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What Ails Chinese Acquisitions Abroad?

by Ying Zhang

March 14, 2016

In order to be successful, Chinese acquisitions overseas should target disruptive business models and not just resources.

In the past few decades the majority of Chinese overseas acquisitions have targeted resources. Their aim is to improve performance or lower costs by acquiring other companies’ resources, such as technology, raw material, talent, etc. Acquisitions with this purpose come with several challenges afterwards.

In many cases, the acquirer mistakenly believes that it would be easy to integrate the target’s resources into its existing model in post-acquisition, however it fails in the end. This is because the resources acquired were not compatible with the acquirer’s own resources and existing models. So the integrated resources and models are not able to offer a product that meets either of these two goals: achieve better performance by charging customers a premium price, or offer them more affordable prices but build a larger customer base.

In such cases, after a few years of integration in the post-acquisition phase, a host of troubles emerge, presented explicitly by a lower profit margin and a drop in share price. In many cases, managers and CEOs blindly believe that it is due to culture conflicts in the integration process. The real reason, in my opinion, is incompatibility of resources.

Regarding these types of resource-targeted acquisitions, acquirers are suggested to think through four crucial questions before making acquisition decisions:

(1) Which resources are you targeting exactly?

(2) Which compatible resources from your target can offer value and then integrate seamlessly into your existing business model?

(3) Are your customers willing to pay a premium price for your products in the post-integration phase? Are the resources you acquired capable of lowering your product costs significantly?

(4) Are you calculating your profits from the integrated resources by taking your target’s pre-profit formula as a reference?

So if acquiring for resources isn’t such a great idea, how should companies go about evaluating possible acquisition targets? A better alternative choice is for companies to acquire for disruptive business models. Acquisitions with this purpose can help acquirers avoid the commoditization trap which usually locks acquirers into an undifferentiated model.

In recent years we have frequently observed many Chinese firms with cross-sector and overseas acquisitions experience a boom in share prices in the short-term, but a fluctuating and lower share price in the long-run. Even though many of them have been acquired with diversification in mind, not many of their targets s. As a result many Chinese acquirers suffer from a sluggish growth model after a few years of acquisition. Acquiring for a disruptive business model will, effectively in the long run, mitigate the problem of eroding profits from existing business models that are being hurt by competition and new technology.

To achieve this, Chinese acquirers are urged to figure out whether their targets embrace what I would call a series of “secure footholds”, from the low end of the market to a higher value-added market with a higher performance and higher margin products and models. If so, their models are disruptive and Chinese firms should acquire them and help them transform, to grow not only “with fish”, but also “through fishing” (shou ren yi yu bu ru shou ren yi yu).

Integration from such acquisitions requires acquirers to cautiously localize the new model in a separate business unit early in the integration phase. A recent case in point is the Dalian Wanda Group’s acquisition of American cinema chain AMC Entertainment Holdings in 2012. Wanda did a very good job of separating AMC’s business from Wanda’s main business. Wanda respected AMC’s own genes and business model and helped develop it further. As a result, AMC’s financial performance got a dramatic boost in the post-acquisition stage.

Most Chinese acquirers are erroneously working on a resource-seeking track. Lenovo’s acquisition of IBM’s PC business is such a case and provides many lessons. To date, Lenovo still suffers from the fallout of an unsatisfactory integration process therefore had less than optimal financial performance. The major reason is not culture conflict or resource incompatibility between the two sides as many have claimed. Lenovo’s biggest mistake is very common among Chinese acquirers: wrong category target and wrong strategy after acquisition.

To Lenovo, the most valuable assets from this acquisition are not only IBM’s technology and resources, but more importantly the IBM PC division’s business model itself and the ability of the model to bring Lenovo new technology and products (in addition to the existing technology) at more affordable prices and better performance for customers. Lenovo obviously worked on this acquisition with an eye on resources but overlooked the fact that IBM’s PC division had a disruptive model, at least in the past, and that could be nurtured into an independent unit with less intervention in the post-acquisition stage. Lenovo made a series of wrong decisions: first targeting IBM’s PC division with an eye on resources (which is clearly a wrong move) and second, pushing the Lenovo culture on the integrated entity. In the end, Lenovo was not able to take advantage of the strengths of IBM’s PC division and missed the golden window to boost its own PC development in a competitive era.

In order to succeed, acquisitions have to follow the principle of three rights:

(1) Honing in on the right purpose of the acquisition: is it for acquiring resources that lead to premium product prices or lower costs, or is it to acquire a disruptive business model for transformative growth?

(2) Choosing the right time to acquire: are the institutional, social, economic and organizational conditions favorable?

(3) Selecting the right targets to acquire.

By being aware of these three rights, acquisitions could possibly help Chinese companies in this era to transform successfully in a “tian shi di li ren he” (translated to: just at the right time, right place and with the right person) environment.

Ying Zhang is Associate Dean at the Rotterdam School of Management, Erasmus University, and visiting fellow at Harvard Business School and Harvard Law School.

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