We frecuently read announcements of millionaire acquisitions by big companies but we know little  about if the strategy of acquisitions of a company will produce profits in the long term. Despite the excess of opinions, there seems to be little thoughtful analysis regarding the principles and strategies behind these acquisitions.

Successful M&A Processes

In 2011, Mike Volpi, Cisco’s former chief of strategy during the 1990s, outlined a list of principles that should exist behind a strategic acquisition. As Volpi mentioned Cisco’s methodology of acquisitions to grow, it could serve as the basis for a wide range of media or retail companies to generate the next phase of growth. It is worth remembering that during Volpi’s management, Cisco had an intense activity in M&A (75 acquisitions in 7 years) that few medium-sized firms could mimic in terms of reach and investments.

Here is a summary of the six principles:

1 Choose a central objective

Boost market share. Build economies of scale. Recruit the best talent. These objectives of the company are all very well, but can not – and should not – collectively determine the acquisition strategy. We must choose a target and adapt the acquisitions accordingly.

“At Cisco, we were pretty clear that we wanted to get into new markets,” writes Volpi, who is now a partner at Index Ventures. “We fundamentally believed that we could better leverage [our] distribution channel with a product portfolio that was broader than what our organization could organically produce within the required timeframe. As a result, they bought a lot of young companies with promising technologies or products. ”

2 Develop a portfolio

Technology acquisitions, says Volpi, are not independent events. They must build an interconnected investment portfolio. Some of these investments will work and others will not.

“No matter how well an acquisition process is built, the odds are against for any deal to succeed,” Volpi writes. “It is only when it is assumed that a certain failure rate is normal and that significant success occasionally happens that probability and the expected value equation begin to work in their favor.”

3 Understand that valuation is secondary to whether the acquisition serves strategy

Only 20 percent of the company’s acquisitions will yield great results. It’s better to look for those “2 out of 10”  to have big returns – and pay a premium of up to 30 percent for them – to try to negotiate the best offer with insignificant details.

“Worry less about what you pay and more for what the market is saying about whether the products and the company fit into your organization,” Volpi writes.

4 Build long-term incentives

Volpi is not a fan of earn-outs. These incentives, often linked to revenue, profits, market share, or other milestones of the company acquired, can be handled with some ease. And “they create a just schism at the starting point of the relationship between the two companies,” he says.

“Simple acquisitions using stocks rather than cash are much more effective,” writes Volpi. “Of course, they help retain the employees acquired but more importantly, they align the incentives of both parties. All involved parts want the price of the shares acquired to increase in value. ”

5 The “second best” is not good enough

Corporate development teams are often faced with this decision: Buy an expensive market leader, or the relatively inexpensive No.2 market, or one the top two competitors from another level. Although the first option seems to be the most expensive (and therefore not a “good deal”), Volpi advises to think less about price and more about value.

“There were a lot of YouTube contenders in the market,” he says. “Google could have acquired any of them worth 1/10 of YouTube. Instead, $ 1.75 billion was paid by the market leader, a seemingly huge amount of value for a young company. But few today would suggest that it was not a good deal. Through that brave move, Google closed that market. ”

6 Combine advantage points with strengths

Synergies are important. But what does it really mean to align synergies? Volpi offers two examples: distribution and operations. The first one places the best products of the acquired company in a large distribution channel of the absorbing company, and the second uses the economies of scale of the largest company to procure the services (bandwidth, server, storage) or production Large scale for the smallest company.

It also warns against cost reduction. “When acquisitions are justified by the reduction of costs in the acquired company, one should always raise a skeptical eyebrow.”

That article was written by Anni Layne Rodgers on March 4, 2014