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Mergers and Acquisitions

Mergers, acquisitions and alliances are all common methods for achieving growth strategies.
Strategy Methods:

Organic Development: (eg: Amazons Kindle)


- Default method = do it yourself.
- Relying on internal capabilities.
- A strategy is pursued by building on and developing an organizations own capabilities.
- 5 principal advantages to relying on organic development:
1. Knowledge and learning: acquisition and internalization of deeper knowledge than a
hands-off strategic alliance.
2. Spreading investment over time: reduction of upfront commitment may make it easier
to reverse or adjust a strategy if conditions change.
3. No availability constraints: do not have to depend on availability of suitable
acquisition targets or potential alliance partners.
4. Strategic Independence
5. Culture Management: organic development allows new activities to be created in the
existing cultural environment, which reduces the risk of culture clash.
- Reliance of organic development on internal capabilities can be slow, expensive and risky.
- It is not easy to use existing capabilities as the platform for major leaps in terms of innovation,
diversification or internationalization.
- However, organic development can be very successful and, as in the example of Amazons
Kindle, be sufficiently radical to merit the term corporate entrepreneurship.
- Corporate Entrepreneurship: radical change in the organizations business, driven principally by
the organizations own capabilities.
- The concept of corporate entrepreneurship is valuable because it encourages an entrepreneurial
attitude inside the firm. Example: low-cost airline Ryanair.

Mergers and Acquisitions:


- Involves large sums of money and public competitions for shareholder support.
- Can also provide a speedy means of achieving major strategic objectives.
- Sometimes, they lead to spectacular failures. Example: Royal Bank of Scotlands takeover of
Dutch ABN AMRO ended in a commercial disaster which led to the Banks nationalization by
the British Government.
Types of Mergers and Acquisitions:
- Typically about combination of two or more organizations.
- Acquisition is achieved by purchasing a majority of shares in a target company.
- Most acquisitions are friendly and sometimes they are hostile where target management refuse
the acquirers offer.
- Acquirers are generally larger than target companies although occasionally there may be
reverse takeovers, where acquirers are smaller than targets.
- Merger: combination of two previously separate organizations in order to form a new company.
- Merger partners are often of similar size, with expectations of broadly equal status, unlike an
acquisition where the acquirer generally dominates.
- In practice, the terms merger and acquisition are often used interchangeably, hence the
common shorthand M&A.
Timing of Mergers and Acquisitions:
- Since records began in the late nineteenth century, mergers and acquisitions have shown a
cyclical quality, involving high peaks and deep troughs.
- 2007 was a record year for global mergers and acquisitions.
- Mergers and acquisition cycles are broadly linked to changes in the global economy but are also
influenced by new regulations, the availability of finance, stock market performance,
technological disturbances and the supply of available target firms.
- They may also be driven by over-optimism on the part of managers, shareholders and bankers
during upturns, and by exaggerated loss of confidence during downturns.
- This cyclical pattern suggests that there are better times than others for making an acquisition.
- At the top of a cycle, target companies are likely to be very highly priced, which may reduce the
chances of success for an acquirer.
- These cycles should warn managers that M&A may have a strong fashion or bandwagon
element. Especially in an upturn, managers should ask very carefully whether acquisitions are
really justified as prices may be high.
- Many national governance systems put barriers in the way of acquisitions, especially hostile
acquisitions.
- However, companies from fast-developing economies such as China and India have become very
active in large-scale acquisitions in order to access Western markets or technology, or to secure
material resources needed for growth.

Motives for Mergers and Acquisitions:


