diversification

9 – 7 0 8 – 4 4 5

R E V : N O V E M B E R 3 0 , 2 0 1 5

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Professors Bharat Anand and David J. Collis and Research Associate Sophie Hood prepared this case. HBS cases are developed solely as the basis for class discussion. Cases are not intended to serve as endorsements, sources of primary data, or illustrations of effective or ineffective management. Copyright © 2008, 2011, 2015 President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1- 800-545-7685, write Harvard Business School Publishing, Boston, MA 02163, or go to http://www.hbsp.harvard.edu. No part of this publ ication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means—electronic, mechanical, photocopying, recording, or otherwise—without the permission of Harvard Business School.

B H A R A T A N A N D

D A V I D J . C O L L I S

S O P H I E H O O D

Danaher Corporation

In early April 2010, Danaher Corporation’s Chief Executive Officer Larry Culp and his senior executive team were getting ready for another round of performance reviews of the firm’s diverse operating businesses. As usual at Danaher, this process was likely to involve not only conference room presentations but visits to the factory floor and conversations with customers. Culp had joined Washington, D.C.–based Danaher after graduating from Harvard Business School in 1990, and was appointed CEO in 2001 at the age of 38. He had taken over a company that had generated compound annual stock returns of over 25% since its founding in 1985. Under Culp’s leadership so far, Danaher’s performance continued unabated. Between 2001 and 2006, Danaher’s revenues and net income more than doubled, the firm consummated over 50 acquisitions, and its stock price continued

to outperform its peers by impressive margins1 (see Exhibit 1). And, while the “great recession” of 2008–2009 affected Danaher’s businesses as it had other industrial conglomerates, the company emerged relatively unscathed. Indeed, Culp was about to announce higher than expected earnings for yet another quarter.

Culp was wary of the term “conglomerate,” instead referring to Danaher as a family of strategic growth platforms. Management defined a strategic growth platform as “a multi-billion-dollar market in which Danaher can generate $1 billion or more in revenue while being No. 1 or No. 2 in the

market.”2 In 2010, Danaher’s portfolio comprised five such platforms, representing over 80% of its total revenue. In addition, the firm operated in seven focused niche businesses—a “business operating in a fragmented or small market in which Danaher has sufficient market share and acceptable margins and returns.”3

The company’s portfolio had evolved over the years. Once a cyclical industrial company, Danaher had in recent years become a scientific and technical instrumentation company that competed in less

cyclical markets.4 This evolution was most apparent when considering the build-out of the Dental and Life Sciences & Diagnostics platforms.5 (The firm’s other platforms were Environmental, Test & Measurement, and Industrial Technologies; see Exhibit 2 for the portfolio segmentation.) Danaher boasted leading market positions in a number of its business areas (see Exhibit 3 for the leading brands in its portfolio). Many of these companies were the result of successful acquisitions executed in the past dozen years.

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Culp had earned widespread praise for being a “hands-on” CEO. He believed that “the role of the CEO is to ensure the company has a clear and well-articulated strategy coupled with the right people

to execute that strategy.”6 For Danaher, a central pillar of that strategy was the Danaher Business System, or DBS (Exhibit 4 illustrates the system’s core tenets). As one analyst described, “[T]he DBS process system is the soul of Danaher. The system guides planning, deployment and execution.” 7 Culp affirmed the significance of the company’s philosophy of kaizen, or continuous improvement, in his first letter to shareholders in the 2001 Annual Report: “The bedrock of our company is the Danaher Business System (DBS). DBS tools give all of our operating executives the means with which to strive for world-class quality, delivery, and cost benchmarks and deliver superior customer satisfaction and profitable growth.”

Danaher’s successful implementation of DBS across its acquisitions had resulted in rapid growth. Indeed, Danaher’s management team had an impressive track record of expanding the operating margins of acquired companies (see Exhibit 5 for margin expansion of the companies). One equity research firm also noted that it was “pretty amazed at the number of new product introductions

across the portfolio.”8

However, despite its tremendous success, Danaher still faced a number of challenges. First, as the company grew to over $13 billion in revenues with strong cash flow, could it continue to identify and execute attractive, value-added acquisitions, as well as drive organic growth within its current businesses? Second, what challenges might arise as it applied DBS to some of the higher-technology, science-based industries that Danaher had expanded into in recent years? Last, some observers wondered how long “continuous improvement” could continue.

