Given the proliferation of cloud networks, artificial intelligence, and increasing processing power, the opportunity for supply chain professionals to implement a digitalization strategy to transform their supply chain has never been more accessible. As a result, companies are rushing to bring together automation and data collection tools into a cohesive system that, alongside artificial intelligence and machine learning, will minimize supply chain disruptions, improve efficiencies, and allow for faster responses to customers’ needs.
However, there is no plug-and-play solution to digitalization. It’s not possible to follow a series of prescribed steps to achieve it. Instead, companies must forge their own path and pull together disparate opportunities to transform their supply chain, and what works for one company, won’t necessarily work for another.
Up until now, it’s mostly been the larger players that have been implementing a fully fledged digitalization strategy, as they have the resources (both time and money) to work through this uncharted territory. Amazon and Walmart are two obvious examples, but firms like Tyson Foods1 and the pizza restaurant company Domino’s have also gone to great lengths to digitalize their supply chains. In fact, Domino’s biggest single department is now its information technology (IT) department.2 The CEO even talks about Domino’s as being more of a technology company than a food company.3
While these larger companies are reaping the benefits of embracing supply chain digitalization efforts (Domino’s was arguably brought back from the brink of bankruptcy by it), most small- and medium-sized businesses (SMBs) haven’t ventured down the digitalization path much. According to a 2020 survey by the industry association MHI, nearly two-thirds of respondents said they either have low levels of automation or none at all.4
This should not, however, be read as an accusation. Rather it should be heard as a call to action. Given that most industries adopt technology along a normal distribution curve (the risk-oriented innovators and adopters implement the technology first, while the majority of businesses follow after that), there’s been little expectation that SMBs would have jumped into digitalization strategies. However, we’re now entering the thickest portion of the distribution curve. MHI’s survey revealed that 80% of its respondents believe a digital supply chain will be the predominant model within five years. It’s time for SMBs—and some large corporations, too—to start formulating a digitalization strategy.
According to Nathan Dey, CEO of Navegate, a logistics and supply chain management software company, supply chain digitalization isn’t a “winner-take-all” situation, but an opportunity for all adopters to become more nimble and improve margins. Sam Anderson, CEO of Bay and Bay, a trucking and logistics company, agrees, saying that “companies who can adapt … with the constant evolution of technology will have a great opportunity for growth.”
As Supply Chain Quarterly has discussed before, digitalizing the supply chain isn’t just a matter of flipping a switch, nor is it just about implementing the latest, greatest technology.5 It’s an extensive process that involves every aspect of one’s organization plus the collaboration of every other player along the supply chain.
However, it is entirely possible to speed up the process. One way to accomplish this is by using mergers and acquisitions as opposed to internally developing the technology and expertise yourself. A digitalization-by-acquisition strategy may be particularly attractive in the following circumstances:
1) You can get unique proprietary technology (that isn’t available by licensing),
2) You can get robust data that your company can’t otherwise access, or
3) You can get talent that is difficult to attract in your industry.
For example, if you are licensing software, consider purchasing the company from which you are licensing it. This not only brings the developers in-house where they can customize the software exactly to your needs, but it prevents your competitors from using the same software. Amazon is notorious for using this strategy. Another strategy might be purchasing a key supplier or customer in order to integrate them into your digitalization efforts, as there is no faster way to share data and key performance indicators (KPIs) than within your own organization.
One of the largest potential pitfalls with such a digitalization-by-acquisition strategy is that you are usually acquiring a target that’s operating in a different industry and with a different business and operational model than your own. In the last few years, nontechnology companies have been increasingly acquiring technology companies. Indeed, by some measures, nontechnology companies make more acquisitions in the space than technology companies themselves.6 In most cases, acquiring a company as part of a digitalization strategy requires a different playbook than many typical M&A transactions.
