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Have you ever felt frustrated when scrolling through your television guide and seeing hundreds of channels you pay for but never watch?
You’re not alone.
More and more people are cutting their cable subscriptions. Statista reports the average annual churn for paid television subscribers has gone from 0.4% in 2015 to 5.9% in 2020—that’s more than a tenfold increase in just five years.
Instead of buying hundreds of useless channels, viewers are increasingly cherry-picking the offerings they want, like Netflix and Disney+, and dropping the rest.
Acquirers Are People Too
Acquirers don’t like buying what they will not use either. At the same time, they will pay a significant premium for a company with an entirely differentiated offering.
In this way, acquirers are no different than the rest of us. Assuming you spend $100 per month for a cable package that gives you access to 500 channels, you pay 20 cents per channel ($100/500). Still, most of us are happy to pay $10 per month for Netflix—50 times more than we would pay per channel for a cable bundle.
That’s why adding undifferentiated offerings to a unique core product is almost always a value killer for your business. When an acquirer considers a growth strategy, they must choose between acquiring a company or building it themselves.
Therefore, a potential acquirer will evaluate your business to understand how differentiated your offering is. If an acquirer concludes that your product or service is commoditized, an acquirer may offer you a couple of years’ profit if they are determined to grab market share quickly. However, the acquirer is more likely to assume that if they dropped their price or introduced a low-priced offering, they would pick up most of the business you’re getting today, making it unnecessary to buy your business.
Suppose you’ve bundled a collection of generic products and services among one differentiated offering. In that case, an acquirer will likely ask you to sell them just your differentiated offering or discount the value they place on the collection of things they neither need nor want.
You may argue that while the undifferentiated services and products will not be as valued by an acquirer, there is no harm in offering them in the short term because they give you more revenue to help underwrite your fixed costs. However, you pay a hidden set of taxes when you offer unattractive products and services. Firstly, those offerings suck up resources like time and cash. More problematic, they diminish the attractiveness of your business in the eyes of an acquirer. Acquirers are savvy and know you will want to be paid for your entire business even though they may only be interested in a portion of it. They know this will cause friction and may even choose not to engage in the first place.
Selling Half a Business
Look at the story of Calvin Johnson, who built Vancouver-based Lykki, an office supplies business. Johnson supplied offices with consumables like photocopier paper, toner cartridges, and sticky notes. Lykki’s product lineup was commoditized, and Johnson only got around 20 points of gross margin on a typical order. Johnson noticed how much less price-sensitive his customers were regarding the office kitchen. Employees were starting to demand better onsite coffee, so Johnson began to supply high-end coffee machines and his brand of quality beans.
Johnson could command 60 points of gross margin on kitchen supplies and marked up his premium coffee beans even more.
Lykki was growing when Johnson celebrated his 50th birthday, and the milestone caused Johnson to reflect on his life. Johnson realized he had been working at Lykki for his entire professional career, and he reasoned there was more that he wanted to do.
Johnson decided to sell.
He packaged up his business and took it to market. Johnson got a lot of interest from potential acquirers, but as their offers started coming in, the acquirers made it clear they did not want both businesses. Instead, they offered to buy the assets on one side of Lykki or the other.
In the end, Johnson decided to separate the two businesses. His kitchen supplies business was attractive, and he received a good offer from a global office supply company. The offer valued Johnson’s kitchen supplies business at about 75% of one year’s revenue, paid in cash at the time of closing.
The office supplies business was harder to sell. Johnson had to settle for 50% of one year’s revenue as a valuation. Half of his proceeds were paid up front, with the other half at risk in an earn-out. As he explained on a recent episode of Built to Sell Radio, Johnson isn’t sure if he will see anything from his earn-out.
Adding new products and divisions to your company can be an attractive way to grow, but if they make your business more commoditized, your new product lines may do more harm than good.