During Culp’s 20-year tenure with Danaher, he had seen the company rise to numerous challenges before. He was quietly confident that the firm would do so again.

Corporate History

Origins

Steven and Mitchell Rales were two of four brothers; they had grown up in Bethesda, Maryland. In 1980, they formed their initial investment vehicle, Equity Group Holdings, with an objective to acquire businesses with the following characteristics: (1) understandable operations in a reasonably defined niche, (2) predictable earnings that generate cash profits, and (3) experienced management with an entrepreneurial orientation. In 1981, they acquired Master Shield, Inc., a Texas-based vinyl siding manufacturer. Then, they acquired Mohawk Rubber Company of Hudson, Ohio, using $2 million of their own money and borrowing $90 million.

Soon after, a real estate investment trust (REIT) called DMG, Inc., came to the attention of several investor groups, including the Raleses. DMG had not posted a profit since 1975, but it had more than $130 million in tax-loss carry forwards.9 In 1983, the brothers gained control of publicly traded DMG and sold the company’s real estate holdings the following year. They then folded both Master Shield and Mohawk Rubber Company into the REIT, sheltering the manufacturing earnings under the tax

credits.10 They also changed the company’s name to Danaher, after a favorite fly-fishing locale in western Montana. The Danaher River traced its name to the Celtic root “Dana,” or “swift flowing.”11

From then on, the brothers used the newly tailored Danaher as an acquisition vehicle. With a considerable amount of debt, Danaher launched a series of both friendly and hostile takeovers. They focused on low-profile industrial firms and purchased 12 additional companies within two years of

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Danaher’s debut. Early acquisitions included various manufacturers of tools, controls, precision components, and plastics. In such mergers, Danaher’s focus was on cutting costs and paying down debt through the divestiture of underperforming assets. By 1986, Danaher was listed as a Fortune 500 company with revenues of $456 million. The 14 subsidiaries were at that time organized into four business units: automotive/transportation, instrumentation, precision components, and extruded products.

Despite its rate of growth, Danaher’s acquisition strategy was far from indiscriminate. As outlined in the 1986 Annual Report: “As we pursue our objective of becoming the most-innovative and lowest- cost manufacturer of the products we offer, we are seeking a market position with each product line

that is either first, second or within a very distinctive market niche.”12 At least 12 of its 14 subsidiaries were market leaders. Danaher considered its strategy distinct among the numerous serial acquirers of the mid-1980s: “If there’s one thing that distinguishes us from the other players in the M&A field, it’s that we stay in touch with the companies,” commented Steven Rales in 1986. After all, he added, “we’re reasonably young fellows with long time horizons.”13

Continuous improvement Around 1988, the Rales brothers shifted tack in three noteworthy areas. First, they turned an eye inward—both to the subsidiaries’ operations, and to the operations of the overall corporate entity. The managers of Jacobs Vehicle Systems, one of Danaher’s divisions, had studied Toyota Motor Corp.’s lean manufacturing, with great success. Before long, the brothers implemented the system companywide. The move bespoke what certain Danaher managers later described as their “near-instinctive affinity for lean manufacturing.”14 This penchant for lean manufacturing was the first aspect of a broader philosophy of kaizen—an approach that would ultimately become known as DBS, one of Danaher’s hallmarks.

Second, the Rales brothers noticed early warning signs in the junk-bond market, prompting them to reduce their debt. As a result, they were able to successfully weather the recession of the early 1990s.15 Finally, Steven and Mitchell chose to retire from their positions as chief executive and president. Although the brothers stayed on as chairman of the board and chairman of the executive committee, they looked to someone else to take the day-to-day helm.

The Sherman Years

In February 1990, Danaher appointed George M. Sherman as president and chief executive officer. Sherman was 48 at the time of his appointment, an engineer by training who also had an MBA. He joined Danaher from the Black & Decker Corporation, where he had been a corporate executive vice president and president of the Power Tools and Home Improvement group. Sherman was known as a highly effective leader; one analyst commented that he was “the highest-energy CEO I’ve met. He is

exhausting to be around.”16 At Black & Decker, he was widely credited with the turnaround of the Power Tools businesses, which grew twice as fast as the market during his tenure. Prior to that, Sherman had been at General Electric and Emerson Electric.

