By Jim Belfiore
As part of a company's growth strategy, mergers and acquisitions (M&A) can ensure dominance over competitors in a given product line, technology or market. While there are many reasons a business would consider an M&A transaction (market expansion, acquiring complementary core competencies, creating opportunities for cross-selling), determining when an acquisition makes good business sense is a critical challenge. Even when an M&A strategy is well-defined, determining if any acquisition opportunity will align with the current and future strategic goals of a combined organization is a daunting task.
TRIZ is a well-established method used for product and process design evolution. This case proposes that elements of TRIZ can be successfully used as an early-stage M&A planning and research tool to help predict and identify potential evolutions of products, technologies and markets. Results of such analysis can be quickly validated through patent and industry research. A practice of employing TRIZ concepts and applications to develop and validate the early stages of an M&A strategy will be presented using a conventional TRIZ and knowledge-enabled innovation software application. A case study will be presented which demonstrates its applicability, and describes a recent acquisition of a medium-sized company by a large company.
Companies of all sizes, public or private, strive to create and return value to shareholders, customers and employees. The definition of value depends on the individual company's mission and strategy. An important aspect of value creation, however, appears constant across all companies – substantial value is created through innovation.
If innovation is critical to value creation, then all companies should be focused on fostering product or process innovation throughout their operations and culture. This is a trend that has grown steadily in many companies, but it is not an easy proposition. Internal investments in research and development or product and process optimization often take significant time to implement. In today's competitive landscape where time to market is often an overriding concern, reaping the long-term benefits of deploying quality improvement practices such as Lean or Six Sigma, design practices such as value-added/value-extra, and innovation practices such as TRIZ across an organization is often deemed too risky.
Is there a shortcut? Can a company "buy" the innovation needed, when it needs it? This is becoming a powerful, complementary strategy in medium and large companies which tend to be risk-averse "fast-followers" rather than pure leaders of innovative technology or process development. Proctor & Gamble's (P&G) "Connect and Develop" innovation strategy seeks to bring external innovation together with internal business units.1 P&G demonstrates a belief that innovation, while fueled by risk takers (usually smaller companies) using front-end processes and methodologies (of which TRIZ is a part) is realized through back-end processes that qualify and commercialize ideas through existing resources which are plentiful in a larger company. M&A is an essential tool in larger company innovation strategies. M&A is not, however, an activity that is necessarily initiated by a research or engineering organization.
There are common reasons why companies look to M&A as part of a value-creation strategy. Companies that engage in M&A activity often want to:
This list is not definitive, but it is clear that M&A can be an effective substitute for internal innovation. M&A as part of an innovation strategy requires skills for identifying and validating companies (including their technologies and processes) that will deliver on the value-creation promise. TRIZ can provide unique insight and assistance in this area.
A fundamental lesson of TRIZ is that technical systems follow specific and predictable laws of evolution. All systems have a preferred evolutionary state or ideal final result (IFR) in which the system has no physical instantiation, but performs its functions without problems and with complete usefulness.
The IFR of a system is often unattainable. It is an ultimate state which provides designers with a goal. The relationship to which a system evolves over time toward IFR can be represented with S-curves.2 An S-curve characterizes the evolution of a system from a low to high level of ideality over time, and typically takes the shape of the letter "S" tilted on its right side. With respect to M&A, ideality can address a number of factors (and hence a number of S-curves) that go beyond traditional S-curve analysis of parametric constraints on product or process evolutionary state. These may include cost, market saturation, profit and intellectual property value/risk, etc.
There are three distinct stages of an S-curve. As shown in Figure 1, ideality (however the practitioner defines it) will move through predictable stages of infancy, rapid growth and maturity.
During the infancy stage, a potentially innovative technology or idea is usually in the incubation stage. The developers have a vision, but it is not yet recognized or demanded by a larger market. From an M&A perspective, acquiring a company or technology at this stage presents a high risk/reward ratio. The potential rewards for acquiring a winning technology early in its development are significant but may take time to realize. The risk that the technology will never be brought to the market even after substantial capital investment is extremely high.
During the rapid growth stage, key individuals and groups (early adopters, early-stage markets) emerge and begin what often becomes a viral expansion of interest, leading to substantial demand creation of the technology, product or service that was developed in the system's infancy stage. During the rapid growth stage, substantial improvements to the system (an increase in ideality) can occur because the economics of bringing forth these changes suddenly becomes attractive. As ideality increases, investor risk decreases. From an M&A perspective, acquiring a company or technology at this stage presents a moderate risk/reward ratio. The potential rewards in this scenario are not much lower than in the infancy stage, and take less time to realize. Rapid growth often leads to rapid returns. The risk of not bringing the technology to market is significantly lower than in the infancy stage.
