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Hitt Chapter 7 Acquisitions and Restructuring Strategies

Exam 3 MGT 3136 Sec 2

Mergers, Acquisitions, and Takeovers: What are the Differences?MergerA strategy through which two firms agree to integrate their operations on a relatively co-equal basisAcquisitionA strategy through which one firm buys a controlling, or 100% interest in another firm with the intent of making the acquired firm a subsidiary business within its portfolioTakeoverA special type of acquisition when the target firm did not solicit the acquiring firms bid for outright ownership2

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Acquisitions: Increased Market Power

Factors increasing market power

When there is the ability to sell goods or services above competitive levels

When costs of primary or support activities are below those of competitors

When a firms size, resources and capabilities gives it a superior ability to compete3

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Acquisitions: Increased Market Power (contd)Market power is increased by:Horizontal acquisitionsVertical acquisitionsRelated acquisitions4

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Market Power Acquisitions5Acquisition of a company in the same industry in which the acquiring firm competes increases a firms market power by exploiting:Cost-based synergies ( using existing resource, distribution network, elimination of redundant activities, economies of scale). Revenue-based synergies ( selling more products to existing customers). Acquisitions with similar characteristics result in higher performance than those with dissimilar characteristics

Horizontal Acquisitions

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Market Power Acquisitions (contd)6Acquisition of a supplier or distributor of one or more of the firms goods or servicesIncreases a firms market power by controlling additional parts of the value chain

Horizontal Acquisitions

Vertical Acquisitions

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Market Power Acquisitions (contd)7Acquisition of a company in a highly related industryBecause of the difficulty in implementing synergy, related acquisitions are often difficult to implementMicrosoft- Nokia

Synergy - Whole is greater than the sum of its parts

Horizontal Acquisitions

Vertical Acquisitions

Related Acquisitions

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Acquisitions: Overcoming Entry BarriersFactors associated with the market or with the firms currently operating in it that increase the expense and difficulty faced by new ventures trying to enter that marketEconomies of scale Differentiated productsCross-Border Acquisitions Purchase made by companies whos HQ is located in different countries- Tata- Jaguar, Landrover. 8

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Acquisitions: Cost of New-Product Development and Increased Speed to MarketInternal development of new products is often perceived as high-risk activityAcquisitions allow a firm to gain access to new and current products that are new to the firmGain access to Acquired firms products which were unfamiliar before. A university with no Law department can acquire another university which has a law department, and hence can continue with the law department service. With the help of the acquired firm, company can develop new products more efficiently. A Bakery shop can acquire another bakery shop and with the help of the acquired firms expertise in baking

Returns are more predictable because of the acquired firms experience with the products9

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Acquisitions: Lower Risk Compared to Developing New ProductsAn acquisitions outcomes can be estimated more easily and accurately than the outcomes of an internal product development process

Managers may view acquisitions as lowering risk10

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Acquisitions: Increased Diversification

Using acquisitions to diversify a firm is the quickest and easiest way to change its portfolio of businessesAcquiring new firm is easier than diversifying products which differ from regular product line. Both related diversification and unrelated diversification strategies can be implemented through acquisitionsThe more related the acquired firm is to the acquiring firm, the greater is the probability that the acquisition will be successful11

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Acquisitions: Reshaping the Firms Competitive ScopeAn acquisition can:Reduce the negative effect of an intense rivalry on a firms financial performanceIn highly competitive industry, firms who cant compete based on price face financial risks compared to the competitors. With the acquisition of new firms, a firm can reshape its business model and can come back harder on competitors. Reduce a firms dependence on one or more products or marketsA firm can attract new products, reshape existing products (Tata Jaguar), target acquired companys customersReducing a companys dependence on specific markets alters the firms competitive scopeScope increases with geographic expansion through cross border acquisition. 12

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Acquisitions: Learning and Developing New Capabilities

An acquiring firm can gain capabilities that the firm does not currently possess:Special technological capabilityBroaden a firms knowledge baseReduce inertiaFirms should acquire other firms with different but related and complementary capabilities in order to build their own knowledge base

A number of large pharmaceutical firms are acquiring the ability to create large molecule drugs, also known as biological drugs, by buying bio-technology firms. Thus, these firms are seeking access to both the pipeline of possible drugs and the capabilities that these firms have to produce them. Such capabilities are important for large pharmaceutical firms because these biological drugs are more difficult to duplicate by chemistry alone (the historical basis on which most pharmaceutical firms have expertise). 13