Sherman commented upon joining Danaher that he hoped “to add strategic planning with a

market-driven emphasis to enhance the admirable position of Danaher’s companies.”17 In addition, he looked to reposition the portfolio toward more attractive, less cyclical businesses. The company began to “look at international opportunities for expansion both in terms of selling our products overseas and selective acquisitions.”18 It also began divesting those companies making tires, tools, and components for the auto industry, as Danaher had neither the brand identity nor the sufficient scale to withstand pricing pressures affecting the industry. Beyond this, Danaher invested in new “platforms,” refocusing the firm’s acquisition approach and generating economies of scale not only in

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production but in distribution. Initial platforms included environmental controls, electronic test instrumentation, and precision motors. Last, Sherman concentrated on “making fewer but larger acquisitions, many of them family-owned firms with good products and respectable market shares

that were under-performing financially.”19

In 1986, Danaher had 16 operating companies. By 1995, it had 24 operating companies, and by

2000, 51 operating companies.20 As Danaher moved into electronic test instruments, water-quality instruments, temperature and pressure sensors for food and pharmaceutical manufacturing, and

“hardware for utility companies and other businesses,”21 their management team “proved to be adept at integrating these companies into their existing operations.”22 The acquisitions also solidified the shift in the company’s business mix that Sherman had jumpstarted in 1990. In 1985, 86% of revenue came from tires and rubber goods; in 1991, 78% of sales came instead from tools and automotive equipment. By 2001, over half of all revenues came from the Environmental, Electronic

Test and Motion Control platforms23 (see Exhibit 6 for percentages of revenue and profit by segment and geographic area from 2004–2010).

During Sherman’s tenure, Danaher’s sales increased from $750 million to $3.8 billion.24 The last five years of Sherman’s leadership saw Danaher achieve a compound annual growth rate in earnings

of over 20% and revenue growth of about 15% per year.25 Danaher also worked to expand and ingrain the continuous quality improvement techniques the founders had introduced. DBS came to be understood as the keystone of the firm’s continual success. The investment community praised Sherman’s leadership, opining that, between 1990 and 2001, Danaher had emerged “from midcap

company status to become the premier large-cap industrial company.”26

Danaher, 2001–Present

Portfolio

During its early years, Danaher pursued a financial orientation toward its choice of businesses, making resource allocation decisions on the basis of return on invested capital (ROIC). Starting in the mid-nineties, Culp noted, the company’s portfolio evolved toward “fewer, better businesses”27 by creating “platforms” based on a lead company with a strong position in an attractive market around which add-on acquisitions could be made. Danaher’s purchase of Fluke in 1998 was the first substantial acquisition that demonstrated the value in this approach.

Business selection was driven by a belief that “the market comes first, the company second.” In this, the firm adhered to Warren Buffet’s well-known comment that “when an industry with a reputation for difficult economics meets a manager with a reputation for excellence, it is usually the industry that keeps its reputation intact.” Rather than identify potential targets and then assess their market potential, Danaher conducted a top-down analysis that progressed from market analysis to company evaluation to diligence, valuation, negotiation, and finally, integration.28

Industries were screened according to certain desirable criteria. Culp explained:

First, the market size should exceed $1 billion. Second, core market growth should be at least 5%–7% and without undue cyclicality or volatility. This excludes Rust Belt and Silicon Valley businesses for us. Third, we look for fragmented industries with a long tail of participants that have $25–$100 million in sales, and that can be acquired for their products without necessarily needing their overheads. Fourth, we try to avoid outstanding competitors such as Toyota or Microsoft. Fifth, the target arena should present a good opportunity for

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applying the DBS so that we can leverage our Danaher skill sets. Last, we look for tangible product-centric businesses. This rules out, for example, financial services. Broadly, this set of criteria is rooted in a simple premise: we look for markets of size and where we can win.”

