal development still has its advantages. Most important of these is control. R&D teams can be focused on specific targets, and funding spigots can be opened up or closed down. In many instances, internal developers can continue the pace of commercialization and the degree of conformance with industry standards. The resultant product and service can be highly proprietary or open for others to share and leverage. Moreover, internal developers are bred from the same corporate culture, and pool the benefits of cumulative experience for their corporations.

But many companies that have relied solely on internal development have been frustrated by their inability to keep up with, much less exploit, the accelerating pace of it and marketplace dynamics.

A Look At the Forces

I have mentioned five fundamental, yet interrelated, forces (which I call "infotrends") that are driving external development. Let's examine each in turn.

As emphasis swings from the mass marketing of generic facilities to the specialized, often vertical marketing of content-differentiated products, the available R&D dollars and talent are spread too thin to satisfy all (or any) development imperatives. As a result, hardware and telecommunications firms, previously vertically and horizontally integrated, are seeking out content-laden partners.

For example, Wang has begun to take positions in data bases that relate to document preparation. Apple, and most other computer manufacturers, are increasingly cultivating value-added resellers with differentiative applications software through co-marketing arrangements and even, in some cases, financial and technical support. Local telephone companies and value-added network carriers are encouraging interconnections and joint marketing of audiotex and other electronic bases.

The Perfect Exchange

End users become more sophisticated; they're seeking "interoperability," which I define as the perfect exchange of content--even where that content has to travel across disparate D/O devices, operating and data-base-management systems, network architecture and CPUs, provided or operated by multiple It suppliers. The quest for interoperability has led some content companies to enter the facilities business. Dun & Bradstreet, for example, now has Dunsnet and GEISCO has Marknet.

Also, numerous computer, office and telecommunications equipment companies have co-ventured with other suppliers on the (1) physical interconnection of their products (for example, Northern Telecom's computer-to-PBX interface), (2) the interexchange of messages (for example, the X.400 electronic-mail standard), (3) the compatibility of their operating systems (for example, the recent European supplier agreements involving Unix), (4) the interface between systems and applications software (for example, the Japanese MSX project), (5) the compatibility of storage media and drives (for example, CD-ROM) or (6) a broader set of industry-specific interoperability standards, such as General Motors' proposed Manufacturing Automation Protocol.

More than simple agreements and co-ventures, however, some players involved in communications hardware have begun to acquire others who have interconnecting components. Among the products that "fit" together in an interoperable system are terminals, coders, modems, LANs, multiplexers, switches, concentrators, private wide-area networks and network-management devices. And external developments among suppliers of these and other related products is spreading rapidly.

As interoperability becomes more universal, so will direct content exchanges between buyers and sellers. This can be business-to-business, such as with industrial products, or business-to-consumer. This is leading to massive restructuring of other industries and the potential bypassing of intermediaries between buyers and sellers. I call this process "disintermediation." Some of the endangered species include travel agents, banks, wholesale distributors, outside sales forces and certain classes of retailers.

Major New Entrants

The spectre of disintermediation is spurring businesses with deep roots in other industries to enter the information industry. Several banks and aerospace firms have been among the leading computer servicers since the 1960s. But now, they're being joined by other financial institutions (for example, CIGNA and Merrill Lynch) and other types of manufacturers (such as General Motors and Toyota). Moreover, leading players in other industries are joining the fray, including retailing for example, Sears and JC Penney), distribution (McKesson) and transportation (American Airlines and Norfolk Southern).

Some, like Gulf + Western, which is acquiring Prentice Hall, may simply be diversifying into what they perceive to be a more-robust industry. But most of the others are impelled primarily by the need to control the restructuring of their core businesses and secondarily by the diversification opportunity.

Interoperability and disintermediation are both causes and effects of global markets. Globalization is a very powerful rationale for external development. One goal is to gain economies of scale by spreading fixed and semi-fixed costs over a broader geographical base. But even the largest firms are finding it increasingly difficult to deepen penetration in foreign markets unilaterally.

New Collaborations

As a result, they have established collaborative relationships with strong indigenous players. Xerox (Rank Xerox, Fuji Xerox), Honeywell (Honeywell Bull) and Fujitsu (Siemens, TRW, Amdahl) were among the first to go this route during the 1960s and 1970s. Some of these partnerships no longer exist, and there were relatively few followers until recently. Now such diverse US entities as AT&T Technologies, Dun & Bradstreet, well are leveraging their products and services, in part, through joint ventures and other collaborative agreements with foreign firms.

A second goal related to globalization is to gain access to leading-edge markets and technologies. And this is the principal rationale for the intensifying invasion of North America by European and Asian firms, most often through external development. US print and electronic publishing has become a hotbed of external development activity for British, Dutch and Australian publishers.