- Strategic motives for M&A: Involves improving the competitive advantage of the organization.
These motives are often related to the reasons for diversification in general.
1) Extension: M&A can be used to extend the reach of a firm in terms of geography,
products or markets, speedy way of extending international reach, an effective way of
extending into new markets (diversification).
2) Consolidation: increases market power by reducing competition, combination of two
competitors can increase efficiency through reducing surplus capacity or sharing
resources, greater scale of the combined operations may increase production efficiency
or increase bargaining power with suppliers, forcing them to reduce their prices.
3) Capabilities: High-tech companies such as Cisco and Microsoft regard acquisitions of
entrepreneurial technology companies as a part of their R&D effort. they allow
entrepreneurial start-ups to prove the idea, and then take over these companies in order
to incorporate the technological capability within their own portfolio. For example,
Google and Apple have made substantial acquisitions in order to gain a foothold in the
new high-growth mobile advertising market.
- Financial motives for M&A: concern the optimal use of financial resources, rather than directly
improving the actual business.
1) Financial Efficiency: It may be efficient to bring together a company with a strong
balance sheet with another company that has a weak balance sheet. The company with a
weak balance sheet can save on interest payments by using the stronger companys
assets to pay off its debt, and it can also get investment funds from the stronger
company that it could not have accessed otherwise. The company with the strong
balance sheet may be able to drive a good bargain in acquiring the weaker company.
Also, a company with a booming share price can purchase other companies very
efficiently by offering to pay the target companys shareholders with its own shares
(equity), rather than paying with cash upfront.
2) Tax Efficiency: Sometimes there may be tax advantages from bringing together
different companies. For example, profits or tax losses may be transferrable within the
organization in order to benefit from different tax regimes between industries or
countries. Naturally, there are legal restrictions on this strategy.
3) Asset Stripping or Unbundling: Some companies are effective at spotting other
companies whose underlying assets are worth more than the price of the company as a
whole. This makes it possible to buy such companies and then rapidly sell off
(unbundle) different business units to various buyers for a total price substantially in
excess of what was originally paid for the whole.
- Managerial motives for M&A: Managerial motives are so called, therefore, because they are
self-serving rather than efficiency-driven.
1) Personal Ambition: Senior managers personal financial incentives may be tied to
short-term growth targets or share price targets that are more easily achieved by large
and spectacular acquisitions than the more gradualist and lower-profile alternative of
organic growth, large acquisitions attract media attention, with opportunities to boost
personal reputations through flattering media interviews and appearances (managerial
hubris issue as well), acquisitions provide opportunities to give friends and colleagues
greater responsibility, helping to cement personal loyalty by developing individuals
careers.
2) Bandwagon Effects: In an upswing, there are three kinds of pressure on senior
managers to join the acquisition bandwagon. First, when many other firms are making
acquisitions, fi nancial analysts and the business media may criticize more cautious
managers for undue conservatism. Second, shareholders will fear that their company is
being left behind, as they see opportunities for their business being snatched by rivals.
Lastly, managers will worry that if their company is not acquiring, it will become the
target of a hostile bid itself.
- There are bad reasons as well as good reasons for acquisitions and mergers.
- The average performance of acquisitions is unimpressive, with evidence suggesting that half of
acquisitions fail.
- Nevertheless it is worth asking skeptical questions of any M&A strategy. The converse can be
true of course: there can be bad reasons for resisting a hostile takeover.

M&A Processes:
1. The search to identify an acquisition target with the best possible fi t. This process may take
years but under some circumstances can be completed very rapidly.
2. Process of negotiating the deal: to agree on terms and conditions and the right price.
3. Decide on the extent to which the new and old businesses will need to be integrated and
this will have significant implications for the amount of time required to create value.
- Three key steps: target choice, negotiation and integration.

- Target Choice:
1. Strategic Fit
The extent to which the target firm strengthens or complements the acquiring fi rms
strategy.
Relates to the original strategic motives for the acquisition: extension, consolidation
and capabilities.
Danger is that potential synergies are often exaggerated to justify high acquisition
prices.
Negative synergies (contagion) involved are easily neglected.
2. Organizational Fit
Refers to the match between the management practices, cultural practices and staff
characteristics between the target and the acquiring firms.
Large mismatches are likely to cause significant integration problems.
International acquisitions can be particularly liable to organizational misfits, because
of cultural and language differences between countries, although the extent to which
there is actual cultural clash will be determined by the extent of integration intended.
A comparison of the two companies cultural web might be helpful to highlight
potential misfit.
The two criteria of strategic and organizational fit are important components of due
diligence a structured investigation of target companies that generally takes place before a
deal is closed.
- Negotiation in M&A:
Negotiation process in M&A is critical to the outcome of friendly deals.
Ways in which the price is established by the acquirer are through the use of various valuation
methods, including financial analysis techniques such as payback period, discounted cash
flow, asset valuation and shareholder value analysis.
Acquirers typically do not simply pay the current market value of the target, but have to pay a
so-called premium for control. This premium is the additional amount that the acquirer has to
pay to win control compared to the ordinary valuation of the targets shares as an independent
company.
It is therefore very important for the acquirer to be disciplined regarding the price that it will
pay. Acquisitions are liable to the winners curse in order to win acceptance of the bid, the
acquirer may pay so much that the original cost can never be earned back.

- Integration in M&A:
The ability to extract value from an acquisition will depend critically on the approach to
integrating the new business with the old.
Integration is frequently challenging because of problems of organisational fit.
Poor integration can cause acquisitions to fail.
The most suitable approach to integration depends on two key criteria:
1) The extent of strategic interdependence: the need for the transfer or sharing of
capabilities or resources
2) The need for organizational autonomy: In some circumstances it is the distinctiveness
of the acquired organization that is valuable to the acquirer. In this case it is best to
learn gradually from the distinct culture, rather than risk spoiling it by hurried or
overly tight integration.
Four integration approaches:

1) Absorption: Absorption requires rapid adjustment of the acquired companys old


strategies and structures to the needs of the new owner, and corresponding changes to
the acquired companys culture and systems.
2) Preservation: Appropriate where the acquired company is well run but not very
compatible with the acquirer.
3) Symbiosis: implies that both acquired firm and acquiring firm learn the best qualities
from the other. The most complex of the integration approaches.
4) Holding: where there is little to be gained by integration, acquirer will not integrate the
company into its own business to avoid contamination but will impose stringent short-
term targets and strategies in order to solve its problems.
It is argued that organizational justice is particularly important for successful integration.
Organizational justice refers to the perceived fairness of managerial actions, in terms
of distribution, procedure and information.
Distributive justice: the distribution of rewards and posts.
Procedural Justice: procedures by which decisions are made: for example, if
integration decisions are made through appropriate committees or task forces with
representation from both sides.
Informational Justice: how information is used and communicated in the integration.

