Acquisition provides a rapid means of gaining an estab1ished product/ market position. Acquisitions may be a particularly attractive means of corporate development under certain strategic and financial conditions.
In mature industries containing a number of established firms, entry through acquisition can avoid the competitive reaction that can accompany attempts to enter the industry by internal development: rather than intensifying the rivalry by adding a further player, the potential competition is purchased. In other industries in which competitive advantage rests in assets built up over considerable periods of time acquisitions can immediately achieve a market position that could be virtually impossible to develop internally. For example, Sony, the Japanese electronics company, has achieved competitive position with its acquisition of CBS Records and Columbia Pictures.
The importance of acquisitions is clear by the volume of activity. In 1994, US companies spent in excess of $222 billion on domestic acquisitions and a further $24 billion on cross-border transactions. However, acquisitions are not without their risks. Empirical studies have consistently shown failure rates approaching 50 per cent, regardless of the criteria used.
McKinsey and Company's study revealed that 43 per cent of a sample of international acquisitions failed to produce a financial return that met or exceeded the acquirer's cost of capital. Another study found that between 45 per cent and 50 per cent of acquisitions are considered failures or not worth repeating by the managements involved. Porter's examination of the diversification records of large US firms over the period 1960-86 also supported the findings of previous studies. He found that 53 per cent of all acquisitions were subsequently divested, rising to 74 per cent for unrelated acquisitions.
Many acquisitions apparently fail to create value. There appears to be four major reasons. Firstly, the acquired company needs to be integrated with the acquiring company’s own organizational structure which may require the adoption of common management and financial control systems and the joining together of operations, or the establishment of linkages to share information and personnel. Integration gives rise to a number of problems particularly relating to differences in corporate culture, high management turnover and employees not liking the acquiring company’s way of doing things. The loss of management talent and expertise and the constant tension between the businesses, can materially harm the performance of the acquired unit.
Secondly, the companies often overestimate strategic advantages and the potential for creating value by combining different businesses due to which they pay more for the target company than it is worth. Top managers typically overestimate their ability to create value from an acquisition primarily because rising to the top of a corporation has given them an exaggerated sense of their own capabilities.
Thirdly, the purchase price of an acquisition typically includes a bid-premium of 30- 40 per cent over the previous market value of the target company that makes it difficult for acquisitions to be a financial success for the acquiring company. Many acquisitions fail because the perceived benefits of increased market share and technological, manufacturing, or market synergies fail to increase profit margins or raise turnover by the amount necessary to justify the price paid to conclude the deal.
The final reason for acquisitions failure is management’s inadequate attention to pre-acquisition screening. Many companies decide to acquire other firms without thoroughly analyzing the potential benefits and costs. After the acquisition is completed, many acquiring companies find that instead of buying a well-run organization, they have purchased an uneasy business.
Acquisitions can only be justified in cases in which the post merger benefits have been solidly defined. In order to successfully create value through acquisition, the future cash flow stream of the acquired company has to be improved by an amount equal to the bid- premium, plus the often over-looked costs incurred in integrating the acquisition, and the costs incurred in make the bid itself.
Four value-creation mechanisms are available to achieve this:
Value Creation Mechanisms:
1. Resource sharing: In resource sharing operating assets of the two merging companies are combined and rationalized, leading to cost reductions through economies of scale or scope. For example, the British pharmaceutical company Glaxo planned to save $600 million annually following its acquisition of Welcome by combining headquarters operations, rationalizing, duplicated R&D facilities onto selected sites, and adopting a single sales force in overlapping product areas. )
2. Skills transfer: Value- adding skins such a production technology, distribution knowledge, or financial control skins are transferred from the acquiring to the acquired firm or vice versa. Reduction in costs or improvement in market position creates additional value. The effective transfer of functional skills involves both a process of teaching and learning across the two organizations, and therefore tends to be longer -term process than resource sharing. Nevertheless, it is often the primary value-creating mechanism available in cross-boarder acquisitions, in the opportunities to share operational resources may be found by geographic distance. For example, in its acquisition of the Spanish brewer Cruz del Campo, the drinks company Guinness planned to recoup the acquisition premium by using marketing expertise to establish Cruz as a major national brand in the fragmented Spanish market.