Japanese firms, for the most part, have opted for collaborative arrangements in the US, rather than outright acquisitions. In many cases, these are OEM arrangements; for example, Ricoh, Canon and Toshiba manufacturing image equipment for US partners such as AT&T, Kodak and 3M to market domestically. Some are joint development efforts, such as Sharp and RCA in CMOS. Other collaborations leverage Japanese manufacturing and technology experience. Examples include Toshiba and Westinghouse, which are jointly manufacturing CRTs in the US, and NEC, which is developing integrated circuits for Corvus.

Europeans are especially interested in the US. A late-1984 survey of European CEOs published in the Wall Street Journal showed that 45 percent picked the US as the first choice for foreign investment. Only 28 percent picked other European countries. Olivetti, AT&T's partner in certain European segments, also has cultivated several dozen equity positions in US companies. Siemens, Plessey and Racal are among the more-acquisitive European hardware firms, while Nixdorf, Ericsson, CIT Alcatel and Nokia seem to favor joint ventures and other such vehicles.

External Development

Ultimately, it is the convergence of I.sup.2 interests among the leading players that is driving them to high levels of external-development activity. IBM proudly asserts its intentions to be a $100-billion concern by 1990 and $185-billion by 1994. Few question their R&D competency, but to achieve and then surpass a five-percent share of the swelling world's I.sup.2 market undoubtedly will lead them to expanded external development in the years ahead. Other publicly held firms, less sizable than IBM and lacking R&D critical mass, will rely even more on external development in the years ahead. Many are severely limited by current profit and cash-flow pressures in expanding their R&D budgets, but can leverage their stock value or debt/equity position in acquiring other firms.

Smaller, mainly privately held firms are in an even tighter bind. Venture capitalists--until recently, their primary funding source--are strung out and the initial-public offerings (IPO) market has tightened up markedly. During the halcyon days of 1983, some 75 percent of $3 to $4 billion in venture capital went into the information industry, while some 120 I.sup.2 companies went public for the first time, raising another $3 billion. By 1984, those funding sources had dropped by 40 percent and are unlikely to recover fully for some time. Worse yet, if all companies financed by venture capital in 1983 alone had been initially successful, they would have required an additional $9 billion over the ensuing two to four years to keep going, shutting out subsequent startups.

And even where available, R&D monies don't go as far as in the past. Good R&D talent is hard to find, motivate, control and retain. R&D facilities are growing more asset-intensive. Information technologies are becoming more specialized and the failure rate of new-product introduction is high.

R&D isn't the only area where scale and scope is critical. Many manufacturing, software and service companies fund they lack distribution leverage. The leverage they seek may be geographic or horizontal scale, or it may relate to boosting sales productivity or tightening account control. As a result, larger I.sup.2 firms with substantial marketing, maintenance and physical-distribution capabilities can often readily acquire or collaborate with the manufacturers and developers of their choosing, especially those that bring vertical product market expertise to the table.

A case in point: The computer service and software sector of the information industry was the first to come to grips with these external development drives, and other I.sup.2 companies, confronted with them for the first time, would do well to heed the microcosmic lessons learned by this sector.

First, let's look at the trend in computer services/software. Since 1969, the number of annual US acquisitions has swelled from 20 to nearly 150. Initially limited to raw facilities firms, mainly batch data processing centers, contract programming and timesharing, the majority of deals now are in content-related areas--software, value-added reselling and remote transaction processing. Many of the early deals were stock swaps and other easily valued transactions. Nearly 75 percent of today's acquisitions involve cash, and over 60 percent involve contingency valuations, such as earnouts.

ADP was one of the pioneers in growth primarily by external development. By 1973, ADP had already made more than 40 acquisitions, and by year-end 1984 had done many more. And who can quarrel with this strategy this far? ADP stands alone among all publicly held I.sup.2 firms in recording more than 25 unbroken years of growth in revenues and profits. Many other information-service firms have been relatively successful in external development. D&B's 1983 acquisition of McCormack & Dodge stands out in retrospect as a particularly shrewed deal for both parties.

Indeed, there is a growing affinity among content-based information-service firms, hardware and telecommunications firms. Younger software suppliers, transaction processors and data-base developers find that they cannot afford to develop national, much less international, distribution power by themselves. Microcomputer retailers are highly selective in inventorying software and hardware from smaller, unproven firms. Specialized data-base providers and transaction processors lack end-user visibility unless promoted by a strong marketer.

Besides distribution, emerging players lack the wherewithal to develop next-generation products because they are stretched out fully trying to make the current generation successful. Meanwhile, larger hardware, telecommunications, publishing and non-I.sup.2 companies know that they cannot marshall enough talent or vertical market knowledge; hence, they produce internally to satisfy their growth objectives and market strategies. They need those smaller content-based firms. And that's why the computer services/software sector has been an early hotbed of convergence.

