Uncommon Wisdom

Sep 22 2010   1:20PM GMT

Will tech M&A activity fill need for broad-based product strategy?

Tom Nolle Tom Nolle Profile: Tom Nolle

Companies are now actively pursuing mergers and acquisitions to consolidate and improve economies of scale. Even when mergers and acquisitions don’t directly consolidate the companies (IBM’s deal with Netezza is an example), they are likely to result in some job loss overall. And even where companies aren’t involved in M&A in any way, they’re pressured to produce better profits in a world of nearly static sales. That means cutting costs, and probably jobs, or at best not hiring much. The phenomenon is market-wide and includes tech.

In tech, M&A is still fueled mostly by a combination of competitive pressure to offer a broad-based product strategy and a desire to “mine” revenue from customer relationships. The key point here is that revenue mining works only when there’s revenue to mine. Where markets are commoditizing, you can improve efficiency and costs, but it’s a race to the bottom that U.S. companies will lose to offshore competitors, particularly in China.

In IT, where most of the M&A has been happening, software is a key differentiator, and technology is directly linked through software to the productivity value proposition. In networking, the underlying problem is price commoditization at the network layer and below, and that problem cannot ever be solved again. Thus the major players in the space will ultimately fail, specialize or seek differentiation elsewhere. Alcatel-Lucent, Ericsson, and NSN are all vulnerable here because they have broad product portfolios that can be attacked piecemeal by Huawei and ZTE.

Will they go the Nortel route? It’s possible in our view, but it’s more likely that there will be a musical-chairs shifting of business elements among these players as each one strives to find a niche it can defend. In effect, these companies have to get smaller in product footprint and revenue to survive.

The challenges of the major network players may create problems for smaller vendors, many of whom are relying on OEM relationships with giants in networking or IT, or are looking to these firms as buyers down the road. There are surely going to be network deals done (Juniper is said to be preparing to announce it is buying Trapeze from Belden, an example of musical-chairs product elements), but we think these will be fewer, smaller and harder to monetize effectively than those of the IT space. Network vendors are losing strategic engagement, as our spring study showed, and without that it’s hard to leverage even good assets.

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