3. Combination benefits: These are size related benefits such as increased market power, purchasing power, or the transfer of financial resources. A company making a large acquisition within its existing industry, or, a series of smaller ones, may succeed in raising profit margins by effecting a transformation of the industry structure. The emergence of a dominant player within the industry should reduce the extent of competitive rivalry, as well as providing increased bargaining power over both suppliers and customers for the acquiring company. The European food processing industry, for example, has consolidated rapidly through\ acquisitions, driven both by a desire to reduce competitive rivalry and ' belief that larger brand portfolio will help to maintain margins in the face of increasing retailer concentration. Financially based combination benefits may be available. The superior credit rating of an acquirer may be used to add value by refinancing the debt within an acquired company at a lower interest rate. In other instances in which the acquired company has been a loss-maker prior to acquisition, the associated tax credits can be consolidated to new parent, thereby reducing the latter's tax charge.
4. Restructuring: If the acquired company contains undervalued or underutilized assets, acquisition 'costs are recouped by divesting certain assets at their market value and by raising the productivity of remaining assets. This may be accomplished by closing down surplus capacity, reducing head office staff, or rationalizing unprofitable product lines. Very often the two elements are combined; for example, the closure of surplus capacity may lead to a vacant factory site, which can then be sold off at a premium for redevelopment. A further form of restructuring is the "unbundling" that involves acquiring an existing conglomerate the market value of which is less than the sum of the individual constituent businesses. The businesses are then sold off piecemeal, creating a surplus over the acquisition cost. Restructuring is essentially financially based, in that it does not require any strategic capability transfer between the two firms. Rather, the skill of the acquirer in recognizing and being able to realize the true value of the targets' assets. A good example of value-creation through restructuring is Hanson plc's acquisition of the diversified tobacco company, Imperia. Hanson paid $5 billion for Imperial and within a year had sold off its food and brewing interests along with its London head office, for $3 billion, leaving it with the core tobacco business that generated 60 per cent of Imperial's previous profits for only 40 per cent of the acquisition cost. However, the presence of value-creating opportunities does not in itself guarantee a successful acquisition. Plans have to be effectively implemented before the benefits can be realized in practice. This is the second area in which acquisitions frequently fail. In many cases organizational issues hinder the ability of the acquirer to create the planned value. Critical personnel may leave the organization after the acquisition, clashes of organizational culture may cause mistrust and lack of communication, or inappropriate control systems may obstruct the efficiency of the newly acquired firm.
In mature industries containing a number of established firms, entry through acquisition can avoid the competitive reaction that can accompany attempts to enter the industry by internal development: rather than intensifying the rivalry by adding a further player, the potential competition is purchased. In other industries in which competitive advantage rests in assets built up over considerable periods of time acquisitions can immediately achieve a market position that could be virtually impossible to develop internally. For example, Sony, the Japanese electronics company, has achieved competitive position with its acquisition of CBS Records and Columbia Pictures.
The importance of acquisitions is clear by the volume of activity. In 1994, US companies spent in excess of $222 billion on domestic acquisitions and a further $24 billion on cross-border transactions. However, acquisitions are not without their risks. Empirical studies have consistently shown failure rates approaching 50 per cent, regardless of the criteria used.
McKinsey and Company's study revealed that 43 per cent of a sample of international acquisitions failed to produce a financial return that met or exceeded the acquirer's cost of capital. Another study found that between 45 per cent and 50 per cent of acquisitions are considered failures or not worth repeating by the managements involved. Porter's examination of the diversification records of large US firms over the period 1960-86 also supported the findings of previous studies. He found that 53 per cent of all acquisitions were subsequently divested, rising to 74 per cent for unrelated acquisitions.
Many acquisitions apparently fail to create value. There appears to be four major reasons. Firstly, the acquired company needs to be integrated with the acquiring company’s own organizational structure which may require the adoption of common management and financial control systems and the joining together of operations, or the establishment of linkages to share information and personnel. Integration gives rise to a number of problems particularly relating to differences in corporate culture, high management turnover and employees not liking the acquiring company’s way of doing things. The loss of management talent and expertise and the constant tension between the businesses, can materially harm the performance of the acquired unit.
Secondly, the companies often overestimate strategic advantages and the potential for creating value by combining different businesses due to which they pay more for the target company than it is worth. Top managers typically overestimate their ability to create value from an acquisition primarily because rising to the top of a corporation has given them an exaggerated sense of their own capabilities.
