CHAPTER 7

Acquisition and Mergers
STRATEGIC ACTIONS: STRATEGY FORMULATION

Strategic Management Management of Strategy
Competitiveness and Globalization: Concepts Seventh Concepts and Cases and Casesedition
Michael A. Hitt • R. Duane Ireland • Robert E. Hoskisson

PowerPoint Presentation by Charlie Cook The University of West Alabama © 2007 Thomson/South-Western. All rights reserved.

KNOWLEDGE OBJECTIVES Studying this chapter should provide you with the strategic management knowledge needed to:
1. Explain the popularity of acquisition strategies in firms competing in the global economy. 2. Discuss reasons why firms use an acquisition strategy to achieve strategic competitiveness. 3. Describe seven problems that work against developing a competitive advantage using an acquisition strategy. 4. Name and describe attributes of effective acquisitions. 5. Define the restructuring strategy and distinguish among its common forms. 6. Explain the short- and long-term outcomes of the different types of restructuring strategies.
© 2007 Thomson/South-Western. All rights reserved. 7–2

Mergers, Acquisitions, and Takeovers: What are the Differences?
• Merger
 Two firms agree to integrate their operations on a relatively co-equal basis.

• Acquisition
 One firm buys a controlling, or 100% interest in another firm with the intent of making the acquired firm a subsidiary business within its portfolio.

• Takeover
 A special type of acquisition when the target firm did not solicit the acquiring firm’s bid for outright ownership.
© 2007 Thomson/South-Western. All rights reserved. 7–3

7–4 .FIGURE 7.1 Reasons for Acquisitions and Problems in Achieving Success © 2007 Thomson/South-Western. All rights reserved.

Reasons for Acquisitions Increased market power Overcoming entry barriers Learning and developing new capabilities Reshaping firm’s competitive scope Making an Acquisition Cost of new product development Increased diversification Lower risk than developing new products Increase speed to market © 2007 Thomson/South-Western. All rights reserved. 7–5 .

• Acquisitions intended to increase market power are subject to:  Regulatory review  Analysis by financial markets © 2007 Thomson/South-Western. 7–6 .Acquisitions: Increased Market Power • Factors increasing market power when:  There is the ability to sell goods or services above competitive levels. resources and capabilities gives it a superior ability to compete. All rights reserved.  A firm’s size.  Costs of primary or support activities are below those of competitors.

7–7 .Acquisitions: Increased Market Power (cont’d) • Market power is increased by:  Horizontal acquisitions: other firms in the same industry  Vertical acquisitions: suppliers or distributors of the acquiring firm  Related acquisitions: firms in related industries © 2007 Thomson/South-Western. All rights reserved.

© 2007 Thomson/South-Western.Market Power Acquisitions Horizontal Acquisitions • Acquisition of a company in the same industry in which the acquiring firm competes increases a firm’s market power by exploiting:  Cost-based synergies  Revenue-based synergies • Acquisitions with similar characteristics result in higher performance than those with dissimilar characteristics. All rights reserved. 7–8 .

Market Power Acquisitions (cont’d) Horizontal Acquisitions Vertical Acquisitions • Acquisition of a supplier or distributor of one or more of the firm’s goods or services  Increases a firm’s market power by controlling additional parts of the value chain. All rights reserved. © 2007 Thomson/South-Western. 7–9 .

Market Power Acquisitions (cont’d) Horizontal Acquisitions Vertical Acquisitions • Acquisition of a company in a highly related industry Related Acquisitions  Because of the difficulty in implementing synergy. © 2007 Thomson/South-Western. All rights reserved. related acquisitions are often difficult to implement. 7–10 .

7–11 . • Can be difficult to negotiate and operate because of the differences in foreign cultures. © 2007 Thomson/South-Western. All rights reserved.Acquisitions: Overcoming Entry Barriers • Entry Barriers  Factors associated with the market or with the firms operating in it that increase the expense and difficulty faced by new ventures trying to enter that market • Economies of scale • Differentiated products • Cross-Border Acquisitions  Acquisitions made between companies with headquarters in different countries • Are often made to overcome entry barriers.

All rights reserved. 7–12 .Acquisitions: Cost of New-Product Development and Increased Speed to Market • Internal development of new products is often perceived as high-risk activity.  Acquisitions allow a firm to gain access to new and current products that are new to the firm.  Returns are more predictable because of the acquired firms’ experience with the products. © 2007 Thomson/South-Western.

