Consolidation is a normal part of any industry. They help to establish economies of scale that drive down the cost of goods and services and make the marketplace more competitive – and therefore affordable – for consumers.
There are three stages of consolidation in which an industry can be a part of: Fragmentation, Acquisitions & Expansion.
Each of these stages presents certain opportunities – and, perhaps, limitations – for business owners looking to exit their companies. By knowing the unique dynamics of each stage, you can be better equipped to make the most of your inevitable exit.
The fragmentation stage represents the early lifecycle of an industry. As there’s little history associated with the industry thus far, companies fight to blaze trails and establish themselves as leaders. To do this, they must leverage an acquisition-based growth strategy, where one-off companies are acquired with a focus on building revenues more so than building profit growth.
As an industry moves into this second stage, you’ll notice that leaders begin to emerge from the early fragmented stage. These leading companies are attracting capital, allowing them to buy up competitors in a continued path toward acquisitions-based growth.
You’ll recognize that as a whole, the acquisition stage still reflects a somewhat fragmented industry; however, the leaders of the industry are well known to all. In fact, it’s likely that the top four companies make up nearly 45% of the market share.
The acquisition stage marks a shift in the types of companies acquired. During the fragmentation stage, one-off acquisitions focused on enhanced revenues is the norm. During the acquisition stage, however, companies begin to place more emphasis on pace of growth and developing scale.
As an acquiring company, that means targeting businesses that offer both revenue enhancement and opportunities for cost reduction.
An acquisition target – during this stage – is still smaller in size than its acquiring company; however, it’s typically larger in size than during the first stage in an effort to leverage cost-reduction opportunities.
Companies who are able to succeed during stage two are those who acquire key competitors and who can focus on integrations as well as acquisitions. Integrations include IT systems, employee training systems, and building a scalable operations management platform.
The third stage in consolidation is the expansion stage. Companies who still exist as we arrive at this stage have had to endure a rather fast-paced stage two, and are now committed toward expanding their business at a pace that’s larger and quicker than their competitors.
During this stage, the frequency of acquisitions tends to minimize; however, they are often enormous, large-scale deals taking place among the remaining companies that have survived all earlier stages.
Once all is said and done at the end of this stage, the top companies could possibly control nearly 2/3rds of the market.
During an industry’s infancy, one-off acquisitions are the norm. That’s no longer the case, as these types of acquisitions are typically inadequate in offering opportunities for cost reduction or revenue enhancement. Besides, at this point in an industry’s life cycle, the big companies have established a large enough brand recognition to afford them the ability to pay a premium for any existing customer base.
Consolidation at this point is far more focused on acquiring companies that will present higher returns and lower risks. During this stage, an acquiring company will look to fill any holes that may exist within its organization while also looking to make decisions that deliver predictable growth outcomes that sit well with their investors.
If your industry is in this expansion stage, you, as a seller, should understand that acquiring companies will likely no longer need new talent; nor will they be quick to invest in projects to build scale. Premiums will also drop substantially. This is because companies in this stage will only continue to thrive so long as they are disciplined in how they grow.
Following the expansion stage, industries will reach an age of maturation where acquisitions become all but nonexistent. The market is now fully developed and just a few key companies hold the reigns of the entire industry.
This is the case in industries such as the automotive industry and in some consumer goods industries such as soft drinks.
Timing can be everything when it comes to your exit strategy. When deciding to sell your business, it’s worth understanding which consolidation stage your industry is in. Based on this, you’ll know what acquiring companies are looking for and willing to pay a premium for. You, then, can determine whether the time to sell is right, or if you believe you’ll find better offers as your industry moves through the consolidation stages.
RC Victorino contributed to this article.