Thirdly, the purchase price of an acquisition typically includes a bid-premium of 30- 40 per cent over the previous market value of the target company that makes it difficult for acquisitions to be a financial success for the acquiring company. Many acquisitions fail because the perceived benefits of increased market share and technological, manufacturing, or market synergies fail to increase profit margins or raise turnover by the amount necessary to justify the price paid to conclude the deal.
The final reason for acquisitions failure is management’s inadequate attention to pre-acquisition screening. Many companies decide to acquire other firms without thoroughly analyzing the potential benefits and costs. After the acquisition is completed, many acquiring companies find that instead of buying a well-run organization, they have purchased an uneasy business.
Acquisitions can only be justified in cases in which the post merger benefits have been solidly defined. In order to successfully create value through acquisition, the future cash flow stream of the acquired company has to be improved by an amount equal to the bid- premium, plus the often over-looked costs incurred in integrating the acquisition, and the costs incurred in make the bid itself.
Four value-creation mechanisms are available to achieve this:
Value Creation Mechanisms:
1. Resource sharing: In resource sharing operating assets of the two merging companies are combined and rationalized, leading to cost reductions through economies of scale or scope. For example, the British pharmaceutical company Glaxo planned to save $600 million annually following its acquisition of Welcome by combining headquarters operations, rationalizing, duplicated R&D facilities onto selected sites, and adopting a single sales force in overlapping product areas. )
2. Skills transfer: Value- adding skins such a production technology, distribution knowledge, or financial control skins are transferred from the acquiring to the acquired firm or vice versa. Reduction in costs or improvement in market position creates additional value. The effective transfer of functional skills involves both a process of teaching and learning across the two organizations, and therefore tends to be longer -term process than resource sharing. Nevertheless, it is often the primary value-creating mechanism available in cross-boarder acquisitions, in the opportunities to share operational resources may be found by geographic distance. For example, in its acquisition of the Spanish brewer Cruz del Campo, the drinks company Guinness planned to recoup the acquisition premium by using marketing expertise to establish Cruz as a major national brand in the fragmented Spanish market.
3. Combination benefits: These are size related benefits such as increased market power, purchasing power, or the transfer of financial resources. A company making a large acquisition within its existing industry, or, a series of smaller ones, may succeed in raising profit margins by effecting a transformation of the industry structure. The emergence of a dominant player within the industry should reduce the extent of competitive rivalry, as well as providing increased bargaining power over both suppliers and customers for the acquiring company. The European food processing industry, for example, has consolidated rapidly through\ acquisitions, driven both by a desire to reduce competitive rivalry and ' belief that larger brand portfolio will help to maintain margins in the face of increasing retailer concentration. Financially based combination benefits may be available. The superior credit rating of an acquirer may be used to add value by refinancing the debt within an acquired company at a lower interest rate. In other instances in which the acquired company has been a loss-maker prior to acquisition, the associated tax credits can be consolidated to new parent, thereby reducing the latter's tax charge.
4. Restructuring: If the acquired company contains undervalued or underutilized assets, acquisition 'costs are recouped by divesting certain assets at their market value and by raising the productivity of remaining assets. This may be accomplished by closing down surplus capacity, reducing head office staff, or rationalizing unprofitable product lines. Very often the two elements are combined; for example, the closure of surplus capacity may lead to a vacant factory site, which can then be sold off at a premium for redevelopment. A further form of restructuring is the "unbundling" that involves acquiring an existing conglomerate the market value of which is less than the sum of the individual constituent businesses. The businesses are then sold off piecemeal, creating a surplus over the acquisition cost. Restructuring is essentially financially based, in that it does not require any strategic capability transfer between the two firms. Rather, the skill of the acquirer in recognizing and being able to realize the true value of the targets' assets. A good example of value-creation through restructuring is Hanson plc's acquisition of the diversified tobacco company, Imperia. Hanson paid $5 billion for Imperial and within a year had sold off its food and brewing interests along with its London head office, for $3 billion, leaving it with the core tobacco business that generated 60 per cent of Imperial's previous profits for only 40 per cent of the acquisition cost. However, the presence of value-creating opportunities does not in itself guarantee a successful acquisition. Plans have to be effectively implemented before the benefits can be realized in practice. This is the second area in which acquisitions frequently fail. In many cases organizational issues hinder the ability of the acquirer to create the planned value. Critical personnel may leave the organization after the acquisition, clashes of organizational culture may cause mistrust and lack of communication, or inappropriate control systems may obstruct the efficiency of the newly acquired firm.