 Managers may view acquisitions as lowering risk associated with internal ventures and R&D investments. © 2007 Thomson/South-Western. 7–13 . All rights reserved.Acquisitions: Lower Risk Compared to Developing New Products • An acquisition’s outcomes can be estimated more easily and accurately than the outcomes of an internal product development process.  Acquisitions may discourage or suppress innovation.

7–14 . the greater is the probability that the acquisition will be successful. © 2007 Thomson/South-Western. All rights reserved. • The more related the acquired firm is to the acquiring firm. • Both related diversification and unrelated diversification strategies can be implemented through acquisitions.Acquisitions: Increased Diversification • Using acquisitions to diversify a firm is the quickest and easiest way to change its portfolio of businesses.

© 2007 Thomson/South-Western.  Reduce a firm’s dependence on one or more products or markets.Acquisitions: Reshaping the Firm’s Competitive Scope • An acquisition can:  Reduce the negative effect of an intense rivalry on a firm’s financial performance. • Reducing a company’s dependence on specific markets alters the firm’s competitive scope. All rights reserved. 7–15 .

Acquisitions: Learning and Developing New Capabilities • An acquiring firm can gain capabilities that the firm does not currently possess:  Special technological capability  A broader knowledge base  Reduced inertia • Firms should acquire other firms with different but related and complementary capabilities in order to build their own knowledge base. All rights reserved. © 2007 Thomson/South-Western. 7–16 .

All rights reserved.Problems in Achieving Acquisition Success Integration difficulties Too large Inadequate target evaluation Managers overly focused on acquisitions Problems with Acquisitions Extraordinary debt Too much diversification Inability to achieve synergy © 2007 Thomson/South-Western. 7–17 .

7–18 .Problems in Achieving Acquisition Success: Integration Difficulties • Integration challenges include:  Melding two disparate corporate cultures  Linking different financial and control systems  Building effective working relationships (particularly when management styles differ)  Resolving problems regarding the status of the newly acquired firm’s executives  Loss of key personnel weakens the acquired firm’s capabilities and reduces its value © 2007 Thomson/South-Western. All rights reserved.

7–19 . All rights reserved.Problems in Achieving Acquisition Success: Inadequate Evaluation of the Target • Due Diligence  The process of evaluating a target firm for acquisition • Ineffective due diligence may result in paying an excessive premium for the target company. • Evaluation requires examining:  Financing of the intended transaction  Differences in culture between the firms  Tax consequences of the transaction  Actions necessary to meld the two workforces © 2007 Thomson/South-Western.

All rights reserved.Problems in Achieving Acquisition Success: Large or Extraordinary Debt • High debt (e.. junk bonds) can:  Increase the likelihood of bankruptcy  Lead to a downgrade of the firm’s credit rating  Preclude investment in activities that contribute to the firm’s long-term success such as: • Research and development • Human resource training • Marketing © 2007 Thomson/South-Western. 7–20 .g.

7–21 . • Firms experience transaction costs when they use acquisition strategies to create synergy. • Firms tend to underestimate indirect costs when evaluating a potential acquisition.Problems in Achieving Acquisition Success: Inability to Achieve Synergy • Synergy  When assets are worth more when used in conjunction with each other than when they are used separately. © 2007 Thomson/South-Western. All rights reserved.

© 2007 Thomson/South-Western. • Disadvantage: It is also difficult to create. All rights reserved. • Advantage: It is difficult for competitors to understand and imitate. 7–22 .Problems in Achieving Acquisition Success: Inability to Achieve Synergy (cont’d) • Private synergy  When the combination and integration of the acquiring and acquired firms’ assets yields capabilities and core competencies that could not be developed by combining and integrating either firm’s assets with another company.

Problems in Achieving Acquisition Success: Too Much Diversification • Diversified firms must process more information of greater diversity. © 2007 Thomson/South-Western.  Increased operational scope created by diversification may cause managers to rely too much on financial rather than strategic controls to evaluate business units’ performances.  Strategic focus shifts to short-term performance.  Acquisitions may become substitutes for innovation. All rights reserved. 7–23 .

 Completing effective due-diligence processes. © 2007 Thomson/South-Western.Problems in Achieving Acquisition Success: Managers Overly Focused on Acquisitions • Managers invest substantial time and energy in acquisition strategies in:  Searching for viable acquisition candidates. All rights reserved.  Managing the integration process after the acquisition is completed. 7–24 .  Preparing for negotiations.

