Buying is Usually Cheaper than Building New
Amit Lohia, Vice-Chairman, Indorama Corporation writes about why acquisitions are better than new builds.
To buy or build, that’s a classic question for entrepreneurs and senior business professionals. Like a movie without a clear ending, there are bound to be different interpretations and even your own thoughts might change over time. But it shouldn’t have to be a philosophical question, but rather a very straight forward one rooted in practical experiences.
I’ll describe 5 main reasons why I think acquisitions can be easier, less risky, and more value accretive than greenfield projects.
But I will not delve into the “how” of making acquisitions successful, that’s a different (and maybe more important) question - let’s leave that for another day. Also, please bear in mind that these views and experiences have to be seen within the context of chemicals and industrial materials. It might not be as relevant for people in other sectors.
Reason # 1 – Don’t add to the supply problem
In general, the global manufacturing sector is riddled with the problem of oversupply. This is not a new phenomenon. It’s been around for a while now since the growing emergence of China as a manufacturing superpower, which has intensified over the past 15 years. This problem has also accelerated because plants are becoming bigger and bigger over time due to technological improvements and pressures to reduce cost. Oversupply, which is when the capacity to supply is much greater than demand, leads to a squeeze on prices and margins. While this is good for consumers, it’s painful for manufacturers, especially when new builds start cutting prices to poach customers from competitors. On the other hand, buying an existing producer does not change the market balance and one inherits existing and stable customer relationships, which also means considerably less market risk.
Reason # 2 – Consolidate
Acquiring existing players, namely your competitors, mitigates the problem of oversupply as described above in more than one way. It also helps the industry become more consolidated, which leads to better industry discipline and sustainability. Consolidation also presents an opportunity to create value and make the overall industry more efficient and competitive by introducing synergies and better scale.
Reason # 2 – Avoid risk of delays and cost blowouts
Maybe in the good old days it was possible to implement greenfield projects on time and budget, but that doesn’t seem to be the case anymore. Nowadays, a project is considered on time even if it’s late by a quarter, or “more-or-less” on time even if it’s late by two or three! That’s how difficult it’s got. And we’re not even counting the delays that typically arise post startup due to technical problems, slow ramp up, etc.
The same applies to costs. Even after planning and budgeting for costs meticulously and providing sufficient contingencies, there are numerous cases of project cost “blowouts”. We know of companies who literally went bust or became severely impaired because of big fat projects spiraling out of control. Also, entrepreneurs are intrinsically optimistic people and tend to underestimate the challenges around new builds (regulatory approvals, environmental concerns, land issues, pressure on infrastructure, trouble makers, etc.). At least when you’re buying an operating unit, you know what you’re getting into and there is less chance of unknowns.
Reason # 3 – Access new products and markets more easily
There are many products that have a long and challenging customer qualification and approval process, especially if they involve personal safety or wellbeing. Needless to say, consumer products, be it a car or a diaper, sell based on their delivery of quality, performance, and safety. A car has more than 10,000 components in it, even a diaper has over a dozen; any defect or failure can have disastrous repercussions for the brand. So if you want to make airbags for cars or fiber material for diapers, brands are going to put your product through a very rigorous qualification process before changing their existing and proven suppliers. If you’re new to the industry, it’s almost suicidal to build a new facility for such products so the most logical way to enter such markets is by buying an existing player.
Similarly, in case you want to enter a new country and become a local player there, it’ll be much easier to accomplish that by buying a local unit instead of building something from scratch, especially if there are language barriers, complex local regulations, and large distances involved.
Reason # 4 – Get ready know how and management
The most commonly cited challenge for growing organizations is people. For some reason, no matter how large the organization, talent pool is a bottleneck. Greenfield ventures are inherently challenging and your best people should be deputed to lead them, especially if it’s in a new field or location. This drains your talent pool. But when you buy an existing operation, there is an opportunity to retain the management and add to your talent pool.
Also, if you are dealing with critical products like the ones described earlier, there will be a lot of specialized know how involved. In such cases, it’s even more important to buy operators with knowledgeable management in place instead of trying to replicate it with a brand new one. The learning curve can be catastrophic.
Reasons # 5 – Buying is usually cheaper
Finally, buying is usually cheaper than building new. Assets can often be acquired for well below their Replacement Value, particularly when they are distressed or have poor earnings. Or sometimes it’s just not feasible to build new plants in certain places due to high costs and it’s cheaper to acquire existing vintage plants there. A word of caution. It’s important to consider all the costs in order to make an apple-to-apple comparison. For example, don’t forget to consider things like working capital or the cost to modernize acquired assets.
On the whole, all things considered, buying is usually cheaper than building, and rarely more expensive.
So when should you build?
Does this mean that one should never build? Not at all. There are certain times when you have to and I can point out to 3 such instances:
When there’s a significant technological leap. Once in a while, there are new technological developments that make older plants obsolete or very uncompetitive and you have to adopt the new one to stay in the game;
When there are significant locational advantages concerning raw materials, proximity to customers, and/or fiscal incentives;
When it’s a brownfield expansion that utilizes your existing resources, infrastructure, and/or customer relationships.
To sum it up, I strongly believe that it’s usually better to buy than build. It is less risky (unless you’re buying very distressed assets) and usually cheaper (especially if its distressed assets!). There is less drain on your management bandwidth and growth can be much faster. Also, it can lead to two very significant and value accretive strategic results: industry consolidation and access to new products/markets.
None of this should imply that acquisitions are easy to pull off. Just like specific competencies and expertise are required to execute greenfield projects successfully, there are particular skill sets and prerequisite conditions necessary to make acquisitions successful. But as I said, that’s a discussion for another day.
Opinions expressed in the article are author’s own.