Bellwether Companies Are Buying Startups to Grab Tech and Talent

Maybe it’s time to buy a startup. You have a mandate to innovate as you transform your company to a digital enterprise, whatever that entails. Yet 74 percent of CIOs find it challenging to balance business innovation and operational excellence, according to our 2015 State of the CIO research. Maybe an injection of entrepreneurs and their inventive new technology can help.

You may also be having trouble finding talent in analytics, mobile development and social media. This year will bring shortages of those key skills, our research finds. Buy a startup, though, and you get a whole team instantly. Even some of those brilliant “data scientists” you’ve read about. Problem solved, perhaps.

Aetna, Capital One, Home Depot, Wal-Mart Stores and several other non-IT companies have made such acquisitions recently, pursuing startups for their technology and talent. That type of activity has been especially brisk for the past two years. And there’s no slowdown in sight. In the insurance industry, for example, 59 percent of companies are expected to buy digital startups in the next three years, according to a survey by Accenture.

Chris Laping, CIO and senior vice president of business transformation at Red Robin Gourmet Burgers, keeps up with new technology and says he is always open to the idea of buying a startup. “You look at ideas they have and think, ‘Man, it would be great to have this exclusively ours; we would get such competitive advantage if we were to buy that,'” he says.

However, Laping is in the minority. Not many CIOs are involved in these transactions. Finding, vetting, acquiring and integrating a small company of out-of-the-box thinkers is harder than you know. You probably can’t do it, at least not without upending many of the expectations your C-level peers have about the CIO. And about half of startup acquisition deals fail, says John Sullivan, a management professor at San Francisco State University who studies innovation and people management. Often key talent leaves or the technology goes nowhere. “It’s hard for a large nontechnology company to recruit tech talent,” he says. “Doing this is even harder.”

And yet, if you pull it off, you could catapult your company ahead of competitors and boost your own credibility as a digital strategist. Ready for the risk?

Build Cred

There are many ways to tap into the startup world for an infusion of innovation. Options include holding competitions for great ideas, investing seed money, forming partnerships and creating incubators. In 2013, the giant U.K. supermarket Tesco set up an investment unit, Dunnhumby Ventures, to incubate fledgling tech companies. Tesco benefits by, for example, getting to try out new wearable technology to make warehouses more efficient. Other Dunnhumby clients include Coca-Cola, Pepsico, Kraft, T-Mobile and L’Oreal. BNY Mellon recently opened a Silicon Valley office to focus on innovation. So did AstraZeneca. By making such moves, non-IT companies gain access to brand new technology and entrepreneurial talent while stopping short of buying startups outright.

Typical IT budget models–with little unallocated capital and even less capacity for risk–don’t allow CIOs to wheel and deal to acquire companies on their own, says Mark Raskino, an analyst at Gartner. Even buying a tiny one- or two-person company is out of the question. Marketing groups and business units usually have more play in their budgets and can more easily fund acquisitions, he says.

For IT to initiate a deal, the CIO must bring the idea to the CFO, COO or CEO. Perhaps even to the chief digital officer. But fellow executives might be cool to a proposal from someone inexperienced in M&A, Raskino says. Some CIOs lack business savvy. Some are viewed as better service providers than business partners. “Not many CIOs are that externally facing,” he says.

Some, such as Land O’Lakes CIO Mike Macrie, do have extensive experience with mergers and acquisitions. Macrie even hired an IT executive to help with such deals, including the purchase of an analytics company in 2012. But M&A know-how isn’t as widespread in the CIO profession as it is in others.

Politically, it’s shrewd for a CIO to get involved. One reason: Boards of directors may come to expect it, Raskino says. In the past few years, corporate boards have awakened to the importance of IT, he says, and are now more open to technology acquisitions, especially if the company lags in online or mobile capabilities.

For example, PetSmart last year bought Pet360, an online pet supply store and social network, for its e-commerce and digital capabilities. PetSmart ran its own e-commerce site but it has been small potatoes, accounting for just 1 percent of the retailer’s $1.7 billion in sales for the most recent quarter. Pet360, meanwhile, runs two e-commerce sites and six content sites that cater to different types of consumers.

As CEO David Lenhardt told financial analysts last summer, “This transaction is a smart and efficient way to immediately position PetSmart as a leading online pet specialty retailer of food and supply.” Pet360, he said, brings “significant online and technology experience.”

Wyatt McSpadden

The CEOs of these acquired businesses frequently gain influential positions at the parent company. For example, Pet360’s CEO became PetSmart’s chief digital officer and now oversees all of the company’s online and mobile marketing and products. Also last year, $2.3 billion athletic clothing company Under Armour bought MapMyFitness, a mobile app vendor, and immediately appointed the startup’s founder, Robin Thurs­ton, to be the parent company’s senior vice president, connected fitness and digital.

