Sunday, July 06, 2014

Tower and Moat

I've just read this VentureBeat article on 'Why old-school tech giants need M&A to stay relevant' in which it talks about the importance of mergers and acquisition to companies like SAP. I don't know much about VentureBeat or whether this article is try to drum up business but there's a big warning here.

Before going on an M&A spree then you better know your competitors, especially if you're up against someone with a tower and moat play (which I suspect Salesforce is using). To summarise the tower and moat, I'll use the map from an earlier post on epic fails of sensible executives.

Figure 1 - Map

Notes on map.
  • A[1] to A[2] represents the change of an activity from product to utility. Let us suppose our business has established around selling a product A[1]  whilst the new entrant has introduced the more industrialised form A[2]. As per normal there is inertia to the change caused by changing practices, business models and capital (knowledge, social etc).
  • The competitor is running an ILC model around A[2] and hence it is building an ecosystem. Along with efficiency benefits this will enable them to accurately identify (through consumption data) future successful changes such as C[1] and then industrialise such changes to additional components (e.g. C[2]). An ILC model will cause the competitor's innovation rate, efficiency and customer focus to increase simultaneously with the size of the ecosystem.
  • There is an emerging market which is less advanced in terms of provision of the activity, hence we could sell A[1] to the emerging market. However, this won't deal with the issue that A[1] is going to be replaced with the more evolved form of A[2]. Concentrating on the emerging market will simply lay the groundwork for the competitor to enter that emerging market.
  • We could try to recreate past profitability around A[1] through cost cutting but again this doesn't deal with the issue that A[1] is going to be replaced with the more evolved form of A[2]. All that cost cutting is likely to do is create a spiral of death for us.   
  • We could attempt to 'innovate' by trying to create a high risk and uncertain differential B[1] or by  acquiring a company that provides this. However the competitor can simply copy us and then aim to provide it in a more industrialised form B[2]. This is particularly dangerous as part of a tower and moat play.  
  • So what is the tower and moat? A cunning competitor will try to build a tower of revenue around A[2] and build a moat devoid of any and all potential differentials (e.g. B[2] and C[2]) that surrounds it.  Every time we try to 'innovate' (e.g. B[1]) whether through acquisition or our own efforts, then the competitor will industrialise the act and provide it for free.  The danger to us of this play is that as their ecosystem grows they exploit both it and our own efforts to bolster their moat. Once we eventually realise that the future is not A[1] or trying to sell A[1] to emerging markets but instead it's about competing around A[2] then our problem becomes that the competitor has a large ecosystem around its core revenue and there is little to no room left to differentiate. It's basically game over for us.

So, now back to the VentureBeat article. M&A can be important in a counter play against someone running a tower and moat but you have to know what you're doing. It's extremely easy to spend hundreds of millions on buying up so called 'differentials' (e.g. B[1]) and find yourself still in a worsening position as the competitor copies you, growing their moat whilst their tower (and related ecosystem) expands.

The article talks about SAP 'augmenting its offerings' and buildings its 'competitive advantage' through acquisitions.  From my perspective, I'm not sure SAP realises how much trouble it is in. As far as I can see, its future positioning is poor, it's up against a tower and moat and random acquisitions aren't going to help it.