During the maturity stage, the system has reached one or more ceilings in its technical development, and any value-creation potential of the system has been realized. From an M&A perspective, acquiring a company or technology at this stage makes sense only to a small section of the M&A market. The value-creation proposition for this generation of a technology has already been extracted (the product or process is usually commoditized). Companies looking to acquire mature technologies are usually interested in preserving old businesses and niche markets with dependable, low-growth revenue streams.
The time between the end of infancy and the beginning of rapid growth is critical for M&A specialists to identify. Now other aspects of TRIZ can be leveraged to remove some risk from the acquisition decision before the viral expansion begins. As shown in Figure 2, there are five critical points of interest on an S-curve.
The point of pure innovation is at the beginning of an S-curve – a new idea is given the opportunity for development. For a period of time, the technology under development may experience difficult and expensive prototyping and setbacks until it reaches a stage where it can be produced.
At the second critical point, the idea or technology has been productized or put into operation such that value is being demonstrated to the select or lucky few that are at the right place at the right time to benefit from it. If a technology really has something to offer, it can be capitalized and lead to tremendous rewards. During technical innovation older technologies (and their business models) may be displaced or disrupted, and M&A can have the greatest success by realizing rapid returns because of rapid growth.
By the third critical point, the idea has been productized and undergone numerous improvements. The products or processes have been in the marketplace or in practice long enough to have been validated, and have extracted substantial value to the point of saturating the market. Fast-followers have already appeared on the scene, and any M&A at this juncture might be considered a more conservative play to round out a product portfolio or create a dominating market player. Fast-followers tend to use M&A transactions to buy market share of a maturing technology.
The fourth and fifth critical points represent the end of a system life cycle. New (next generation) ideas and S-curves are well underway as the current generation rapidly enters obsolescence. Aside from niche market opportunities, M&A activity at these stages yields low-growth value. This potentially serves to take mature or dying systems out of the market, or consolidate niche technologies into a larger company interested in creating slow-growing, highly repeatable value.
The authors identified the space just before the second critical point as one where identifying a company with technology or systems at this point in their respective S-curves offers the greatest potential to create value for an acquirer. Having used one idea from TRIZ to plan a strategy for acquisition, how then, can an M&A practitioner identify a company at this stage of technology development?
The structure of TRIZ makes clear that there are laws of system evolution which help us repeatedly identify evolutionary and innovative changes that should be made to systems elements as they interact with their environments. The laws of system evolution are designed to minimize the trial and error process that researchers and engineers typically must endure in any product or process development life cycle. The laws are divided into three groups.
The first group of laws specifies static conditions of evolution which apply at the beginning of a product or process development cycle (usually the first critical point of an S-curve). They include:
The second group of laws specifies kinematic conditions of evolution that apply to systems independent of technology or environmental factors. These laws tend to manifest themselves prior to the second and halfway toward the third critical points of an S-curve. They include:
The third group of laws specifies dynamic conditions of evolution which apply to systems under the influence of physical factors. These laws also tend to manifest themselves at the same stages of an S-curve where the second group of laws apply. They include:
TRIZ has tools that can be applied to design changes to systems that help realize system evolutions defined by the three groups of laws. These tools include, but are not limited to:
The 40 principles of invention (the inventive principles) are a collection of abstract rules that can be used to solve any problem. The principles were critically important observations on the nature of technical innovation made by TRIZ creator Genrich Altshuller and his colleagues. They developed these principles during the analysis of thousands of patents in the former Soviet Union. Independent of any particular area of science or engineering, these 40 ideas appeared repeatedly where breakthrough innovation was described in Soviet patents. Also normally present in these innovations was a dramatic conflict along one or more physical parameters, akin to an irresistible force acting on an immovable object. Altshuller observed that when in the presence of certain parametric conflicts, a handful of the principles of invention applied with significant predictability. Thirty-nine system parameters of improvement and conflict were developed and organized into a matrix of improving versus worsening characteristics, which mapped which inventive principles most likely applied to the possible combinations. This was the foundation of the classic contradiction matrix widely used by TRIZ practitioners in addressing technical design problems.
In M&A research it is important to seek out the conflicts of current technologies used to address contemporary, market-driven problems and postulate a potential leap-ahead or breakthrough method to address the problem, thereby defining the requirements of a new technology. This description can then be researched using patents and innovation literature to assess if such a technology already exists, the current stage of development (i.e., where it is positioned on its S-curve) and the companies driving such innovation, which might present potential acquisition targets.
