SecuLog is a US company specializing in internet security. They mostly provide desktop log-in applications for government organizations.
Recently, SecuLog (SL) have been considering expanding into the mobile security market, so as to provide log-in options for their clients on both Android and IOS platforms.
To do so, they are looking into acquiring a European company, Safe2Bank.
Safe2Bank (S2B) specializes in mobile and banking security and has ongoing contracts with several EU banks. Banking contracts are difficult to obtain and require working within certain conditions in a specially supervised environment (security cameras, restricted access etc.).
S2B is valued at €250m.
SL want to know if they should develop their mobile platform capabilities in-house and, if not, how much they should be prepared to bid for S2B.
Identify the Problem
The candidate should note that the question requires them to analyze the costs and benefits of acquiring S2B vs organic market entry by SL alone.
A good candidate would notice that the two companies operate in slightly different markets and so should ask questions to pinpoint SL’s exact objective, namely:
Does SL just want to expand into the mobile security sector or is also interested in the mobile banking sector?
The candidate should realize that there is also an element of market-entry here and thus be prepared to ask some market-entry related questions later on.
If SL simply wants to develop mobile log-in capabilities for its existing clients, organic entry might be cheaper.
Lead the analysis
Benefits of acquiring S2B
The candidate should brainstorm and come up with a structure for the problem. A good structure would consider potential synergies from the merger as well as additional benefits from it. As much as possible, the candidate should opt for a MECE segmentation of the problem, where the additional benefits do not overlap the synergies. One possible structure would be:
Now, the candidate should deal with the components of their structure systematically.
Looking closer, the candidate should aim to investigate all of these avenues, starting with revenues.
Revenues from providing mobile products to its own customers: $150m
Overview: SL will get access to the difficult-to-enter banking market. They will also acquire the expertise to create mobile security, which would give access to other markets and/or allow them to complement their existing value proposition.
Future revenues from contracts with banks for mobile apps: €500m
Potential new revenues: there is a growing market of US healthcare providers and insurance companies requiring mobile security. The market is valued at $2bn but it is very concentrated, with three companies holding 30% market share each.
Additionally, the market is hard to enter because of R&D barriers
Revenues from providing mobile products to its own customers: $150m
The candidate should enquire about this potential new healthcare and insurance market in a structured way. Some potential questions would be:
- how much penetration can SL achieve?
- Is this in line with expected ROI?
The candidate can then calculate the value of the market share:
2bn x 5% = $100m
The candidate should enquire about potential cost savings, especially in R&D and variable costs.
- There would be no R&D cost savings - producing mobile security requires a completely different set of skills, so the departments couldn’t merge
- No cost reductions on personnel
- However, there would be a significant reduction of 40% in SG&A costs. Current SG&A costs are as follows: SL = $70m; S2B = €40m
- There would be no savings on variable costs since we are essentially dealing with two different products
SL may get a competitive edge when acquiring the ability to produce new technology. This, in turn, would increase its brand reputation.
- Time-zone differences would make it more difficult to communicate – however, since the projects are fairly independent, not that much communication would be needed
- There would also be a currency risk from operating across two currencies with a fluctuating exchange rate.
At this point, the candidate should note that, in acquiring S2B, SL would be entering the banking security market and discuss the fit with the proposed market.
The candidate should now consider the costs and benefits of entering the mobile securities market organically.
Organic entry costs
- SL also has no technical experience with mobile security or the banking sector. It would therefore have to invest in R&D as well as hire software engineers and other personnel to coordinate production of mobile products. The total costs would be $400m. However, if SL chooses only to develop their own products for mobile platforms and sell them to their existing clients, the costs are estimated at $200m.
- The US market for mobile security is difficult to enter and the company is behind in terms of R&D. SL estimate it would take 5 years to get up to speed, which would translate into an opportunity cost of $100m/year in the form of loss of revenue from healthcare and insurance providers, as well as $150m/year from loss of revenue from existing customers.
- The banking sector is nearly impossible to enter organically, so this would mean a potential loss of €500m of revenue
Therefore, the candidate should realize the entry cost can be divided into:
Cost to enter the mobile market for potential customers:
$400m + €500m + ($150m + $100m) x 5 = $2.25bn (where €500m = $600m)
Cost to enter the mobile market for existing customers:
$200m + ($150m + $100m) x 5 = $1.45bn
The candidate can then proceed to calculate how much SL should bid for S2B
To simplify, we will assume 1EUR = 1.2 USD
Bid value = Estimated value + Revenue + potential new revenue + cost reduction
Cost reduction = ($70m + €40m x 1.2) x 40% = 47.2m ≈ $47m
Therefore: €250m x 1.2 + €500m x 1.2 + $100m + $150m+ $47m = $300 + $600 + $100 +$150m + $47 ≈ $1.2b
ROI for insurance and medical market: 100m/1.20bn = 8.3% - so, in line with expectations
Delivering the recommendation
Based on the analysis the candidate’s recommendations should be along the following lines:
SL should acquire S2B rather than develop capabilities in-house because:
- It allows the possibility to enter two different desired markets quickly and it is cheaper than organic entry both in terms of costs and time
- The costs of inhouse R&D wouldn’t guarantee entry to the bank market as contracts are difficult to obtain.
- The ROI from the insurance and medical sector would be in line with the client’s expectations
Potential risks are SL’s lack of experience with the banking sector and potentially not being able to acquire further contracts with banks (although the experience of S2B’s negotiating team should help mitigate this) and the difficulties in merging the two technical teams in the long run.