Acquisition-Led Growth: Leveraging M&A In Fragmented Industries

Leveraging M&A in fragmented industries is a tactical approach to consolidating the market and creating brand dominance. A company operating in a vertical with several small players catering to a diverse selection of customers can use acquisitions to gain a competitive edge.

Purchasing upcoming startups for their customer base, IP, talent, or geographical advantage is an excellent growth strategy. Large enterprises prefer to partner with smaller, more agile startups with disruptive ideas by offering them several key benefits.

You could consider this M&A strategy to consolidate your targeted customer base and expand your market presence. Let’s start by understanding fragmented markets and how they work.

Fragmented Industries Defined

As a rule, new industries go through the life cycle of starting with several small businesses. These companies cater to segments of customers in specific locations or needs with customized offerings. They manufacture a limited selection of products designed to align with demand.

As the industry grows, smaller companies partner to take advantage of economies of scale. These collaborations encourage growth and the ability to offer standardized products to a larger customer base. M&A opportunities gradually contribute to consolidation.

Essentially, a fragmented industry has multiple small and medium brands competing against each other and the major brands. Because of the diversity of their customer base and demand, a single brand is unable to create a strong presence.

Customers are typically loyal to a specific company or brand that provides them with exactly what they need. When new disruptive products enter the market, they also create a niche of their own, serving a specific group of customers—the first users.

The company adds more features as interest in the product grows and more customers catch on. Soon enough, competitors arrive on the market, each with product versions that can cater to similar buyers. These customers can be in a different geographical location or demographic.

Each company offers customization to fulfill somewhat distinct needs and requirements. That’s how the industry grows in domestic and global markets. Eventually, small companies enter into partnerships to take advantage of cheaper inventory sourcing and distribution lines.

They also benefit from shared marketing and advertising efforts to reach more customers and offer them bundled deals. This is where the initial consolidation starts—by leveraging M&A in fragmented industries to grab a bigger market share. However, some verticals experience more fragmentation than others.

Examples of Fragmented Industries

• Retail industries feature multiple vendors, local businesses, and small mom-and-pop stores. These outlets typically sell clothing, plants, books, furniture, and food, specifically cuisines like Thai, Mexican, Chinese, or Indian. They may also cater to a particular demographic by stocking merchandise that appeals to them. For example, Asian ingredients or Indian ethnic clothing.
• Building and construction sectors are highly fragmented because they operate within specific locations. They offer services, skills, resources, and expertise essential for building within the area. For instance, constructing a home in Florida would involve a different skill set than building a house in Michigan.
• The hospitality industry does have major players and brands, but they are restricted to a limited number of outlets. Capturing a major chunk of the market is highly challenging. For instance, local hotels offering rooms and board in tourist destinations.
• The software sector is consistently evolving, and multiple firms compete to provide customized solutions and products to clients. Since firms can operate remotely, new providers emerge on the scene from global locations.
• The finance and accounting industries offer specialized services to clients of all types, such as individuals, businesses, corporations, and others. Since this is primarily a service-based vertical, it’s highly challenging for one or two companies to dominate the sphere.
• The marketing and communications field is diverse and includes several sub-sectors. Thus, it’s easy for new providers to penetrate the market.

Fragmented Industries vs. Fragmented Markets

There are key differences between fragmented industries and fragmented markets. Buyers who are considering leveraging M&A in fragmented industries should understand how that works:

• When discussing fragmented industries, we mean sectors with multiple medium-sized and small-sized businesses. These companies are scattered over a larger geographical area and have their own customer base. None has a sizeable market share or capability to dominate the sphere. However, a fragmented market refers to a market in which the customer base is segmented into different categories. These categories include age demographic, requirements, and preferences.
• While fragmented industries are all about the companies’ internal structures, fragmented markets are about customer characteristics and purchasing habits.
• Companies operating within fragmented industries must find ways to differentiate their products from the competition to build brand value. However, companies catering to a fragmented market must tailor their products to serve specific customer segments.

Why Leveraging M&A in Fragmented Industries Makes Sense for Larger Brands

As a rule, more established brands with a strong market presence tend to dominate the market. However, as industries evolve, they might encounter competition from upcoming smaller startups with innovative products.

Collaborating with these small players is one way to regain that foothold. Here’s why:

Changing Customer Buying Preferences

Well-known brands can rule the market only as long as there’s demand for their products. Changing customer tastes and buying preferences can alter the landscape. For instance, the shift toward organic, preservative-free food.

Because of their size, larger enterprises typically find it challenging to adapt to changing trends. They lack the agility to make drastic changes in their manufacturing processes. Thus, they are unable to keep up with market shifts like small and medium-sized businesses. M&A presents a practical option.

To go with the earlier example, the better-established brand can purchase the startup specializing in organic food to continue serving customers. Thus, it adds to its product portfolio while retaining customers and credibility as an innovative brand that understands their needs.

Availability of Cheaper Alternatives

One of the most critical aspects of fragmented industries is the availability of economical options. Because the space is highly competitive, customers can shop around for cheaper products without compromising on quality. They can also pick the features that meet their needs.

Although larger brands take advantage of economies of scale, they usually have fixed prices for their products. Price-conscious shoppers eventually move away from these brands to go with economical products available at local stores. eCommerce has also made it easier to find great alternatives.

