Make-Or-Buy Decision

  

Categories: Company Management

Acquisitions of small companies by large companies happen all the time at "crazy" prices. GOOG paid $200 million for Slide in 2005, which was 200 times revenues at the time. Yes, you read that right. But the team who built Slide (about 50 engineers) had built a mobile operating system, more or less, and (properly incentivized) that team was able to build Android, the GOOG mobile phone operating system in four months. Had GOOG been forced to repartition its own engineers to build it, taking them off of search and other projects, it would have taken two years, and wouldn't have been as good.

So what was it worth to GOOG to be able to gain 18 months or more in speed against Apple, who was at the time threatening to restrict Google search access to their iPhones (angrily, Eric Schmidt resigned from Apple's board)?

Here it was a make-or-buy decision that was easy. It was a no brainer for GOOG to "over pay" for Slide and get Android "out there fast," rather than wait and just hope for the best.

Happens all the time. Good to be Slide.

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Finance: What are the economics of a goo...2 Views

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Finance allah shmoop what are the economics of ah good

00:05

merger Well you have a baby and they cost a

00:09

fortune You know food clothing diapers school await a different

00:13

kind of merger Sorry moving on In a purely financial

00:17

sense a merger is the coming together of two companies

00:20

such that in theory at least the sum of the

00:22

one plus thie Other one will be more than two

00:25

And there are a few perspectives that outlined the strategy

00:28

behind a good merger Let's start with market share or

00:30

market leadership to home coffee roaster making companies combine each

00:36

owned about twenty percent of the market before the merger

00:38

And together we'll now together Yeah together they own forty

00:42

percent instead of rivalrous lee competing against each other for

00:46

shelf space and marketing keywords on google in suppliers of

00:50

boilers Now the two companies air now the undeniable leader

00:54

and that vaunted position gets them a bunch of quote

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freebies unquote freebies free They're free and they're not competing

01:02

against each other anymore They're a team like they don't

01:05

undercut each other on price right So immediately they could

01:08

raise prices Yeah so think super friends in this and

01:11

how good the coffee must be at the hall of

01:13

justice So what are these freebies they get just by

01:16

being big Aii the market leader in revenues and our

01:19

units sold Well what do they get for being the

01:22

big kid on the block Well one freebie is that

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whenever a journalist writes a story about a coffee roaster

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for home use often in the starbucks haters gazette that

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journalist almost has to get a quote from mega brew

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inc You know or that journalist story really isn't validated

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It would be like writing a story on internet search

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and not getting a quote from google So lots of

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free press comes their way like you know free marketing

01:45

and as part of the process in being vey brand

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While the company likely raises the ceiling on pricing Before

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the merger one product was six hundred ninety nine ninety

01:53

five and the other was maybe six hundred forty nine

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ninety five and claimed we do what there's does for

02:00

five pounds of raw coffee les or something like that

02:03

Yeah we didn't write this loving but now instead of

02:05

competing against each other on price or why not just

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raze overall prices of everything to seven hundred forty nine

02:12

ninety five Who's going to stop Yeah you're the market

02:14

leader the big dog So now with the exact same

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cost structure the company has fifty to one hundred bucks

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more per unit in a pretty much immediate profit And

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if before the unit profit was something like seventy eighty

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ninety hundred bucks while profits just gone up dramatically So

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that's the story on the revenues side What about on

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the expensive side Well a couple of biggie stand out

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immediately Kwan is the cost of supplies like if combined

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they were each ordering one hundred thousand five hundred fifty

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degree blowing many easy bake oven units and paying the

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maker of those units one hundred fifteen dollars a unit

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now under the scale of an order of two hundred

02:50

thousand units Well taken likely get a price break of

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ten maybe twenty bucks a unit and those savings happen

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all the way down the whole building Materials from the

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power cord to the glass shields to the plastic form

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factors to the little rotating spinny wheel thing that has

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the beings going round and round So in a set

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of unit costs of say two hundred fifty bucks a

03:10

unit for the hardware A new home coffee roaster might

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under the combined company's cost them more like two hundred

03:16

bucks Then there's the cost of shelf space or distribution

03:19

Or if you want to think about it kind of

03:21

marketing When the two twenty percenters were competing against each

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other well they'd negotiate for the prime shelf space at

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upscale coffee bars gourmet kitchen retailers and amazon for that

03:31

physical or virtual shelf space Right And they'd negotiate on

03:35

how much of their revenues they were willing to give

03:37

up in order to get that premiere shelf space Well

03:39

that was with the two of them living in a

03:41

world where switching from one brand to the other was

03:44

pushed there about equal But now there's only one dominant

03:47

brand and it's the one everyone who roasts at home

03:49

wants So instead of giving up fifty percent of revenues

03:52

for distribution well now they only have to give up

03:55

forty percent So think about the cascade effect here The

03:58

average retail price used to be say six hundred eighty

04:01

bucks a unit How'd we get that number And we

04:03

what kind of an average of that Six forty nine

04:05

six ninety nine Numbers so on that 6:80 the company

04:08

kept in half or three hundred forty and that three

04:11

forty was enough to cover their costs but not leave

04:13

a whole lot of cash left over By the time

04:15

everything i'ii operating cost marketing lawyers insurance rent lawyers was

04:20

done and paid for But now average retail prices have

04:23

gone to seven hundred fifty dollars And instead of keeping

04:26

half the combined company now keep sixty percent of the

04:29

retail price or four hundred fifty bucks Huge swing here

04:33

That's an incremental keep or take or profit set of

04:36

one hundred ten dollars in the form of higher prices

04:38

and splits and then another fifty bucks in cost savings

04:41

per unit for an incremental total contribution of another hundred

04:45

sixty dollars a unit And in a world where each

04:47

unit contributed maybe forty bucks in the past this is

04:50

a massive game for shareholders of mega brew and just

04:53

like their commercial says But wait there's more In addition

04:57

to these units savings and values added the company should

05:00

they need it can probably get debt cheaper All else

05:03

being equal as a market leader They in theory at

05:05

least carry less risk They certainly have more have to

05:08

be able to borrow money And a bigger scale in

05:10

a borrowing of say twenty five million dollars would mean

05:13

less to them is a combined company than would a

05:15

borrow of twenty five million work if each company were

05:18

separate and still competing against each other and the same

05:21

scale benefits happened for duplicate jobs were taken likely fire

05:24

a third or more of their workforce and negotiate for

05:27

better per square foot prices from their landlords and better

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insurance and better lawyer rates And so on Well it

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all adds up to make this merger a you know 00:05:36.102 --> [endTime] special kind of blend

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