Traditionally, companies were attracted to mergers and acquisitions because of the financial advantages or product extensions and synergy. However, in the last few years, organizations favour acquisitions to either merge ideologies or kill the competition and unite to take on bigger players. The $19 billion Whatsapp acquisition by social media giant, Facebook set the industry buzzing as to why Mark Zuckerberg paid such an unbelievable amount. Was it the growing popularity around the world with millions of users preferring it for quick, internet-based personal communications or the fact that Whatsapp’s services fit into Facebook’s business model like hand in glove?
Whatever the reasons, the acquisition is surely working for this confluence as the number of Whatsapp users has jumped from 450 million at the time of the acquisition two months back to crossing the half a billion mark this past week! The number of users is growing at a mind-boggling rate and Facebook is sure to reap the benefits, not only financially but also in terms of greater reach to the masses in lightning speed. It’s a classic example of selling by Value, not on price (this course can show you how to master value centric selling).
So, what makes an acquisition click? How do businesses make decisions on a beneficial acquisition? The approach to making such decisions based on the type of acquisition, financial health of the company and other factors is called Acquisition Strategy. As a business owner, you must have in place a process of finding logic in a probable acquisition and the various issues that your business needs to factor in before going ahead with the plans.
What is Acquisition Strategy?
A company’s approach to acquiring new businesses, products and services after considering all factors like financial impact, brand image, cultural compatibility, product synergy and other business requirements is called Acquisition Strategy. It is a part of a company’s growth strategy and plays a significant role in the inorganic expansion of the business. Successful acquisitions are based on well-defined goals and strategic value creation logic. Learn more about the financial considerations of acquisitions in our introductory course to Mergers and Acquisitions.We will explore the various aspects of Acquisition Strategy that will help you as a business owner or entrepreneur in making strategic decisions.
Types of Acquisitions
- Stock Purchase
The acquirer buys the seller’s stocks from shareholders, all assets and liabilities and off-balance sheet items as well. Book values are used for valuation of assets and liabilities, which can be modified as well for any step-ups or step-downs. This type of acquisition is inexpensive and quick to execute; it is mostly preferred by the seller and is popularly used for acquiring public or large companies. You can learn more about stocks and stock valuation in this course.
- Asset Purchase
Here, the buyer gets to choose the assets he wants to acquire and liabilities that he wants to assume; these have to be clearly defined in the purchase agreement. In asset purchase, every single asset / liability must be valued separately before the transfer takes place; this makes the process complex as well as time-consuming. Asset purchase gives the buyer greater flexibility to choose, therefore it’s preferred by the acquirer. Private companies commonly use this kind of acquisition and it’s also used for divestitures and distressed sales.
Mergers and Acquisitions need a lot of strategic logic and must be driven by value creation and certain rationale. What are the motives for acquisitions and what opportunities do they present for value creation? Let’s look at some of the common acquisition strategies that businesses use to achieve their organizational goals, whether it’s targeted towards growth or strategic positioning.
- Achieving Economies of Scale
When your line of business is same as that of the target company, then you can combine the resources of the two companies to achieve economies of scale. By cutting down on redundant costs and consolidating the operations, you can drastically increase savings thereby making the business more profitable. Sharing of services like office administration, financial accounting and control, top-level management etc. and merging the production facilities, marketing and R&D efforts, you can achieve economies of scale. For example, the acquisition of Compaq Computer Corp. by Hewlett Packard raised an annual savings of roughly $3 billion, just nine months after the purchase.
While achieving economies of scale seems like a walk in the park, remember that the success of such an acquisition strategy is based on the cultural compatibility of the two companies and the management effectiveness in bringing the resources together. A classic example of an acquisition failure is the case of the merger between AOL and Time Warner, one of the largest in corporate history. Aimed at synergizing their operations for complete market control, the acquisition proved to be a disaster due to conflicting organizational cultures and the economic slowdown in the early 2000s. With stock prices plummeting down to almost 90% in just 2 years, this merger was the biggest loss for Time Warner and subsequently AOL was spun-off as an independent company.