Acquisitions that followed these criteria fell into three categories based upon the target’s relation to existing businesses:

 New platforms As the classification suggested, a new platform acquisition represented a significant expansion of Danaher’s portfolio into new markets and products. Such an entry point could be a division of a larger corporation, a stand-alone public firm, or a private company. “Platform-establishing acquisitions,” explained the 2001 Annual Report, “bring in

‘Danaher-like’ businesses where our skills and abilities can create value.”29 Summarizing their importance, Culp remarked that “it was tough to build a string of pearls from later add- on acquisitions without a center of gravity on which to build.” Targets tended to be large and in sectors of strategic importance. Danaher’s recent expansion into the medical sector was one instance of platform entry into an attractive market where, by 2006, the firm had “invested over $2.6 billion in acquisitions with a focus on building our Medical Technologies platform.”30

 Bolt-ons Bolt-ons were smaller transactions that sought synergies between existing Danaher businesses and new targets. Acquired companies were comprehensively integrated into the core business in terms of management, organization, and distribution. In 2004, for example, Danaher acquired various product lines from Harris Corporation for $50 million, bolting them onto the Electronic Test platform.

 Adjacencies Unlike bolt-ons, adjacencies tended to function as predominantly stand-alone businesses after acquisition, despite their connection to a particular platform. For instance, Danaher acquired Trojan Technologies in 2004 for $191 million. While Trojan operated within the Environmental platform, its water treatment products occupied a particular niche and the business continued to function post-acquisition as a more or less distinct organization.

Although Danaher was on a pace of one acquisition per month by 2007, platform acquisitions were rare. A list of target industries was maintained by a corporate group that included the CEO, CFO, the head of Strategy Development, and the head of M&A; this list was reviewed regularly by the board. Often, Danaher would already know something about a business that it became interested in. For example, Culp noted that “American Sigma [acquired in 1995] was familiar to us as we had used its waste water sampling products at Veeder-Root. Similarly, Gilbarco [acquired in 2002] had been my first customer back in 1990.” But the firm also searched broadly to find the right business opportunity. The idea of entering the dental market, for example, was identified as early as 2002.

In identifying appropriate targets, Danaher was “willing to accept that an entry-point firm might not have a great leadership team, a key facility, or a terrific infrastructure in place. The only deal killer is when we cannot identify management to fill any anticipated gaps.” If a suitable company was not available, Danaher was prepared to wait. Yet, Culp believed that “because of our preparation, we are tactically advantaged when it comes to entering a new platform business. For example, we were decisive in the bid for KaVo in 2004 since the dental market had already been investigated by us and approved as a target by our board in 2002–2003.”

Smaller bolt-on acquisitions to existing platform businesses were more common than entering new business areas. Bolt-on acquisitions were the responsibility of the operating companies, with legal, pricing, and deal expertise contributed by the corporate M&A group. Implementation of such

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acquisitions would typically involve folding the target’s structure and operations into the existing platform. Such deal opportunities were reviewed monthly with each business, although the company walked away from far more deals than it ultimately consummated.

Distinguishing between various types of acquisitions informed the merger process from start to finish. Indeed, even post-acquisition benchmarks were determined by the type of add-on, as explained in the 2001 Annual Report: “[W]e scrutinize return on invested capital (ROIC) on all acquisitions. Our minimum hurdle rate is 10% after-tax ROIC within three years on average, with bolt-ons frequently reaching this threshold more quickly and platform-establishing transactions taking a little longer, but not exceeding five years.”31

Reshaping the portfolio since the mid-nineties had occurred without any large divestitures. Instead, trimming had mainly occurred around the edges.