The system of standard solutions represents a set of frequently used solutions for well-understood classes of problems. The documented 76 standard solutions are organized into five classes. Each solution offers a recommendation as to how a system can be transformed to eliminate a specific problem and evolve the system closer to an ideal state of design. (In one respect, their application is similar to that of a fortune cookie – the fortune cookie's message provides an abstraction to ponder and potentially apply to a specific situation. Ultimately the consumer is responsible for the transformation of the suggestion into an action and result.) The standard solutions are technology and system agnostic. As such, they are universally applicable to any problem or system one wishes to solve or improve.
The five classes of standard solutions are:
Each class has a sub-class that provides guidance and detail on how to apply a standard solution to a technical problem. In the case of M&A research, it is not about solving the problem itself, but rather using the description of the applicable standards in the context of the problem to obtain a potential lead on one or more breakthrough technologies. Such leads can then be validated through patent or innovation literature research, and potentially leveraged via M&A.
By being mindful of the laws of system evolution and knowledgeable of the tools provided by TRIZ, practitioners can attempt to predict a technical evolution that addresses a current or emerging market, and validate the existence of the evolution. More importantly, these ideas, generated by TRIZ, can lead us to the companies behind such evolutions, through the research of patents.
The need for clean, potable water has increased dramatically as global populations and demographics have shifted, but its availability has decreased. The shifts in population and demographics (increased population combined with higher standards of living) do not appear to be receding. A substantial demand on a precious resource is growing and will continue to grow. This raises social concerns, as well as opportunities for companies that develop water management technologies to address these needs. Larger companies that see synergies of this situation with their own products and goals may wish to leverage the potential value for their own operations and shareholders. An M&A strategy to create or fortify a technology portfolio that addresses the clean water market may save time and money which could then be applied to other business areas. How can TRIZ help in knowing where to look, or deciding what features to track in assessing water filtration providers?
Look first at the simplicity of the laws of system evolution in relation to the problem of water filtration. During filtration a barrier is introduced into the path of contaminated water and unwanted particles, chemicals and/or organisms are removed resulting in clean water.
The law of synchronization is in the first group of laws that specify the appropriate conditions of the beginning of a technical system. This law states that the necessary conditions for a system to be effective in its actions is through the coordination of periodic actions (or natural frequencies of operation) related to any parameters of the system's operation. This law provides an example of what to investigate in the research of water filtration technologies. Is there a need to synchronize distinct actions within any filtering technology that might separately address physical contaminants versus chemical or biological impurities? This may be a starting point in investigating past, present and emerging water filtration technologies.
Water filtration usually involves multiple stages. Filtration of large sediments is often first, followed by filtration of smaller particles and then chemical and microscopic filtration. Assuming that filtration uses multiple active stages, are there ways to look for emerging technologies that might follow one or more laws of system evolution? Studying the standard solutions may provide ideas for additional technical literature research – particularly patent data.
The second group of standard solutions discusses the development and modifications of S-fields. A S-field is a graphical model for describing an inventive problem and a visual method of expressing both the initial situation and the solution process. Each S-field consists of at least two substances and a field. In a simple example, a product "S1" will be produced by a tool "S2."3 A field "F" will be used by the tool (S2) to assist in producing the product (S1). The standard solutions specific to S-field interaction can be applied to basic water filter concepts as a means to generate ideas for investigating advances in water filtration. Two examples follow:
Figure 6 shows a combination of the suggestions presented in Figures 3, 4 and 5 using a simple construction application of one software tool. When analyzing a problem such as clean water first identify an action that would improve the quality – removing impurities using a filter. If using solution 2.3.3 it becomes clear that to "improve" the action practitioners must identify the useful elements and negate the harmful.
Whether using classical TRIZ concepts or a software-facilitated TRIZ problem statement, the selection is the same – a TRIZ-supplied concept specific to the potential evolution of water filtration technology that practitioners can begin to validate through the research of technical and patent literature.
Many of the initial stages of M&A research involve finding technologies (and their owners) that satisfy current market needs. For mature markets this would likely position the majority of contemporary solutions (products, technologies) far along in their respective S-curves. It is possible to use this assumption to a company's advantage by analyzing a handful of the current-generation's leading solutions to understand what problems are holding them back from creating a next-generation or leap-ahead solution.
In the case of water filtration, there have been a variety of solutions and competitive providers in the United States since the 1940s. A review of contemporary product literature and research shows that filtration processes use multi-stage processes (or multiple actions, which was seen as a suggestion from the standard solutions) that create waste streams which are often harmful to the filters, and must be dealt with or removed from the stream flow to minimize damage to the filters. Harmful streams can include many contaminants – i.e., high concentrations of acid salts, minerals and polymers. Often the solution is simply to purge the waste stream – a potentially large amount of water is consumed to filter a smaller amount. A system that filters 100 percent of the water used in the filtration process would be highly valuable.
