Interesting article in the New York Times about the dearth of strategic buyers in the M&A market (see Battling Headwinds).

It’s true that some blockbuster strategic deals have been announced recently, including AT&T’s $39 billion proposed acquisition of T-Mobile from Deutsche Telekom and Nasdaq’s $11.3 billion unsolicited bid for NYSE Euronext.

But these deals belie a strange fact: strategic bidders, or bidders that are operating companies, appear hesitant to re-enter the takeover market.

The article highlights some recent deals in which strategic bidders were conspicuously absent, and then attempts to explain the increasing reticence of strategic acquirers to participate in the M&A market as due to a changing mindset among executives.

Private equity firms have historically been at a disadvantage on how much they can offer. Strategic bidders can often realize greater cost savings and synergies by eliminating duplicative functions and combining and operating the acquired company more efficiently within their other operations.

This advantage was partly eclipsed in the cheap-money years before the financial crisis. But we are supposed to be back in more normal times, so why are strategic buyers hanging back?

The apparent reluctance may be the result of a fundamental reassessment of the value of takeovers, one that was occurring even before the financial crisis. Since then, chief executives and boards have been more concerned with running their businesses and surviving than with chasing expansion through takeovers. This is particularly true when the chance of success is far less certain, as in hostile takeover attempts.

The last 15 years have produced mergers that proved to be spectacular failures. AOL’s merger with Time Warner and Daimler’s acquisition of Chrysler are among the most notable. Together, these deals destroyed more than $150 billion in shareholder value.

During this time, studies have shown that while there are gains to be made, many M&A deals prove unsatisfactory for buyers. McKinsey & Company estimates that only a third of merger deals create value. In a separate study, Prof. Robert F. Bruner, dean of the Darden School of Business at the University of Virginia, found that almost half of deals failed, although these results were skewed by some spectacular miscues.

These studies illustrate that achieving a successful merger is hard work, requiring strategic vision and a focus on integrating the acquired company.

Although that’s a compelling explanation, I’m not sure I’m buying it.

Over the last 50 years or so, it’s been well documented that the overwhelming majority of strategic acquisitions fail to create value for shareholders (see also More Deals Gone Bad, Great Shareholder Ripoff, Why M&A Deals Go Bad, Dumbfounded by the Data, and The Complexity of Strategic Acquisitions). And despite the fact that we’ve known for about half a century that most acquisitions fail, deals consummated over the past 10-20 years haven’t performed appreciably better than those consummated in the 30 years prior (see Are You Paying Too Much for That Acquisition? and The Synergy Trap).

In short, there’s scant evidence that we’ve learned from past M&A mistakes. So what makes us think that anything has changed now?

For this reason, I’m less inclined to believe that the explanation for the dearth of strategic acquirers is that we have finally learned our lesson (…sounds reminiscent of the “This time it’s different” meme). Rather, the reason for the dearth of strategic acquirers (to the extent that there is one) likely has more to do with the residual effects of the financial crisis — an increased focus on core businesses, operating in capital preservation mode, a reticence to take on debt, and/or the lack of adequate capital — than any fundamental change in the mindset of executives towards M&A deals.

Fascinating read in the March 2011 issue of Wired magazine documenting an increasing trend among U.S. small businesses: They seem to be bringing manufacturing work that had been outsourced to China back stateside (see Small Businesses Buck Trend, ht Jon).

According to Wired:

For US firms, the decision to manufacture overseas has long seemed a no-brainer. Labor costs in China and other developing nations have been so cheap that as recently as two or three years ago, anyone who refused to offshore was viewed as a dinosaur, certain to go extinct as bolder companies built the future in Asia. But stamping out products in Guangdong Province is no longer the bargain it once was, and US manufacturing is no longer as expensive. As the labor equation has balanced out, companies—particularly the small to medium-size businesses that make up the innovative guts of America’s technology industry—are taking a long, hard look at the downsides of extending their supply chains to the other side of the planet.

“Companies are looking to base their decisions on more than just costs,” says Simon Ellis, head of supply-chain strategies practice at IDC Manufacturing Insights, a market research firm. “They’re looking to shorten lead times, to reduce the inventory they have to carry.” When accounting giant KPMG International recently asked 196 senior executives to list their top concerns for 2011 and 2012, labor costs ranked below product quality and fluctuations in shipping rates and currency values. And 19 percent of the companies that responded to an October survey by MFG.com, an online sourcing marketplace, said they had recently brought all or part of their manufacturing back to North America from overseas, up from 12 percent in the first quarter of 2010. This is one reason US factories managed to add 136,000 jobs last year—the first increase in manufacturing employment since 1997.

The US certainly isn’t on the verge of recapturing its past industrial glory, nor can every business benefit by fleeing China. But those that actually build tangible goods should no longer assume that “Made in the USA” is an unaffordable luxury. Unless a company is hell-bent on selling the cheapest goods possible, manufacturing at home makes more sense than it has in a generation.

This is not inconsistent with the anecdotal evidence that I have gathered from my interactions with managers. I have found that managers typically overestimate the benefits of offshore outsourcing (i.e., the ability to access cheap labor) and underestimate its costs (e.g., those born out of cultural, political, economic, and regulatory differences across countries). Unfortunately, many only learn the hard way – they commit to the outsourcing strategy before they discover the costly mistake.

The article continues:

Once they do [outsource], these businesses often realize something profound: China isn’t the great deal they expected. A January 2010 survey by the consulting firm Grant Thornton found that 44 percent of responders felt they got no benefit from going overseas, while another 7 percent believed that offshoring had actually caused them harm. One big reason for this growing dissatisfaction is quality…In addition to quality issues, subcontracting also exacerbates a second major problem with Chinese manufacturing: the lack of safeguards on intellectual property…Finally, sheer distance remains an intractable problem.

The Wired article provided a nice read, touched on some important points, and offered some interesting vignettes. I encourage you to take a look for yourself.

That said however, the issue is not all that new. It is reflective of a long-standing debate in the international business literature, and reminds me of a similar article written in the Harvard Business Review nearly 25 years ago (see Manufacturing Offshore is Bad Business).

Although I agree that there are compelling business reasons to consider offshore outsourcing, it is also important for managers to recognize that the practice is not without strategic consequences.

Wonderfully rich exposition of the economic competition between China and the U.S. from The Economist (see China Overtakes U.S.).

Constant worrying about exactly when the superpower will fall into second place is causing anxiety throughout American society…[but] in some important fields, China has already surpassed America.

Great stuff!