Scope, not scale
To understand why digitalization M&As are different, it helps to take a step back and realize that M&A transactions typically fall into one of two categories: “scale” transactions and “scope” transactions. As the name implies, scale transactions increase the buyer’s scale and capture efficiencies and incremental benefits such as lowered costs, increased margins, greater market share, and the possibility of capturing niche markets within the buyer’s broader market. In most scale deals, a buyer seeks to acquire a competitor whose business (including the risks, asset base, and potential cost synergies) the buyer already fundamentally understands. The acquisition risks are generally lower and more easily understood. The rewards are usually accretive in the short term and, perhaps, even immediately.
Scope deals, however, transform the buyer by fundamentally changing its business capabilities—think of a brick-and-mortar retailer acquiring an e-commerce software company. In these transactions, the buyer and target are usually in different industries. At the outset, the buyer’s management may not fully understand the target’s operations and business. Most digitalization deals are scope transactions.
The first step to a successful transformative digitalization acquisition is articulating a clear and testable thesis for the transaction. The thesis should state the expected post-transaction value proposition and explain how the target’s capabilities, once integrated into the buyer’s business, will enable or contribute to that proposition. A vague statement that the target’s technology will make the buyer’s operations more efficient typically ends in an expensive investment with lackluster to poor results. Similarly, acquiring a target because the buyer’s competitors are approaching similar companies also often result in failed deals.
A clear and testable thesis might read as follows: “In the last five years, we have lost market share to competitors that have developed artificial intelligence and data analytics platforms that more efficiently allocate cargo across their fleets. We believe the target company’s proprietary analytics software is a best-in-class solution for supplementing our platform. If we acquire the target company and successfully integrate its software into our platform, we believe that in one year we will have met our competitors’ technological advantage and reclaim market share, and within three years, we will have developed a more successful platform allowing us to increase market share.”
Since a scope transaction fundamentally changes a company’s business capabilities, developing a solid investment thesis requires cross-functional buy-in, as the ability to transform the business will be dependent on various functional groups’ current and future operations. Most M&A transactions are often conducted on a need-to-know basis within a buyer’s organization to preserve secrecy and confidentiality. A core deal team (often within the finance department) is assembled and functional groups are integrated as needed throughout the transaction timeline. But in these transformative digitalization transactions, broader organizational participation early in the process will identify the transformative effects throughout the business, tease out potential integration issues, and identify unforeseen risks. Many abandoned deals have fundamental issues that could have been identified early on (and before significant management time and advisor expense was incurred) had the right functional groups been involved.
Reconsider due diligence
All the subsequent steps in the M&A should be guided by the deal thesis. Let’s begin with due diligence, which includes the investigation and analysis of the target company’s financial statements and records, corporate governance, contractual and regulatory requirements, and other issues related to its operations.
In scale transactions, initial diligence request lists are broad in scope—covering matters as diverse as the target company’s debt and equity structure, financial statements, employment arrangements, and real estate lease arrangements, among numerous other issues. Since the standalone value of the target is key to valuation, the value and quality of each constituent part of its operations is important. Moreover, the buyer knows the key diligence questions based on its experience with its own operations.
But in transformative digitalization transactions, the diligence process is different. The buyer’s management may not even know the right questions to ask. Input from the buyer’s various functional groups—such as its IT group—may provide guidance. But in certain specialized cases, such as with artificial intelligence and data analytics, the buyer may need to seek the assistance of third-party consultants who can adequately vet the target’s claims and operations.
Additionally, many of these transformative digitalization transactions may implicate regulatory regimes to which the buyer is not currently subject to and about which the buyer is not familiar. Jeewon Serrato, a partner in the Digital Transformation and Data Economy group of the national law firm BakerHostetler, notes that many data analytics operations implicate privacy regulations, such as the California Consumer Privacy Act. In the last five years, several new laws and consumer protection regulations have gone into effect which are often extraterritorial in scope and govern far more than what most nonexperts think of as private information (such as social security or credit card numbers). “In some cases, even creating customer profiles or drawing strategic inferences from behavioral data could be covered by these regulatory regimes,” says Serrato. Serrato notes that considering these issues only in the late stages of a transaction, or worse, after closing, is extremely risky. She recommends that buyers engage with outside expert advisors early, especially if a buyer lacks in-house expertise on privacy, data security, and related regulations. The failure to do so could create significant problems. For instance, it’s possible a buyer could acquire a data analytics company only to find out the buyer is prohibited from using or analyzing customer data as planned. It is better to find that out before the buyer has incurred substantial expense diligencing or negotiating the transaction or, even worse, closing the transaction.