The research into contemporary water filtration technologies shows a conflict that can be addressed using the inventive principles. The goal as an M&A practitioner is not to solve the problem, but to obtain additional insight into research that could identify newer technologies and their owners which might fit their company's M&A strategy.
Most contemporary filtration technologies use a multi-step (usually two) process to first attack chemical impurities, and then remove insolubles from a fluid stream. The first stage creates a stream of harmful materials that can damage the second stage filters. The classic contradiction matrix and inventive principles of TRIZ can be used to help develop an idea of what a solution to this problem might look like, and provide a lead for a next-generation water filtration technology.
One suggestion is to use the principle of separation. Is there a technology, means or method of isolating the harmful effects of chemical treatment in a way that it has no impact on physical filtration? Can the fluid stream be treated in advance of the current process? Follow TRIZ and look for technologies that discuss means or methods of water pretreatment specific to filtration. A search of patents will reveal a short list of companies to consider reviewing.
When pursuing any kind of extended, iterative investigation (i.e., a chain of discoveries is created, each discovery building on the one that preceded it) it is important to remember how the problem solver arrived at any particular point along the way. In this case, researchers are able to review a list of companies specific to advancements in water filtration that were suggested by TRIZ. By knowing how systems evolve, using tools to project how a basic filtering system should evolve, and putting those ideas in context to discover who is already working on relevant evolutionary technologies, it is possible to close in on companies that might be generating potentially high value, and as such, may be a valid M&A transaction, either as the acquirer or an investor.
When researching specific water pretreatment patents researchers found that the specific water pretreatment patent of interest belonged to a company that had been acquired by another in 2002. Looking at the company and its technology portfolio it is apparent that the company develops water filtration and treatment technologies. The patent application that was identified by the pretreatment question speaks of an emerging need to "avoid production of concentrated liquid wastes" and "a further need…to achieve the goal of zero liquid discharge."4 This patent application speaks both to an approach of separating a bad outcome from a desired outcome, which was suggested by the inventive principles, and a discussion of moving this technology toward an ideal final result, or maximum ideality. From a TRIZ-driven perspective, this is an exciting discovery. It raises questions as to the nature of the company's other patents and intellectual property. Are they as focused on ideality as they appear to be in this patent application? What is the nature of their patent portfolio? Do they own technologies that are potentially next-generation ideas, with potentially early entries on their respective S-curves?
A quick assessment of the company's water filtration and treatment patent portfolio using the software tools shows a high level of activity for decades.
Over the years, this company generated close to 200 patents in the areas of water purification and treatment. Additional analysis of patent metadata relevant to their portfolio (patent classification code distribution, for example) shows that larger manufacturing companies have had an interest in the same types of technology that this company provides, but generally do not own the specific types of technology that they had pioneered.
Applying TRIZ enabled the researchers to build a case for how water filtration technology might tend to evolve. Validation of some of the evolutionary concepts has helped identify their relevant owners, and project where next generation advances might occur. This effort has directly lead to a company that is not only developing and productizing those advances, but is doing so in a space with larger, potential acquirers.
On November 24, 2004, General Electric (GE) announced its intention to acquire the smaller company for $1.1 billion in cash, at an almost fifty percent premium to its previous market value. GE's press release stated that it was acquiring the company to give GE infrastructure "the technology, project experience, and service necessary to compete globally in the water (purification and treatment) business."5 The smaller company's pioneering technology, identifiable through application of TRIZ ideas and methods, fit the case for GE's eventual acquisition, securing GE's place as a world leader in water purification and treatment technology and services.
Ideas and concepts from TRIZ can be used for the purpose of driving M&A research. No method of predicting future financial transactions of an individual or company can be considered 100 percent reliable. Applying known system evolution concepts in a search for business value creation, however, can help reduce the time it might otherwise take M&A practitioners to find ideally suited companies for their portfolios. TRIZ has long been a methodology well-suited for tactical systems design and creative technical problem solving. There are viable business development applications of TRIZ, and these applications should be considered and practiced in the highly strategic realm of mergers and acquisitions.
Thank you to TRIZ Master Isak Bukhman for his kind discussions, and permitted use of several of his TRIZ tutorial materials during the preparation of this paper.
Note: This paper was originally presented at The Altshuller Institute's TRIZCON2008.
Jim Belfiore is the director of innovation practices and a certified innovation master with Invention Machine Corp., a software company that helps drive sustainable innovation in global organizations. Mr. Belfiore has led more than 100 strategic innovation research projects at numerous Fortune 500 firms. He holds a bachelor of science in Physics and Astronomy from the University of Massachusetts, at Amherst. Contact Jim Belfiore at jbelfiore (at) invention-machine.com or visit http://www.invention-machine.com.