Under Armour had a CIO, but the IT team was focused mainly on internal operations, according to Thurston. “There was a gap in what the needs were in the leadership of digital,” he says.

Under Armour CIO Chris Gates says his group focuses on consumer experience through point-of-sale and e-commerce systems. The acquisition of MapMyFitness “now opens up career paths,” Gates says. “Both of our teams are excited.”

Wise Up

To tune in to the startup world, CIOs will need to change their habits and get involved in conversations that could lead to transactions, says Karla Viglasky, CIO-in-residence at Stafford and Associates, a consulting firm that connects CIOs with emerging technology providers.

Staying ahead of your rivals is just the start. Better still is to develop a point of view about not only where your industry is going, but also where you can push it, says Viglasky, who is also a former CIO of ITT. As companies tackle digital transformation, CIOs will be expected to scout the future this way, she says.

But sifting through thousands of startups is time-consuming, she says, remembering her attempts when she was at ITT. “When I reached out, some were ready and some were not,” she recalls. “I didn’t have the time to waste finding that needle.”

CIOs have to mix in different circles. You should get to know venture capitalists, for example, or attend conferences and speed-dating sessions with startups. And make sure you’re listed on the corporate website, so startups and VCs can find you, Viglasky says.

Laping, the CIO at Red Robin, enlists help. He works with a consultancy, Trace3, which introduces him to young companies looking for customers and investors. Red Robin hasn’t bought any startups yet, but Laping would make an internal pitch if it made financial and technological sense, he says. Meanwhile, he’s using the cloud and social technologies of several new ventures.

Two years ago, Laping informally proposed a buying a stake in an international retail point-of-sale software company whose analytics and integration capabilities he loved. He and Red Robin’s president and COO approached the vendor’s founders and were turned down. But Laping isn’t deterred. “I’m always pitching our CEO,” he says.

Making the right business case is critical. You’re buying a small, young company without a big market share and often without much of a customer base. You won’t see financial results immediately. Still, saying simply that the target will be useful won’t cut it either. You license useful technology all the time. It’s got to be a killer case where taking the target off the market might, for example, prevent competitors from getting access to strategic technology, Raskino advises. Or where buying the company blasts your own way ahead or into a dazzling new business. Right time, right technology, right people.

“When you can prove the tech is going to do something amazing for customers or in differentiating your [corporate] performance, you have to tell that story,” Laping says. Sometimes the payback period might be five or 10 years and the CEO must be convinced, he says.

To build a great case, a CIO must first understand the returns on other investments the company makes. At Red Robin, for example, the point at which opening a new restaurant starts to generate profit is an internal rate of return of 12 percent. If Laping can show that acquiring a company and using its technology can generate returns of, say, 30 percent, why wouldn’t Red Robin consider it? Investors expect Red Robin to do the smartest thing it can with money on hand. “What’s important for the CIO is to put a [forecast] on the table that dwarfs the typical return the company gets for a typical use of its cash,” he says.

Fight the Failure Odds

Once an acquisition closes, integration work begins. Beware: Some entrepreneurs view getting bought as selling out. A big bonus may keep people in the fold, but it won’t keep them excited, Sullivan says. The peer pressure, along with an itch to create a new company, can be hard to manage. “You feel like an outcast. Your friends won’t talk to you,” he says.

Enterprise IT has a bad reputation for bureaucracy, with lots of rules for processes that, at a startup, are pretty fluid, such as who can touch which code when and how to requisition a new server. As a young coder used to working all night on open source or in the cloud, “it frustrates you and blows your innovation,” Sullivan says. “‘Run fast and break things’ used to be Facebook’s slogan,” he notes. “I can’t imagine a bank saying that.”

As Raskino observes, “it’s easy for a company to buy something and crush it.”

CIOs can help avoid smothering the creativity that made the acquisition attractive. There’s financial and moral support to bestow. PetSmart spent $130 million to buy Pet360 and expects to spend another $30 million in “performance-based payments” to Pet360 staff by the end of 2016.

Keep teams together and treat the leader–and the staff–well, advises Sullivan. For example, Wal-Mart’s practice when it buys a tech startup is to install the new team in its @WalmartLabs office in Silicon Valley, where they are charged with building the future of e-commerce and work alongside others from previous acquisitions. Many of the founders of the 15 companies Wal-Mart has bought in the past five years remain with @WalmartLabs as software engineers or senior executives.

Most non-IT companies won’t do tons of deals but can learn from IT vendors that have, Sullivan says.

For example, Cisco, which has bought 36 companies since 2010, is “scientific” about M&A activity, he says. The networking vendor has formalized its acquisition processes and teaches it to other companies. One rule of thumb: If the CEO of the new company doesn’t stay at least a year, the acquisition won’t bear fruit because the team will feel adrift, says Sullivan, who has studied Cisco’s processes. Also, the acquiree’s office should be no more than 100 miles from its new parent’s headquarters, to foster integration without hovering. Communication matters, too. Cisco runs a secure website where newly acquired employees can learn about the company and see updates about how their particular integration is going.

