Why are IT giants willing to spend billions of dollars on acquiring startups?

It"s an amazing fact, but the history of Internet business knows only one case when a large IT corporation made a successful minority acquisition. This package was acquired by Yahoo in China"s Alibaba. At the moment, the entire Yahoo business is many times cheaper than a block of shares in Alibaba. There were many more successful acquisitions. YouTube video hosting and the Android mobile system have become the most important parts of Google, eBay, which once bought PayPal, is now cheaper than a subsidiary. Facebook has become the owner of promising and super popular Instagram and WhatsApp. The Russian market of Internet companies is no exception. The Mail.Ru Group holding has owned VKontakte and Delivery Club for a long time. At the same time, there were attempts to invest, and not to buy ready-made ones. The brainchild of Bill Gates invests through the Microsoft Accelerator. Now he has more than 350 transactions on his account. Even without taking into account two specialized captive funds - CapitalG (formerly Google Capital) and GV (formerly Google Ventures), Google has about 58 investment transactions in its account. This is not a definitive list. Internet giants have invested in thousands of startups. So why, then, in thousands of transactions, only one truly successful one?

The first reason is the size of IT giants.

High-tech companies are huge in relation to young startups. Even the most successful investments in developing companies will not become a significant driver of business growth. Capitalization of Apple exceeds 700-800 billion US dollars, the capitalization of the parent company Google Alphabet exceeds 500 billion US dollars. Even if we imagine that all IT unicorns will transfer 10 percent of the shares to the giants of the industry, this will not significantly increase the capitalization of even one IT giant. The achieved effect will be clearly less than buying, integrating into yourself and further developing the same YouTube, Android or Instagram. Yet even the most influential, far-sighted and wealthy business angels and venture investors in the technology industry were not able to acquire a stake in such projects as, for example, Snapchat, Uber, Airbnb and others at the same time. Returning to Yahoo"s super-deal, we need to remember its complex backstory. To create the conditions for such an investment, Yahoo effectively derailed its core business. Turning again to the Russian segment of the Internet, one can notice a similar pattern. The order of numbers, of course, is significantly reduced, but the essence remains. Even if the Russian Internet giant Mail.ru Group took part in all the big and serious exits of domestic Internet companies in recent years (although in fact only Avito can be spoken of in this vein), then such a venture would undoubtedly bring success to the corporation only several hundred million dollars. The figure is pleasant, but it is only a few percent of the holding"s current capitalization.

The second reason is related to the unpredictability of the results of venture investments.

All minority investments are almost always made under market conditions. This means that even the very influential and wealthy Google and Facebook will not have any fundamental advantages over all other investors. In other words, no one will sell a stake in a company for less just because the buyer is Google or Facebook.

Despite the fact that the whole world has witnessed how corporations with a capitalization of tens and hundreds of billions of dollars have grown from scratch in the past 20 years, in fact, venture investments are not so profitable. It may seem surprising, but on average, given the risk, this industry rarely generates three-digit or even double-digit percentage returns for anyone.

If you analyze the list of Google"s minority investments, you can see deals that have paid off many times over. Among them, for example, investments in Tesla, Baidu and Meituan. These investments have paid for themselves many times and even dozens of times. However, there were more than fifty unsuccessful purchases. In addition, Google and other investors, such as Baidu, have jointly invested only US$15 million. At the same time, Google unsuccessfully invested much more - $ 500 million - in the now unprofitable wireless Internet access operator Clearware. Working with promising startups is a very unpredictable activity, in which even a very high level of expertise does not guarantee success.

A completely different picture emerges when buying a promising company. A high-tech giant can use its unique resources and competitive advantages to conquer the market. This allows you to achieve a much greater efficiency of investments, and, therefore, to receive excess profits. The unique resources that already established companies have include many factors: the presence of legal and financial services, a powerful staff of engineers and developers, the availability of marketing knowledge about the market and consumer needs, and so on. That is why, from the point of view of an IT giant, it is more rational and efficient to spend a lot of money on buying one whole Instagramm, WhatsApp or Youtube, than to acquire only a share in a hundred small startups. Even if one of them is Uber.

The third reason is the need for specialization.

Venture investing is a professional skill and talent that requires constant development and improvement. It is necessary to spend a huge amount of time evaluating startups, studying their investment attractiveness, as well as a general analysis of the market and individual industries. In other words, to achieve the same results in investing as Peter Thiel or Jim Goetz, you need to be them.

The operational managers of large IT companies do not have the necessary qualifications, relevant experience, or even just the time to make competent investment decisions worth tens of millions of dollars. They"re 100 percent already in their business, so they can"t delve deep into startup research.

Why do IT giants still continue to invest in startups?

First, investments provide an opportunity to prepare the conditions for the further purchase of the entire company. In this way, you can take a place in a promising project, which is still too early to buy, but you no longer want to give competitors without a fight. This strategy is actively used by Google. Several examples can be given.

• Purchase of the Appurify platform in 2014. This project allows you to optimize mobile applications and websites and automate their testing. Shortly before this, Google invested 4.5 million US dollars in the company.
• The company Nest, which develops smart home systems, was also first invested, and then completely bought out

In Russia, a similar strategy was demonstrated by Mail.Ru Group when it bought the social network VKontakte. The holding bought shares in the social network in 2009 and 2010, and in 2014 the service was completely taken over by Mail.Ru.

This behavior allows IT giants to monitor the development of promising markets not from the outside, but keeping abreast of the industry. Even if something truly great happens in a high-potential market, it is almost always possible to seize the initiative by buying out the company, rather than being left on the sidelines as a disenfranchised spectator.

Secondly, the largest players in the high-tech market are trying to support the IT ecosystems they need with investments. Among them, for example:

• NVidia has expanded its investment portfolio with several projects in the field of AI. These startups are consumers of NVidia"s hardware
• Microsoft invested in submarine fiber optic cables in 2015. The task of this fiber optic network will be to connect and provide fast data exchange between Microsoft data centers in different countries and even on different continents. By the way, this is a trend. Facebook and Google invested in the development of a similar infrastructure even earlier
• American CRM-system Salesforce also invests in maintaining its own ecosystem. For example, her fund Salesforce Ventures, by investing, supports companies developing add-ons to her CRM.

Thus, it becomes obvious that the decision to invest and the choice of an object for the acquisition of a minority stake are based not only and not so much on profitability indicators and a simple measurable benefit in money. Objective financial performance is certainly important in assessing the attractiveness of an acquisition or investment. But no less important is the potential for integrating a new company into itself and the prospects for the market itself and technology for the future IT giant.