Is Consolidation Killing Innovation?

July 22, 2009: 8:00 AM ET

The shrinking of the tech sector threatens creativity and new thinking

By Christopher Lochhead, strategy advisor and former chief marketing officer, Mercury Interactive

Is Silicon Valley at risk of becoming Detroit 2.0 -- a company town dominated by a handful of big, uninspired conglomerates?

Lochhead advocates a healthy mix of innovation and consolidation

Lochhead advocates a mix of innovation and consolidation

Consolidation is replacing innovation as the hot strategy. During his company's battle for PeopleSoft, Oracle CEO Larry Ellison declared that the software industry has entered  a "period of contraction and consolidation."  

Talk about a self-fulfilling prophesy: Oracle has gobbled up at least a dozen more companies since it closed the PeopleSoft deal in 2005, and a big purchase of Sun Microsystems is pending. And other companies widely are expected to follow Oracle's acquisitive ways.

Is consolidation good for the kind of technological creativity that traditionally has come out of Silicon Valley? More on that in a moment. First, a rundown on what's driving the urge to merge:

Slowing growth
In late 2008 research firm Gartner pegged the industry growth at an anemic 2.3%. As overall growth rates crater, the game for tech giants changes. The thinking in the C-suite goes from: "How do we capture market-share when business is growing?" To: "How do we gain wallet-share as the industry is shrinking?" 

Big portfolios trump hot products

Many mega tech companies today favor quantity over quality. Instead of marketing a single product or service as best-in-breed, these giants push their customers to save money by buying "bundles." This strategy can be good for a particular vendor, but it drives down overall tech spending.

 M&A equals outsourced innovation

Why take the risk of pioneering new technologies and business models when you can leave that up to entrepreneurs and venture capitalists? Let someone else take the arrows in the back. Bigger companies tend to behave more conservatively: Risk-adverse boards of directors want predictable earnings and no surprises. Innovation is risky. Innovation is unpredictable. So the titans let the startups innovate. Then, when smaller companies get to an interesting size and prove their metal, the big boys buy 'em. In this way a consolidation strategy is de-risked innovation.

The IPO window is nailed shut

Despite the recent success of SolarWinds and OpenTable, the IPO window for most startups remains closed. As a result, the most viable exit for smaller companies is to sell. (VCs need to generate returns and entrepreneurs want to get paid.)

Zombies are attractive acquisitions

There seems to be a never ending lineup of troubled technology companies to buy. These zombies tend to have bloated costs that can be cut quickly. Once purchased, the big tech buyer can fire a lot of people, gut sales, marketing, and r&d costs, then milk the maintenance revenue cow. This makes these acquisitions profitable fast. Oracle, by now a master at absorbing its purchases, has said it expects the purchase of Sun to add at least 15 cents (non-GAAP) to earnings in the first full year after closing.

So is the shift to consolidation good news? It depends on your perspective. The ability to successfully execute acquisitions is a meaningful competitive advantage. When done well, acquisitions are a savvy way to gain market share and drive earnings. Just look at how effectively Cisco and Oracle have used their M&A muscle to force competitors to tap out.

But focusing principally on consolidation leaves the big guys vulnerable to attacks from innovators. Apple has been crushing Microsoft, Motorola, and Nokia with their innovative product, marketing, and retailing strategies. 

And when consolidation comes as the expense of innovation, the results can be toxic. Consider all those start-ups that are getting acquired rather than getting a chance to flourish as independent companies: Could one of them been the next Apple or Google, companies that have continued to innovate in spite of their size?

Bottom line: Growth comes from innovation. And without innovation, the tech industry could end up with a few big companies playing a game of musical chairs on the titanic. This will be bad for the industry and bad for the country. Historically tech has been a key growth driver of the U.S. economy. Tech needs to be a growth industry again; that will only come from a healthy mix of innovation and consolidation.

Lochhead is a retired marketing executive turned strategy advisor and ski bum.

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