One helpful technique is to keep acquired companies in separate offices, retain their existing leadership and set special performance goals. Aetna has done this with Bswift, which sells technology for building online health insurance exchanges. Capital One also did it with its user experience acquisition, Adaptive Path.

In 2012, Home Depot bought BlackLocus, a small pricing analytics company started by three Carnegie Mellon graduate students in 2009. The BlackLocus team has become Home Depot’s official innovation lab in Austin, Texas, providing analysis that the retailer uses in merchandising decisions.

Startup employees want to know their inventions are being used and they want to continue contributing, says Thurston of MapMyFitness. Under Armour, he says, has done it right.

MapMyFitness was founded with a mission to build a social network of fitness enthusiasts through mobile apps that track progress in running and other activities. Thurston met Under Armour CEO Kevin Plank in early 2013, just as MapMyFitness was evaluating whether to raise more capital through venture funding or to find another kind of investment partner. Plank was a user of the MapMyRun app and saw potential in a partnership. The $150 million acquisition closed in late 2013.

Had the two met a year earlier or a year later, the deal probably wouldn’t have happened, Thurston says. Earlier, he was too focused on independent growth, and later he might have been on track to go public. “We were at a pivotal moment,” he says.

While Under Armour had focused on the top echelon of athletes, such as Olympians and other elite performers, MapMyFitness focused on regular people trying to get healthier and feel better, 20 million of whom used its apps to track their progress and connect with one another. “The core mission of UA is to make athletes better,” Thurston says, “but they recognized that you have to make more athletes.”

Members of Thurston’s team wondered where they would fit in and what it would mean to go from having equity in a private company to being an employee of a big public company. Thurs­ton, too, was wary. He had worked in a research group at Reuters for several years, where he was involved in a dozen acquisitions. From a people perspective, “none went well,” with unclear roles and lots of acquired professionals let go, he says. “It was incredibly painful.”

The Under Armour deal, however, went well. There was little staff overlap because Under Armour didn’t have much consumer-facing digital technology at the time. “That helped our team feel that UA was truly investing in us,” rather than taking their technology and maybe planning to disregard the people, he says. “We were allowed to continue our vision on a bigger stage.”

Under Armour also assigned an internal IT staff member to the MapMyFitness staff, to make sure the newcomers had the technology they wanted, quickly. That’s an effective technique for avoiding alienation, Viglasky says. Otherwise, people coming from an agile, fast-moving startup to a bigger place with established processes can easily feel stymied, she says.

When the deal was completed, Under Armour valued MapMyFitness technology at $12 million and its customer relationships at $3.6 million. On top of that, it expects that further technology development and cultivation of a community of athletes is worth more than $122 million. The idea is to compete with Nike and Adidas, which have built their own apps and wearable devices. The roster of MapMyFitness users has since grown to 31 million.

Nearly all of the original staff members remain. They recently moved to a brand new Austin office, with spin bikes in the conference rooms and a bank of treadmills that overlook Lake Austin. “The change is exciting,” Thurston says.

Don’t Expect Immediate Results

On the flip side, a corporate CIO should watch for a drop in morale among existing IT staff members after acquiring a startup, Raskino says. They might grumble that they could have come up with that cool algorithm or that innovative idea if they had been given the time and money to experiment. But buying startups can eventually infuse the acquirer with entrepreneurial drive, as Wal-Mart CIO Karen Terrell noted at a Silicon Valley conference in 2012: “It changes companies over time. It’s changed Wal-Mart an awful lot.” (Terrell didn’t respond to requests for an interview for this story.)

Of course, a payoff isn’t guaranteed. Even IT vendors with long track records of dozens of acquisitions don’t get it right a significant portion of the time, Raskino says. CIOs know too well that when a big vendor gobbles up a smaller player, sometimes it disappears completely and customers are left wondering whatever happened to that technology, he says.

Sometimes, it takes years to see results. Wal-Mart has been at it since 2010 and is still in test mode with many ideas. In 2011, Home Depot bought Redbeacon, an online service founded by three former Google employees that helps consumers find local contractors. Redbeacon has grown since, but it’s no powerhouse. Pet360 accounts for less than 6 percent of PetSmart’s overall revenue, and it remains to be seen how much it will contribute.

But Laping, for one, is convinced that payback will come, with creativity and fortitude–and a strong relationship with the CEO. “He’s willing to listen to every idea that comes to mind. I’m good for 30 ideas a week and maybe one will pop,” Laping says. “I don’t have fear about approaching him with a wild idea.”