Finally, realize that due diligence measures related to the standalone operations of the target may not be as important for a scope transaction as they are for a scale transaction. Indeed, some segments of the target company’s business may not even be relevant to the buyer’s plans. Take for example a buyer whose transaction thesis identifies data analytics and machine learning as a necessary component to increase efficiencies in freight scheduling. The deal team identifies a target with a robust analytics platform that the buyer hopes to integrate into its business on a proprietary basis. In a scale transaction, a buyer may spend significant time understanding the target’s sales team’s success rates, compensation, culture, and potential synergies. But none of that matters if the buyer’s strategy is to make the related technology proprietary. Instead, the buyer should focus initially on issues related to the target’s intellectual property. Is the technology dependent on inbound licenses? Can the outbound licenses be terminated or circumscribed? Do the target’s founders or employees retain rights with respect to the underlying technology? The deal team should compare the answers to these questions to the deal thesis to determine whether the transaction is strategically justified. An inefficient and badly run sales team is not an issue if the buyer never intends to further license the technology or otherwise sell the target’s software or services.
Every transformative digitalization transaction is different, and it is impossible to identify a general diligence strategy. The key is to create a due diligence focus that ties to the value drivers of the transaction thesis and to focus on what matters.
Tailor the documentation
The transaction thesis and the results of the diligence survey must guide the negotiation of the transaction documentation and deal structure. Typically, by doing so, a buyer will focus on different negotiation strategies for a transformative digitalization deal than the strategies used in a scale acquisition. In order to reach a quick and efficient outcome, many deal teams and their advisors seek a “middle of the road” or “market” acquisition agreement—a contract that “fairly” divides all the various risks between buyer and the seller. In scale transactions, this strategy can, and often does, reduce cost associated with negotiation posturing. In scope transactions, however, this approach can leave a buyer with risks that are either under- or over-protected.
Take again the example of the buyer purchasing a data analytics company. In that transaction, ownership and use of intellectual property and data privacy and security issues may be the key drivers of value and fundamental to the transaction. In other words, all other things being equal, a buyer would pay less for a company that has limited rights to use its intellectual property than a company with unlimited rights to use its intellectual property. The buyer should spend the majority of its negotiation capital protecting against intellectual property risk and not simply rely on “market” terms seen across all transactions.
Similarly, a buyer should not rely on broad contractual representations (or statements of fact in the contract that if proven false provide the other party with some right to a remedy) or indemnities alone. If, for example, data privacy compliance is a significant risk, the contractual protections should be drafted specifically to cover these areas. For example, most acquisition agreements include general representations that the target company has complied with the law and representations that speak to any litigation to which the company is a party. Since most companies get fined or sued from time to time, these representations generally do not cover small legal matters—such as a $500 fine from the local zoning board or a $5,000 lawsuit from a disgruntled former employee. But areas like data privacy often start as something small—like a single consumer complaint—and metastasize into a material problem—such as a large class action. For this reason, buyers may want to also include claims that involve immaterial monetary damages but have secondary costs, like significant reputational cost or loss of goodwill. The smart buyer would negotiate for both a general compliance with law representation but also for specific representations regarding compliance with data privacy regulations.
Start planning now
Lastly, the buyer must develop an integration strategy early in the transaction process. Integration is the process of combining the acquired company with the buyer’s business (everything from where the acquired company’s employees fit within the buyer’s hierarchy to how the acquired company’s products will be sold on the buyer’s platforms). In many scale transactions, the integration process is developed late in the transaction timeline or based on strategies used in previous transactions. In transformative digitalization transactions, much of the value of the transaction is based on “what could be” and significant internal restructuring may be required to achieve success. For example, the buyer may need to integrate an entirely new division like software engineering that does not currently exist in the buyer’s organization.