Outright acquisitions of publicly held firms are pricey. Since 1980, the price/earnings ratio of publicly held I.sup.2.-niche players has ranged from double to triple those of the Value Line 950 all-industry average. On top of that, the acquisition premium (the amount paid over the trading price two months before the acquisition announcement) has averaged 20-percent more than in other industries. This means that the more-successful acquired publicly held companies typically are being capitalized at 25 to 40 times earnings. Strategic rationale notwithstanding, this places a tremendous onus on the acquirer of a publicly held firm to pay back its external-development investment.

To reduce the risk of not recovering their investment, I.sup.2 firms are increasingly prosecuting other options. These include acquiring privately held firms with more-modest capitalization ratios, often ranging between 8 and 15, rather than 25 to 40.

In computer services/software, where deal-making is a way of life, the median transaction has been around $4 to $5 million. And 75 percent of acquired companies have been lower-profile, privately held businesses. In fact, only 3 percent of acquired information-services companies have been stand-alone publicly held, the balance being divestitures of parts of publicly held firms.

Clearly, the bigger deals, such as GM/EDS, McDonnell Douglas/Tymshare, IBM/Rolm, Dysan/Midec and D&B/A.C. Nielsen, may grab the headlines, but they are just the "tip of the chip" as far as I.sup.2 external development.

Stopping short of outright acquisitions, some firms favor joint ventures with no equity exchanges and no readily determinable valuation. Nevertheless, such arrangements, especially joint ventures, have often proven to be unstable since the strategic interest of the parties, even when congruent at the outset, typically diverge over time. Witness Honeywell/Bull, SBS, Fujitsu/TRW and Ericsson/Anaconda among many, many others. Governance clashes often paralyze or confuse the management of these ventures. Moreover, the venture typically lacks a coherent culture unless the partners are very similar, which is rare.

One less-risky vehicle for I.sup.2 firms is to invest in venture-capital pools directed at areas of potential strategic leverage. Some firms, however, have made the mistake of commingling their monies with others, leading to conflicts and fuzzy objectives, as with joint ventures.

I believe it is better for an I.sup.2 firm to establish its own dedicated pool, typically $10 million or more, with clear-cut strategic objectives relating to specific areas of technology, market, or product development. This "strategic capital" fund can then be invested in multiple situations, thereby spreading the financial and developmental risks while maintaining a clear strategic rationale. These investments, which can be managed internally or by an outside agent, can take many forms--minority equity purchases, loans, OEM discounts, or R&D resources with the ultimate objective of jointly leveraging the portfolio companies' capabilities, once mature.

Four Critical Factors

But regardless of the external-development vehicle, from outright acquisition to strategic-capital funds, successful external development depends on four critical factors:

* Stay close to and leverage your experience and expertise . . . what we call the "strategic core." A survey of the Fortune 100, often quoted by one of the major management-consulting firms, shows that only 27 percent of unrelated acquisitions have been successful, while 64 percent of those related to an existing internal product, market or technology have been successful.

* Relatedness isn't enough; go for strong, longer-term marketplace-driven opportunities--they're the cake, synergies are the icing.

* Select affiliations strategically; they're not deal-making. Not all acquiritions and joint ventures can be directed candidates surface, as they frequently do, successful acquires will have the benefit of an explicit external-development strategy, or at least guidelines against which to evaluate the candidate situation.

* Once a strategic partner is in sight, anticipate how the partnership will best function before the transaction is structured. Potential conflicts abound. Most acquireds wish to retain some or all of their autonomy and culture, yet are seeking some sort of strategic assistance. Acquirers have learned that they need to aspirate, not smother or homogenize, acquired firms.

Must Agree on Issues

Yet, corporate leadership will want more than an addition to the balance sheet or a new bubble on the corporate portfolio grid. Therefore, to overcome the potential for conflict, issues of governance, compensation, reporting, mutual assistance and cultural independence should be agreed upon before the deal is struck.

I.sup.2 strategic management is vectoring toward external development and this, indeed, brings a new dimension to the competitive game. What in IT (information technology) for me is changing to what's in IT for us. "Go for IT" is no longer a unilateral charge. It's a team effort.
COPYRIGHT 1985 Nelson Publishing
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 1985 Gale, Cengage Learning. All rights reserved.

Article Details
Printer friendly Cite/link Email Feedback
Author:Poppel, H.
Publication:Communications News
Article Type:transcript
Date:Jun 1, 1985
Previous Article:ICA Uses All Its Resources to Re-Educate Telecom Industry and Congress on Bypass.
Next Article:Now Is the Time for Telecom Managers to Make an Impact by Taking Control of OA.

Related Articles
Special Interests Compete to Influence Changes in Telecommunications thru Working Task Groups.
NTCA Staff: Trekking across the country.
New broadband market report.

Terms of use | Privacy policy | Copyright © 2020 Farlex, Inc. | Feedback | For webmasters