When that happens, larger enterprises need solutions to maintain sales, and leveraging M&A in fragmented industries is an option. They can purchase the smaller sellers and include them in their portfolio of acquisitions, but also offer them autonomy.

The smaller company can continue serving customers while taking advantage of the benefits a more established enterprise can provide. Like, for instance, cheaper inventory or streamlined distribution. Access to expertise and additional resources is also an advantage.

The parent company retains brand loyalty and value as a competitive brand catering to all types of customers. Everyone wins.

Availability of Innovative Products

Industries like tech and software are highly fragmented because of rapid advancements. Innovative products quickly make existing offerings redundant. Customers select from products with different features to pick the ones that work best for them.

A great example is the smartphone sector, which has multiple companies developing handsets. Some have an extended battery life, while others have a better camera. Customers who cannot afford high-value phones simply shop around for these options.

A larger brand can remain competitive by ramping up its R&D to offer cheaper alternatives with similar features. It can also acquire a smaller brand for its tech capabilities and IP. Purchasing an upcoming startup for its team is also a great strategy.

Why Penetrating Fragmented Markets is Crucial

Leveraging M&A in fragmented industries becomes crucial for larger enterprises to penetrate fragmented markets and remain competitive. Here’s why:

Barriers to Entry are Low

Understand that the barriers to entry in fragmented industries are usually low or non-existent. Startups can quickly penetrate the ecosystem, find a niche audience, and set up shop.

Small businesses usually don’t have to deal with regulatory compliance issues or invest large amounts of capital to get started. All they need to do is find a problem, develop a solution, and attract customer attention. If the solution is innovative and customizable for individual needs, that’s a winning deal..

Larger companies, particularly investor-driven or publicly traded ones, need to overcome many hurdles before they can develop new products or attempt to diversify into new markets.

In addition to the costs of research and development, they are answerable to the investors on their board and shareholders.

Flexibility with Pricing

Most importantly, bigger brands must demonstrate rich returns quarter after quarter, so they can’t be flexible with pricing. They absolutely must deliver adequate revenues and profits that reassure stakeholders. Economies of scale aside, they must fix prices that won’t impact their bottom line.

Startups trying to gain a foothold in the market don’t have to deal with these considerations. They can use flexible pricing structures to grab a market share. Further, their costs are low since they mostly use intellectual property (IP) or locally sourced inventory.

For instance, a local mom-and-pop store offering artisanal confectionery and baked goods can better serve customers. Buyers will likely prefer their creative offerings over mass-produced branded items, making it easier for small stores to attract customers and retain loyalty.

Customization to Fulfil Customer Needs

Customization is a significant consideration. Smaller stores can more easily adapt to customer preferences, unlike, say, franchises, which must work according to corporate frameworks. They can quickly play around with new features to impress customers.

Startups can offer exciting, creative products without worrying about conforming to pre-existing industry standards. Customization is also possible because they cater to a small clientele within a fixed geographical location. They can also offer personalized service.

Most importantly, small businesses can serve customers that larger enterprises tend to overlook. Or, perhaps cannot reach because of their mass manufacturing and distribution strategies.

Low-Cost Marketing Solutions

Smaller startups don’t need to invest heavily in marketing and advertising campaigns. Since they have a limited reach, they get by with word-of-mouth advertising, flyers, social media, and informal channels. Since customers like to try new things, converting them is easily done.

Then again, because of the personal connection with customers, these stores can design their advertising for maximum impact. This factor again brings down their advertising costs.

Leveraging M&A in fragmented industries is the optimum strategy for large brands to build a market presence. Their best solution is to partner with the smaller players and enter into strategic partnerships to benefit both participants.

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Consolidating Fragmented Industries and Fragmented Markets with M&A

If the larger players do attempt to penetrate the markets, they’ll likely invest a large amount of resources into marketing. Campaigns would have to be carefully structured to resonate with the local audiences. Further, the messaging would have to be consistent and persuasive.

Further, getting responses, attracting customers, and initiating sales takes even longer. The biggest hurdle here is understanding customers and their needs. Getting customers to convert is challenging when they are habituated to economical and customized products.

Serving customers in fragmented markets typically involves high distribution and logistics costs, which impact profitability and the company’s bottom line. Partnering with local businesses is a more practical option for gaining a foothold in these markets.

Larger enterprises and private equity firms leveraging M&A in fragmented industries use the roll-up strategy. Accordingly, they purchase multiple small businesses operating within a specific sector and assist them with resources and expertise.

The injection of valuable capital helps them get organized under a single brand while maintaining their unique products. Higher operational efficiencies and economies of scale improve customer experience and sales. Eventually, the consolidated company generates higher profits and returns.

Gaining market dominance is always a huge positive. Of course, the focus is always on ensuring customers derive adequate value from the products for brand loyalty and consistent sales.

In Conclusion

Building a market presence in fragmented industries is challenging but not impossible. Larger companies must use the right merger and acquisition strategies to target different customer segments.

With the right integration approaches, companies can provide them with the products they need, customized for their preferences. Using the roll-up strategy, companies can penetrate these markets and scale operations.

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