Danaher’s acquisition strategy had not gone unnoticed. As one strategy consultant favorably

commented in BusinessWeek, “those guys have a very well-defined model of how to do M&A.”32 Over the prior decade, Danaher had expanded into Western and Eastern Europe, Asia, Latin America, and the Middle East. Initial expansion was fueled by adding small European companies to an existing U.S. operation in order to access international markets. More recently, as the firm’s international experience grew, it used certain European acquisitions (such as Radiometer in Denmark or Leica in Germany) as its core entry points into desirable sectors. Indeed, Culp viewed the German Mittelstand—medium-sized, often family-owned, German engineering companies—as ideal territory in which Danaher might make acquisitions since they included companies that had a broad geographic footprint but were typically “capable of more.” Culp believed that the Danaher operating model had been shown to effectively transfer overseas: “It might take a bit longer to change things, but if you accommodate the system to the new context and are always respectful of stakeholders’ needs and requirements, it can be done.” To date, Danaher had pursued fewer acquisitions in Asia, seeing companies there as too small to be valuable additions, and instead emphasized building businesses organically through their growth platforms. However, by the end of 2010, Danaher’s sales in China exceeded $1 billion, which included four separate operating companies, all achieving more than $100 million each.

By 2010, Danaher comprised five strategic business segments: Dental, Life Sciences & Diagnostics, Environmental, Test & Measurement, and industrial technologies. (See Exhibit 7 for detailed descriptions of the platforms, and see Exhibit 8 for acquisitions within various platforms over the years.) Culp broadly sketched future possibilities: “We don’t believe that Danaher’s operating model itself imposes any constraints on the size of the company. While our current platforms are primarily in B2B industries, we believe that we can potentially compete in a wide range of industries.”

Organization

Danaher was headquartered in Washington, D.C., in an unassuming office building six blocks north of the White House. The company’s name was not on the front of the building, nor was it even listed inside. Offices for the 75 or so corporate employees featured plain decor. Corporate functions represented in Washington included finance, accounting, legal, tax, treasury, human resources (HR), and M&A deal making.

By 2010, Danaher was active in dozens of different businesses and had grown to over $13 billion in sales. It operated with 45–55 separate business profit-and-loss statements (P&Ls), but only three segment EVPs reported to the CEO. Danaher liked fewer reporting units and, unlike other

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conglomerates such as Dover and Illinois Tool Works that split units when they got large, Danaher invariably looked to combine smaller units into one operating entity.

Culp himself spent about a half-day a week on external affairs (investor relations), between one- and–a-half and two days a week on strategic or M&A issues, and the remaining time—more than half the week—on operational and HR matters. Although he and other corporate executives had run a number of Danaher businesses effectively in the past, he noted that “today, I don’t make many operating decisions directly. Everything I do is really organization and people related. It’s all about influencing people and helping frame the conversation in a developmental way.”

The other important corporate function at Danaher was the DBS Office (DBSO) that comprised 15–20 executives who were physically located in the businesses rather than at headquarters. Individuals worked in the DBSO for a limited time, as it was seen as a developmental role, but the basic requirement for the position was for the individual to have been a senior operating executive. The current head of the DBSO, for example, was the former president of a Danaher company. The DBSO’s role was to train managers, both in acquired companies and existing Danaher operations, in the DBS. The DBSO was involved with the initial training and kaizen sessions for all new acquisitions. For existing businesses, its services were, in most situations, invited by the business itself, although it was occasionally told to assist a particular business. The DBSO was intentionally kept small because it was not intended to supersede the authority of line managers, who were expected to ultimately implement DBS themselves.

Corporate HR was run by a former company president. Individual businesses were responsible for managing their own people, but there was also a talent funnel from which to fill senior positions. Procedurally, however, corporate HR was intimately involved in executive careers. Any new job opportunity was run through an approximately 2,000-person corporate talent funnel, and all important moves were reviewed by the CEO and head of HR. A talent review was a key part of every operating company review. While Danaher believed in developing expertise in a function within a single business, the bias was to promote and retain executives within Danaher. As a result, approximately three of every four senior promotions were filled internally, and roughly one-fifth of the senior managers were promoted to a new position every year. Opportunities included both promotions within a business as well as opportunities in another Danaher business. An assignment did not have a predetermined length, and further promotions would be considered and planned as part of the talent review process when an employee mastered required competencies within the assignment and performed at or above expectations. Senior managers were expected to continuously develop, manage performance, and upgrade their team members. However, no bottom-performer reduction targets were set. Rather, individuals were assessed based on their performance and fit with DBS values.

Hiring into the firm included a psychological assessment as well as more typical interview procedures. Candidates were expected to “want to win with a team and demonstrate personal humility, while having a passion and energy for creative …