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- Acquire Complementary Resources
Businesses with a single product line may look at expanding their markets by acquiring new products from a smaller company or get the technological resources to enhance their product line. Key ingredients like engineering, product development capabilities and other skills can be easily added to overcome the shortcomings in your organization by taking over another company. Most companies find it easier to do rather than investing time and money to develop technologies and skills internally. Look at the growth pattern of Cisco Systems that acquired 71 companies in a span of 8 years during the 90’s, to grow from a single-product company to becoming the largest player in internet equipment. Their acquisition strategy was purely based on acquiring technologies and skills and their sales grew from $650 million to $22 billion with almost 40% revenue coming in from these acquisitions.
- Increasing Efficiency
Due to poor management, firms often become inefficient and start to lose the race against the competition. Businesses often see poor-performers as good candidates for acquisitions with a belief that their management expertise can turn around the profitability of the target company. By way of cost cutting and increased sales efforts, the buyer can align the operations of the target company to achieve its business goals. This type of acquisition is the most commonly used value-creation strategy that helps improve profit margins and cash flows by increasing the efficiency of the acquired company.
This strategy not only increases the business growth of the acquirer but also increases the operating-profit margins of the target company. Sometimes private companies acquire poorly performing businesses to make them profitable and subsequently sell them for higher returns. For greater insights into creating a differentiated, winning business strategies, take this course.
- Industry Consolidation
If the industry that you operate in has too many competitors vying for market share and excessive capacity, then it makes sense to go for a consolidated takeover that improves efficiency and eliminates excesses, whether it is in the sales, research and development or production capacity etc. The pharmaceutical and banking industry are fine examples of industries that often consolidate the industry by way of mergers and acquisitions. For example, Bank of America’s acquisition of FleetBoston Financial as part of a cost-reduction strategy was preceded by dozens of acquisitions of smaller banks by the two firms that led to a consolidation of the banking industry.
- Roll-up Strategy
If you are an entrepreneur or a small business owner, operating in a highly fragmented industry, then the traditional approach of a roll-up acquisition strategy can rapidly increase your business growth. This strategy basically involves the consolidation of smaller business units operating in a specific industry vertical to align their products and services. Such a strategy builds a larger value proposition for the customers in that vertical and helps the aligned companies to access greater market share. The combined asset valuation is higher than the individual ones and this can be utilized to access credit and growth capital easily for increased development.
In a roll-up strategy, entrepreneurs must focus more on conflict management, sharing of responsibilities and development of the team as a single unit. If businesses can manage their teams efficiently, this kind of acquisition strategy reaps many benefits for all the entities involved and helps start-ups in transforming quickly to a growth stage company. If you are a small business owner or a start-up company, you’ll find this course on how to win in an unpredictable world, very insightful.
Factors to Consider for a Successful Acquisition Strategy
As we discussed earlier, not all acquisitions result in success. As a business owner, you must introspect as to why you want to acquire and how the deal will add value to your business. Here are some of the basic questions one must ask while formulating an acquisition strategy:
1. What is the value created from the acquisition?
Most often, companies end up paying too much for an acquisition at a premium price. Added to this, you need to factor in other expenses in terms of money and time. Businesses must evaluate if the value created by the acquisition is equal to the incremental benefits of the deal without paying a premium. The value creation from the target company must be large to justify the premium paid in the long run. Also, the value must be greater than the value you can create from other investments or business activities. Take this course to learn more about corporate valuation and how to value companies prior to merger.
2. What are the learning costs involved?
If you are entering a new domain, be aware of the learning costs that are involved in understanding the new business area and be cautious not to apply conventional rules that worked in the other domain. Businesses normally burn their fingers by overlooking the learning costs while they go forward with an acquisition. For example, British American Tobacco applied tobacco marketing techniques to boost the performance of Eagle Star, the insurance company that they acquired.
While there are several economic benefits to mergers and acquisitions, sometimes a lack of judgement and good financial assessment leads to disasters. Though there is no assured success formula to building an acquisition strategy, you must consider all factors related to your business objectives, marketing goals and organizational growth while formulating one.