M&A Strategy Over Time:


- Serial acquirers are companies that make multiple acquisitions, often in parallel. Working on
simultaneous acquisitions is very demanding of managerial time and skills.
- Cisco Systems is well known as a successful serial acquirer.
- Divesture (or divestment) is the process of selling a business that no longer fits the corporate
strategy. This is a central part of asset-stripping strategy.
- Funds raised by the sale of an ill-fitting business can be used either to invest in retained
businesses or to buy other businesses that fi t the corporate strategy better.

Strategies Alliances:
- Companies also often work together in strategic alliances that involve collaboration with only
partial changes in ownership, or no ownership changes at all as the parent companies remain
distinct.
- A strategic alliance is where two or more organisations share resources and activities to pursue a
common strategy.
- Collective strategy is about how the whole network of alliances, of which an organisation is a
member, competes against rival networks of alliances.
- Collaborative advantage is about managing alliances better than competitors.
- Types of Strategic Alliance:
1. Equity Alliances: the creation of a new entity that is owned separately by the partners
involved. Eg: joint venture (two organizations), consortium alliance (several partners).
2. Non-equity Alliances: typically looser, without the commitment implied by ownership,
often based on contracts (one common form = franchising), Licensing is a similar kind of
contractual alliance, allowing partners to use intellectual property such as patents or
brands in return for a fee, Long-term subcontracting agreements are another form of loose
non-equity alliance.
- Motives for Alliances:

1. Scale Alliances: Combine to achieve necessary scale, together they can achieve advantages
that they could not easily manage on their own, economies of scale, sharing risk.
2. Access Alliances: access the capabilities of another organization that are required in order to
produce or sell its products and services, can be about tangible resources.
3. Complementary Alliances: can be seen as a form of access alliance, but involve organizations
at similar points in the value network combining their distinctive resources so that they
bolster each partners particular gaps or weaknesses.
4. Collusive Alliances: secretly collude together in order to increase their market power. By
combining together into cartels, they reduce competition in the marketplace, enabling them to
extract higher prices from their customers or lower prices from suppliers.
- Strategic Alliance Processes:
Co-evolution: The concept of co-evolution underlines the way in which partners, strategies,
capabilities and environments are constantly changing. As they change, they need
realignment so that they can evolve in harmony. A co-evolutionary perspective on alliances
therefore places the emphasis on flexibility and change.
Trust: Trust in a relationship is something that has to be continuously earned. Trust is often
particularly fragile in alliances between the public and private sectors, where the profit
motive is suspect on one side, and sudden shifts in political agendas are feared on the other.
- Different Stages In The Life Span of a Strategic Alliance:
1. Courtship: initial process of courting potential partners, where the main resource
commitment is managerial time, courtship process should not be rushed, as the
willingness of both partners is required, each partner has to see a strategic fit and
organizational fit.
2. Negotiation: negotiate mutual roles at the outset, it is important to get initial contracts
clear and correct and it is worth spending time working out how disputes during the life
of the alliance will be resolved.
3. Start-Up: involves considerable investment of material and human resources and trust is
very important.
4. Maintenance: refers to the ongoing operation of the strategic alliance, with increasing
resources likely to be committed.
5. Termination: Often an alliance will have had an agreed time span or purpose right from
the start, so termination is a matter of completion rather than failure, Sometimes the
alliance has been so successful that the partners will wish to extend the alliance by
agreeing a new alliance between themselves, committing still more resources.
Comparing Acquisitions, Alliances and Organic Development
- Buy, ally or DIY?
Acquisitions and strategic alliances have high failure rates.
Acquisitions can go wrong because of excessive initial valuations, exaggerated
expectations of strategic fi t, underestimated problems of organisational fit etc.
Alliances also suffer from miscalculations in terms of strategic and organisational fi t,
but, given the lack of control on either side, have their own particular issues of trust and
co-evolution as well.
With these high failure rates, acquisitions and alliances need to be considered cautiously
alongside the default option of organic development (Do-It-Yourself).
The best approach will differ according to circumstances.
Four key factors that can help in choosing between acquisitions, alliances and organic
development:
1. Urgency: acquisitions = rapid method in pursuing strategy, alliances too may
accelerate strategy, DIY = slowest.
2. Uncertainty: often better to choose the alliance route where there is high
uncertainty in terms of the markets or technologies involved.
3. Type of capabilities: Acquisitions work best when the desired capabilities
(resources or competences) are hard, for example physical investments in
manufacturing facilities. Hard resources such as factories are easier to put a value
on in the bidding process than soft resources such as people or brands. Hard
resources are also typically easier to control post-acquisition than people and
skills.
4. Modularity of Capabilities: If the sought-after capabilities are highly modular, in
other words they are distributed in clearly distinct sections or divisions of the
proposed partners, then an alliance tends to make sense. A joint venture linking
just the relevant sections of each partner can be formed, leaving each to run the rest
of its businesses independently.
It is important to weigh up the available options systematic ally and to avoid favoring one
or the other without careful analysis.

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