Consolidate Or Diversify - Which Way To M&A?

If you happen to be a consumer tech business that is rapidly growing and disrupting legacy and offline businesses, chances are you command something like a single digit market share of the overall market, even if you dominate your tech segment. It is just what it is, segment after segment, apart from the odd exception.

But being in such a situation and mulling over your M&A strategy, there will come a critical question for you to answer - "Do you undertake M&A to consolidate or to diversify?" Faced with this question, I argue that, for most of the lifecycle, for a buyer, consolidation works out better than diversification.

In my observations, tech businesses, when undertaking M&A, prefer to diversify by adding new geographies, new businesses, new customer segments, channels, etc. The rationale given for diversification will usually include benefits such as being able to address more customer use cases (and hence improve retention or add cross-selling opportunities), reduce risk via adding more business lines (which hopefully don't have high correlation), build presence in other attractive business segments, etc. Sure, these benefits can accrue, but in such diversification, there is an element of gamble - that of hoping that this new business being acquired does as well, if not better than the current core business, plus the synergies really make the M&A worth it. And in this gamble, lies a distinct risk of drifting away from your business strategy. Strategics already face a high bar in M&A, as you may recall from the previous post -

And even if you acquire good businesses as part of this diversification led strategy, the consequence of such diversification is the creation of premature conglomerates, i.e. several low market-share businesses banded together under common ownership. These low market shares keep these individual businesses vulnerable to competition in their respective segments. And that diverts management’s attention from growth and profitability in its core business towards tackling competition on multiple fronts. This eventually leads to exhaustion and questioning if all the time and money that was spent on M&A accomplished anything worthwhile.

Instead, if tech businesses are to take a more deliberate approach in their M&A, by looking to consolidate first, they can reduce the competitive intensity in their favour, while building scale in their core business. Market share matters - it is a zero sum game; more for you is less for your competition. And scale opens up potential - be it in pricing power or lowering costs via economies of scale, or for that matter just the increased visibility in the minds of customers or investors or competition. All in all, consolidation is likely to help you build a more resilient & robust business along with the added bonus of not subjecting oneself to multi-front warfare.

Of course, there are situations where consolidation may simply not be feasible - like, where the business is already too dominant or larger for any further consolidation to be meaningful or where it may not be attractive - say in declining industries, or when there are regulatory hurdles and so on. In such situations, diversification might be the way forward, by default. But for the rest, it is worth looking to consolidate first and then to diversify.

Or, in doge speak, try this first -

lest early diversification leads to this -