Tech M&As soar, but startups get swallowed

Facebook’s highly anticipated $19bn acquisition of WhatsApp last year seemed to mark the culmination of a growing trend in the tech industry; the biggest giants are snapping up some of the hottest startups, and they’re doing it more frequently than ever before. Over the past few years, everyone from Yahoo to Google, and from Facebook to Cisco has been in on the game, setting out on billion-dollar spending sprees to bolster their offerings.

But last year saw particularly noteworthy growth, with the number of tech M&As across the world in the first half of the year hitting the highest level since the millennium, and year-on-year growth for the period totalling a staggering 55 percent. $70.1bn was spent on acquisitions in the first quarter alone – double the sum of the same quarter the previous year – and the momentum isn’t anticipated to slow down any time soon.

The flurry is being driven by a range of factors, not least the increasingly common acqui-hire trend, whereby the big names buy startups with the intention of closing them down and keeping the talent. Startup acquisitions are also frequently being made as a means of helping the key players to remain at the top of the innovation leagues, according to Martin Zwilling, CEO and founder of Startup Professionals: “Every large company develops an internal inertia which makes innovation difficult”, he says, adding that it’s faster and cheaper to develop technologies by acquiring startups than by developing from within.

A game of monopoly
Aggressive M&A activity is frequently hailed as beneficial: it can mark an incentive for people to launch startups in the first place, according to Will Mitchell, professor and author of Build, Borrow or Buy. That cycle can, of course, be economically advantageous, generating funds that will then be invested in the local economy and into new companies.

But the potentially damaging implications of excessive acquisition activity are often ignored. Constant startup acquisitions can leave a few key players dominating, creating the sort of environment conducive to duopolies or even monopolies. Google holds a pretty firm grip on the search engine market, while Facebook has a hold over the social media sector, as Jeff Clavier, founder of Silicon Valley firm SoftTech VC recognises: “You could argue that, with 1.3 billion users, Facebook is sort of a monopoly in the social network space”, he says.

Indeed, in the US last year, Facebook owned four of the top 10 iOS and Google Play downloads (Facebook Messenger, Facebook, Instagram and WhatsApp), according to a report by analytics provider App Annie. If Mark Zuckerberg’s empire continues on its aggressive buying tract, that 40 percent could grow to an even more dominant portion.

Clavier says: “WhatsApp has a monstrous user base and Facebook thought that eventually the size of the user base and the retention they have would become a competitor for Facebook, so they decided to bring them into the fold for this massive price.”

Limiting potential
Buying out and shutting down competitors as Facebook did with Instagram and WhatsApp is a common driver for the flurry of startup acquisitions in a wider context, according to tech writer Josh Constantine: “You end up with a choice: [the new startups] either eat your lunch or you buy their lunch. They disrupt you, or you acquire them,” he wrote in an article for TechCrunch. But as the key players grow their market share more and more, so it becomes ever harder for the smaller startups to develop independently and compete. As those smaller players struggle to compete with the bigger names, it becomes evermore necessary for them to be bought out – creating a vicious circle that further propels the dominant names towards duopoly status.

And the firms being bought can face negative consequences as a result of the acquisitions. “A small independent firm… has the freedom to do it what it wants and do it quickly”, Mitchell says. “Once it becomes part of a larger organisation… it inevitably faces some bureaucracy, it has to fit into the strategic objectives of the new owner, and that’ll slow it down.”

And according to Zwilling, the acquired company may find itself completely devoured by its parent: “The startup entity and brand are usually folded into the acquirer and disappear”, he says. That’s especially true with regard to talent acquisitions; startups that might have otherwise flourished are shut down – which also means reducing the number of apps available to consumers.

That’s not to deny the reality that acquisitions can, in some instances, fuel startup growth: PayPal, bought by eBay for $1.5bn in 2002, grew so rapidly it is now going independent and is set for an IPO this year, while YouTube, acquired by Google for $1.65bn in 2006, reached a valuation of $40bn according to an analysis by Jefferies last year. But such stories are few and far between.

Clavier argues startups sometimes make the wrong move in agreeing to a buyout. “There’s always the question of, did you sell too early or should you have sold?”, he says, adding that one of SoftTech’s startups, Niche (which connects celebrities on social media channels with brands to create advertising), could have achieved substantial growth independently. Instead, Twitter bought it for a fifth or even 10th of its potential future price.

Startups dissolving
Mitchell argues most startups wouldn’t reach big-name status if they weren’t bought out, and that most are relying on an acquisition for greater access to resources such as cash, technology, talent and a larger consumer base. But the truth is it’s impossible to know what stage they’d have reached independently because the majority are acquired before ever hitting the IPO level – meaning the future Facebooks, Googles and Amazons could be dissolving away under the stranglehold of the more dominant names.

As they do so, they boost the larger players yet further, moving them ever closer to –opoly status. Mitchell and Clavier argue a full-on monopoly or duopoly will never be seen, because new technologies will come along to replace the likes of Facebook and co.

In the earlier dotcom days, that was certainly the case: newer, smaller companies were able to compete with, and eventually outrun, the likes of Microsoft by winning on the innovation front. But times have changed. Now the dominant players simply incorporate the new technologies into their own bodies through constant acquisitions, growing bigger and bigger by swallowing up the smaller players.

In so doing, the market leaders remove anything that might one day stand in their way, combining the advantages of scale and resources with innovation acquired from outside. That creates a powerful concoction, and it’s one against which new companies are likely to find themselves extremely hard-pressed to compete. Although it might not quite take the giants to monopoly status, it is giving them an undeniably high level of power and a scale that’s not to be undermined.