Unfortunately, integrating a technology company into a logistics business is not a plug-and-play process. For example, many technology companies have unique cultures that contribute to their success, and imposing the buying company’s culture may prove detrimental to future success. In some instances, buyers have found sound results by permitting acquired companies to continue operating (to varying degrees) autonomously.
Additionally, nontechnology companies that have acquired technology companies often find the continued (and very necessary) development of the technology requires substantial investment in engineering and related professionals. Legacy employees of the buyer (especially a buyer in a different industry segment than the target) are often underequipped to handle such responsibilities. Buyers need to incentivize target employees to remain with the combined company or recruit new talent. This can require creativity in situations in which a mature buyer acquires a startup target. The buyer’s incentive compensation schemes are typically based on achieving steady company growth; the startup’s incentive compensation scheme often revolves around getting big wins. These differences must be bridged creatively or a buyer is likely to end up with unhappy legacy employees or unhappy new employees. For example, the buyer may assess the differences in company cultures and integrate some of the policies, such as those promoting employee autonomy and creativity, that are popular at the tech company. However, these types of initiatives take time to develop within most organizations and should not be left to post-closing planning.
Similarly, as discussed above, transactions that revolve around data analytics are highly regulated. Privacy policies and strategies must be put in place and compliance procedures and plans must be developed and understood by in-house regulatory and compliance personnel. As Serrato notes, in-house legal departments need to closely monitor and assess the impact these rapidly evolving regulatory regimes have on the business prior to the transaction. She suggests that buyers develop these policies and strategies early in the transaction process. “It’s too late to wake up the day after closing and start your compliance planning,” she warns.
As more companies—especially SMBs—develop their digitalization strategy, it’s important to keep pace. There have been plenty of reasons to delay venturing down this path in the past, but now more than ever, it’s critical to begin this digitalization journey. Leverage the entire organization, develop a roadmap with actionable and scalable steps, and identify opportunities (particularly via acquisition), and you will put your organization in a position to strengthen your supply chain, overcome disruptions, and better serve your customers.
If you do choose to take the acquisition route, it’s important to keep in mind how acquiring a technology-based company may differ from acquiring one in your own industry. The advice offered here (see Figure 1) hopefully will make the deal—and the future integration—proceed more smoothly.
[Figure 1] Tips for making a transformative digital M&A
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1. John Buckley, “Digitalizing the Supply Chain: Which Comes First Data or Collaboration?” Manufacturing.Net (January 23, 2017): https://www.manufacturing.net/supply-chain/blog/13114734/digitizing-the-supply-chain-which-comes-first-data-or-collaboration
2. Elise Hu, “Domino’s Becomes a Tech Company that Happens to Make Pizza,” NPR (November 4, 2014): https://www.npr.org/sections/alltechconsidered/2014/11/04/359829824/dominos-becomes-a-tech-company-that-happens-to-make-pizza
3. Rhian Hunt, “Tyson’s Digital Outsourcing May Strengthen its Global Supply Chain,” Motley Fool (March 11, 2020): https://www.fool.com/investing/2020/03/11/tysons-digital-outsourcing-may-strengthen-its-glob.aspx
4. MHI and Deloitte, The 2020 MHI Annual Industry Report: Embracing the Digital Mindset (2020): https://www.mhi.org/publications/report
5. Arun Kochar, “Digital supply chain transformation: Taking the first step,” CSCMP’s Supply Chain Quarterly (October 24, 2019): https://www.supplychainquarterly.com/articles/2061-digital-supply-chain-transformation-taking-the-first-step
6. Leslie Picker, “For Non-Tech Companies, if You Can’t Build It, Buy a Start-Up,” New York Times (January 2, 2017): https://www.nytimes.com/2017/01/02/business/dealbook/mergers.html