Problems in Achieving Acquisition Success: Managers Overly Focused on Acquisitions • Managers in target firms operate in a state of virtual suspended animation during an acquisition. All rights reserved. © 2007 Thomson/South-Western. 7–25 .  The acquisition process can create a short-term perspective and a greater aversion to risk among executives in the target firm.  Executives may become hesitant to make decisions with long-term consequences until negotiations have been completed.

© 2007 Thomson/South-Western. • The firm may produce less innovation. All rights reserved. • Formalized controls often lead to relatively rigid and standardized managerial behavior.Problems in Achieving Acquisition Success: Too Large • Additional costs of controls may exceed the benefits of the economies of scale and additional market power. 7–26 . • Larger size may lead to more bureaucratic controls.

Firms with strongest complementarities are acquired and overpayment is avoided 4.TABLE 7. and human resources) 4. Acquiring firm conducts effective due diligence to select target firms and evaluate the target firm’s health (financial. Faster and more effective integration facilitates achievement of synergy © 2007 Thomson/South-Western. Acquiring firm has financial slack (cash or a favorable debt position) 5.. Acquiring firm manages change well and is flexible and adaptable Results 1. lower risk (e. All rights reserved. Lower financing cost.1 Attributes of Successful Acquisitions Attributes 1.g. and avoidance of trade-offs that are associated with high debt 6. Faster and more effective integration and possibly lower premiums 3. High probability of synergy and competitive advantage by maintaining strengths 2. of bankruptcy). Acquiring firm has sustained and consistent emphasis on R&D and innovation 7. Maintain long-term competitive advantage in markets 7. Acquired firm has assets or resources that are complementary to the acquiring firm’s core business 2. Merged firm maintains low to moderate debt position 6. Financing (debt or equity) is easier and less costly to obtain 5. 7–27 . cultural. Acquisition is friendly 3.

© 2007 Thomson/South-Western. Friendly deals make integration go more smoothly. 7–28 . All rights reserved. Provide enough additional financial resources so that profitable projects would not be foregone.Effective Acquisition Strategies Complementary Assets /Resources Friendly Acquisitions Careful Selection Process Maintain Financial Slack Buying firms with assets that meet current needs to build competitiveness. Deliberate evaluation and negotiations are more likely to lead to easy integration and building synergies.

Attributes of Effective Acquisitions Attributes Results Low-to-Moderate Merged firm maintains financial flexibility Debt Sustain Emphasis on Innovation Continue to invest in R&D as part of the firm’s overall strategy Flexibility Has experience at managing change and is flexible and adaptable © 2007 Thomson/South-Western. 7–29 . All rights reserved.

All rights reserved.  Restructuring may occur because of changes in the external or internal environments.  Failure of an acquisition strategy often precedes a restructuring strategy. 7–30 .Restructuring • A strategy through which a firm changes its set of businesses or financial structure. • Restructuring strategies:  Downsizing  Downscoping  Leveraged buyouts © 2007 Thomson/South-Western.

 May or may not change the composition of businesses in the company’s portfolio. 7–31 . All rights reserved. • Typical reasons for downsizing:  Expectation of improved profitability from cost reductions  Desire or necessity for more efficient operations © 2007 Thomson/South-Western.Types of Restructuring: Downsizing • A reduction in the number of a firm’s employees and sometimes in the number of its operating units.

spin-off or other means of eliminating businesses unrelated to a firm’s core businesses. All rights reserved. 7–32 . but not eliminating key employees from its primary businesses.  May be accompanied by downsizing. © 2007 Thomson/South-Western.Types of Restructuring: Downscoping • A divestiture. • A set of actions that causes a firm to strategically refocus on its core businesses.  Smaller firm can be more effectively managed by the top management team.

• Can correct for managerial mistakes  Managers making decisions that serve their own interests rather than those of shareholders.Restructuring: Leveraged Buyouts (LBO) • A restructuring strategy whereby a party buys all of a firm’s assets in order to take the firm private. 7–33 . All rights reserved.  Significant amounts of debt may be incurred to finance the buyout. © 2007 Thomson/South-Western. • Can facilitate entrepreneurial efforts and strategic growth.  Immediate sale of non-core assets to pare down debt.

7–34 . All rights reserved.2 Restructuring and Outcomes © 2007 Thomson/South-Western.FIGURE 7.

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