Reasons for Acquisitions
Mergers and acquisitions are similar strategic moves. In both cases, the result is a combination of two or more businesses that were separate entities into one hierarchical organization. A merger occurs when there is an integration of equals, that is, the participating firms have an equal say in the merged firm resulting from the action. These actions occur far less often than acquisitions, where one firm acquires control over the other. In the latter case, the target firm largely disappears and the acquiring firm’s management is in control of the resulting organization.
It is important to note that mergers and acquisitions are not the only ways to increase the scope of a firm. Firms can internally develop new business units, and many often do. However, there are certain advantages to mergers or acquisitions when compared to internal development.
One of the primary advantages of mergers and acquisitions is speed. A merger or an acquisition produces the desired diversified firm right away. If a firm is seeking to exploit economies of scope, for example, an acquisition could allow the resulting firm to take advantage of cost savings more quickly than it could by internally developing a new unit.
A second advantage from mergers and acquisitions is that they help to overcome entry barriers. For example, when Wal-Mart wanted to enter the United Kingdom, it did so by acquiring the ASDA chain of supermarkets. Wal-Mart could have tried to build a chain of stores in the UK, and it surely had the financial resources to do so. But by acquiring ASDA, Wal-Mart was able to avoid the competitive retaliation that would have tried to crush the new entry in its early stages. In fact, ASDA would have been one of those established firms that would have fought Wal-Mart aggressively from the start.
Acquisitions – Barriers to Success
One reality of acquisitions is that the majority of them fail the better-off test. There are many reasons for this. One problem is that managers of the acquiring company are simply interested in growing the company, that is, in increasing its size. In this situation, managers have put their interests ahead of those of the shareholders. This is called the agency problem, which we will discuss in greater detail in Week 5.
A more common reason is that well-intended acquisitions run into integration problems. Integration of two firms with separate systems and cultures can be extremely difficult. For example, one major problem today is that more and more firms have highly integrated enterprise software connecting all of their activities. This very expensive software is critical for many firms, but its value often comes from the way it is tailored to the specific firm’s needs. Trying to combine two firms’ customized systems can be an expensive and time-consuming process.
Other integration problems arise from the differences in company cultures. Culture is a powerful force in managing a firm. On the basis of the established culture, people have expectations about what will happen in certain situations. For example, a firm may have a strong bias to customer service, even if the service is not cost efficient in the short term.
Managers tend to internalize cultural values, and the values then guide even the smallest of decisions. For example, a culture with a strong bias to customer service would clash with one where cost-oriented decision making is the guideline for all situations. There is nothing necessarily better about either of these perspectives. As stand-alone businesses, two independent firms may earn healthy profits with these respective cultural orientations. However, trying to integrate the two cultures in one firm following an acquisition could destroy both businesses.
Restructuring
The same logic that drives a firm to acquire another firm also drives firms to divest business units. The better-off test comes into play here, too: Will shareholders be better off if the business unit is sold off or spun out from the firm? In the last quarter of the twentieth century, many firms in the United States discovered that a great way to increase investors’ returns is to focus on the areas where they have core competencies and not invest in businesses where they do not. Often, management in a firm can create more value from the same assets. This is not only good for shareholders, it is good for the economy as well.
It is important in any restructuring that the firm focuses on the long-term strategic outcomes it is seeking. Far too often, managers have looked at restructuring as a way to cut costs in the short term but have hurt the firm’s long-term competitiveness in the process. This often happens when jobs are eliminated to cut costs without regard to the competencies those workers provide to the key activities of the firm.
Further, when restructuring is undertaken without a clear understanding of the direction management is going and who will be retained, top employees leave the firm on their own to escape the ambiguity. This is a very undesirable side effect of sloppy restructuring. A firm’s best workers find it easiest to move to new jobs in other firms. Conversely, the worst employees, who don’t have the option to move, are the ones left in the downsized firm to run the businesses.
Not only do restructuring, mergers, and acquisitions require firms to formulate what it is they want to do to exploit their core competencies more effectively, they also require effective implementation.