Effective implementation depends on creating an atmosphere of mutual cooperation following the acquisition. Resource sharing, skills transfer and, to a lesser extent, combination benefits all create value through the transfer of strategic capabilities between the acquiring and acquired firms. Because of the high degree of change often involved, and the uncertainty likely to be felt by employees on both sides following the acquisition, it is critical that the acquirer works to create an overall atmosphere that is conducive to the required capability transfer.
There are five key ingredients to such an atmosphere
(a) Reciprocal organizational understanding.
(b) Willingness to work together
(c) Capacity to transfer and receive the capability
(d) Discretionary resources
(e) Cause-effect understanding of benefits.
(a) Mutual Organizational Understanding: Both companies must understand each other's history, culture, and management style so that they can work together effectively. This process is particularly important in the context of skills transfer, as the acquirer must ensure that the source and origins of the sought-after skills are not inadvertently destroyed during the integration process.
(b) Willingness to work together: Employees of both companies may be unwilling to cooperate and work together after the acquisition. They may fear over job security, changes in management style, or disbelief of the new organization. The negotiation stage of an acquisition can play an important role in creating an atmosphere of cooperation. A clear vision of the future, maintained assurances and a concern for the people involved ensure successful implementation. Post-acquisition, reward and evaluation systems also can be used to encourage cooperation.
(c) Capacity to transfer and receive the capability: For skills transfer it is appropriate to accurately identify and define the skills and actually to affect their transfer. In some smaller acquisitions, for instance, it may prove difficult to transfer the acquirer's control and reporting systems, as the receiving management does not have the time both to collect substantial amounts of additional data and continue to run its business as before.
(d) Discretionary resources: Managements should bear in mind that acquisitions frequently take up more managerial resources than was planned initially. Once a fuller understanding of the new acquired company is developed post-acquisition, new opportunities and problems will often emerge that require managerial time and attention.
(e) Cause-effect understanding of benefits: Finally, the correct atmosphere for implementation can only be generated when there is a clear understanding of how value will be created through the acquisition. Those involved in the value-creation process must understand the benefits south and the costs involved in achieving them. The detailed knowledge about these two elements may be held at different organizational levels. Executive management will have conceptualized the benefits of acquisition, but operating management who will conduct the day-to-day implementation frequently holds the knowledge about the associated costs. Open communication between those charged with planning and implementing the acquisition becomes critical Value can only be created when the acquisition benefits outweigh the implementation costs.
(a) Reciprocal organizational understanding.
(b) Willingness to work together
(c) Capacity to transfer and receive the capability
(d) Discretionary resources
(e) Cause-effect understanding of benefits.
(a) Mutual Organizational Understanding: Both companies must understand each other's history, culture, and management style so that they can work together effectively. This process is particularly important in the context of skills transfer, as the acquirer must ensure that the source and origins of the sought-after skills are not inadvertently destroyed during the integration process.
(b) Willingness to work together: Employees of both companies may be unwilling to cooperate and work together after the acquisition. They may fear over job security, changes in management style, or disbelief of the new organization. The negotiation stage of an acquisition can play an important role in creating an atmosphere of cooperation. A clear vision of the future, maintained assurances and a concern for the people involved ensure successful implementation. Post-acquisition, reward and evaluation systems also can be used to encourage cooperation.
(c) Capacity to transfer and receive the capability: For skills transfer it is appropriate to accurately identify and define the skills and actually to affect their transfer. In some smaller acquisitions, for instance, it may prove difficult to transfer the acquirer's control and reporting systems, as the receiving management does not have the time both to collect substantial amounts of additional data and continue to run its business as before.
(d) Discretionary resources: Managements should bear in mind that acquisitions frequently take up more managerial resources than was planned initially. Once a fuller understanding of the new acquired company is developed post-acquisition, new opportunities and problems will often emerge that require managerial time and attention.
(e) Cause-effect understanding of benefits: Finally, the correct atmosphere for implementation can only be generated when there is a clear understanding of how value will be created through the acquisition. Those involved in the value-creation process must understand the benefits south and the costs involved in achieving them. The detailed knowledge about these two elements may be held at different organizational levels. Executive management will have conceptualized the benefits of acquisition, but operating management who will conduct the day-to-day implementation frequently holds the knowledge about the associated costs. Open communication between those charged with planning and implementing the acquisition becomes critical Value can only be created when the acquisition benefits outweigh the implementation costs.
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