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Problems in Achieving Acquisition Success: Integration DifficultiesIntegration challenges include: ( see example of UPS in the book) , MCD and Burger King. Melding two disparate corporate culturesLinking different financial and control systemsBuilding effective working relationships (particularly when management styles differ)Resolving problems regarding the status of the newly acquired firms executivesLoss of key personnel weakens the acquired firms capabilities and reduces its value14

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Problems in Achieving Acquisition Success: Inadequate Evaluation of the Target

Due DiligenceThe process of evaluating a target firm for acquisitionIneffective due diligence may result in paying an excessive premium for the target company ( Investment banking corporates- Morgan Stanley, Goldman Sachs, Deutsche Bank)

Evaluation requires examining:Financing of the intended transactionDifferences in culture between the firmsTax consequences of the transactionActions necessary to meld the two workforces15

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Due Diligence

Firms may engage in bidding war even though realizing that their current bid exceeds the real parameter set by due diligence companies. In terms of high/increasing stock prices, due dilligence process is relaxed often resulting in overpayments, and may effect a firms long term performance.

Without due diligence, purchase price may be determined by other comparable acquisition prices according to industry standards rather than by a rigorous assessment of where, when and how management can drive real performance gains.

Problems in Achieving Acquisition Success: Large or Extraordinary DebtHigh debt can:Increase the likelihood of bankruptcyLead to a downgrade of the firms credit ratingPreclude/disqualify/discontinue investment in activities that contribute to the firms long-term success such as:Research and developmentHuman resource trainingMarketing17

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Problems in Achieving Acquisition Success: Too Much DiversificationOver diversification may result in decline in performance; each firm has different capabilities to manage diversification; because of over diversification, smaller numbers of business units are created and managing those large number of small units may become complicated.

Scope created by diversification may cause managers to rely too much on financial rather than strategic controls to evaluate business units performances ( when they dont have rich understanding of target firms business/objectives and values. Managers over dependence on financial control mechanism such as ROI may prioritize only those businesses which have short term returns and may discourage long term investments. Acquisitions may become substitutes for innovationCosts associated with acquisitions may result in fewer allocations to activities, such as R&D, that are linked to innovationWithout internal innovation skills, the only option available to a firm to gain access to innovation is to complete still more acquisitions.18

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Problems in Achieving Acquisition Success: Too LargeAdditional costs of controls may exceed the benefits of the economies of scale and additional market powerLarger size may lead to more bureaucratic controlsFormalized controls often lead to relatively rigid and standardized managerial behaviorFirm may produce less innovation because of diminished strategic flexibility. a strategy in which acquisitions are undertaken as a substitute for organic growth has a bad track record in terms of adding value

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Attributes of Successful Acquisitions20Table 7.1

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RestructuringA strategy through which a firm changes its set of businesses or financial structureFailure of an acquisition strategy often precedes a restructuring strategyRestructuring may occur because of changes in the external or internal environmentsLet people buy the items which are not right for you. Restructuring strategies:DownsizingDownscopingLeveraged buyouts21

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Types of Restructuring: DownsizingA reduction in the number of a firms employees and sometimes in the number of its operating unitsMay or may not change the composition of businesses in the companys portfolioTypical reasons for downsizing:Expectation of improved profitability from cost reductionsDesire or necessity for more efficient operationsDownsizing may be necessary because acquisitions often create a situation in which the newly formed firm has duplicate organizational functions such as sales, manufacturing, distribution, human resource management, and so forthProcedural justice and fairness option22

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Types of Restructuring: DownscopingA divestiture, spin-off or other means of eliminating businesses unrelated to a firms core businessesDown scoping has a more positive effect than downsizing. Over diversification-less diversification.A set of actions that causes a firm to strategically refocus on its core businessesMay be accompanied by downsizing, but not eliminating key employees from its primary businesses ( downsizing + down scoping but not eliminating key employees)23

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Restructuring: Leveraged BuyoutsA restructuring strategy whereby a party buys all of a firms assets in order to take the firm privateSignificant amounts of debt are usually incurred to finance the buyoutAcquiring firms own asset + target firms assets are used as a collateral. any interest that accrues during the buyout will be compensated by the future cash flow of the acquired company.Can correct for managerial mistakesManagers making decisions that serve their own interests rather than those of shareholdersCan facilitate entrepreneurial efforts and strategic growth24

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Restructuring and Outcomes26

Adapted from Figure 7.2

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