Mergers and Acquisitions: In whose interest?

There seems to be rarely a day that goes by in the business world without some announcement or rumour of a prospective merger or acquisition. In the week in which this article was written, Swedish truck maker Scania had been busy fighting off a takeover approach from MAN; Macquarie Bank and Texas Pacific had been looking at making a bid for the airline Qantas; an Icelandic business consortium has bought soccer club West Ham United; Bank America had bought US Trust, and a Jersey-based firm were in talks with another soccer club, Newcastle United.

Mergers and acquisitions have been running at record levels in the past year, with deals to the value of £1.77 trillion (a trillion is a 1 with 12 zero's or 1,000,000,000,000 or a million million). Given the apparent popularity of these deals, many of which are between businesses we are unlikely to have ever heard of, we might ask what the reasons for mergers and acquisitions are and what the effects of such activity might be.

One rather smaller-scale case study might help to illustrate some of the issues surrounding mergers and acquisitions. In November 2005, the London-based brewer Fuller, Smith and Turner bought Gales Brewery, a formerly family-run brewers based in Hampshire, in the south of England. A pressure group acting for lovers of so-called 'real ale' voiced its concern after seeing yet another small local brewer swallowed up. The number of local brewers has fallen dramatically in the last 30 years, with many being bought up by large brewing concerns. Often, the local brew has disappeared and the local brewery closed down.

Beers differ depending on the region in which they are brewed. Many drinkers value the traditional local beer but are small brewers being swallowed up by large firms, with beers losing their character as a result? Copyright: Marcin Krawczyk, from stock.xhcng.

Invariably, the management of the firm doing the acquisition claims that the impact on the various stakeholders will be minimal. The acquisition of Gales by Fuller sparked concerns that the Gales brewery in Hampshire would close down. Fuller's stated that they intended to continue brewing Gales beers and that the range of beers Gales owned complemented Fullers' product portfolio.

Pressure groups like the Campaign for Real Ale (CAMRA) were not convinced. Other cases where breweries had been acquired by larger brewers had not only seen the traditional breweries closed down but also the beers they produced discontinued. For example, in 1978, one of the local Nottingham breweries, Shipstones, was acquired by Greenalls, a company based in north-west England. A campaign to 'Save Our Shippo's' was launched but to no avail. Greenalls continued brewing Shipstones beers but moved production of some of the range to its plant in Warrington. Locals felt the taste was not the same. Greenalls eventually decided to give up its brewing arm in favour of retailing, and Shipstones disappeared.

Brewing - often a long tradition in many localities in the UK but a tradition that is fast disappearing. Are such changes in the public interest? Copyright: JP de Swart, from stock.xhcng.

Such a story is typical of the fate of local breweries in the UK. The trend to consolidation of the industry is still growing. Small breweries are finding it increasingly difficult to survive. Does the trend to acquisition in this industry mean we are getting less choice and worse value for money? Some think so. For the business doing the acquisition, the benefits may not always be what were expected.

For Fuller's, however, the acquisition of Gales seems to have been a good thing. Fuller's recently announced its profit figures for the half year to September 2006: its profit was up by nearly a third to £10.9 million. A spokesperson at Fullers put the performance down to the fact that Gales' range of beers complemented those of Fuller's. The latter tends to be focused on winter sales whereas Gales' range is more appropriate for the summer.

That might be excellent news for stakeholders of Fuller's but the Gales brewery in Horndean, Hampshire, was closed down in March 2006 and production transferred to Fuller's brewery in Chiswick in West London. 21 people lost their jobs and 150 years of brewing tradition in the town disappeared.

Theory

The main issues that relate to this story involve consolidation of markets, reasons for mergers and acquisitions and the stakeholder model..

Consolidation of markets

Markets consist of a number of firms selling similar products. They are, of course, differentiated in many respects but essentially the same. The market for beer is divided into lager beers, bitter beers, mild beers and so on; it is, however, commonly described as the 'beer market'.

There are many different types of brand of beer but how many companies are part of the market? Copyright: Anthony Sharpix, from stock.xhcng.

The beer market was made up of hundreds of small independent brewers each producing a distinct range of beers. There are still many of these small brewers that exist - see the Great British Beer Web site for a list. However, over the years, many other small brewers have been taken over or have merged with larger brewing companies. The big brewers are companies such

as Interbrew, Scottish and Newcastle, Carlsberg and Heineken. Each of these companies owns many brands, some of which were originally beers brewed by small brewers.

As the number of takeovers increases, the number of firms in the market gets smaller. Many of the brands might still survive but they are mostly owned by very large firms who are likely to have international interests. As the number of firms gets smaller in number, the market is said to become more consolidated. This has implications for the degree of competition in the market and the effect on consumers.

The reasons for mergers and acquisitions

There are a number of standard reasons given for acquisitions to take place. There are subtle differences in the reasons dependent on whether the acquisition is a merger or takeover but the main categories of reasons are the same. In exam or test questions, you have to strip out the relevant reasons from the ones that are not relevant in relation to the particular case study you are looking at.

In addition, you might be expected to make some evaluative comment about the different reasons - some are likely to be more important or more significant than others. The success of an acquisition in meeting these objectives might also be something that you will have to comment on. It is worth bearing these things in mind as you read through the reasons that follow.

Capacity

Capacity refers to the amount of output that a firm is capable of producing given its existing assets. In theory, firms will have a maximum capacity that they can produce given their capital assets. Acquiring another business might enable it to be able to increase its capacity relatively quickly.

Economies of Scale

Economies of scale are the advantages of large scale production that result in lower cost per unit produced. Economies of scale do not refer to expanding output with existing resources; it is about changing the scale of production. A firm acquiring another increases its scale of operations; it has more labour, more plant and equipment - more of everything!

Economies of scale is not just about the firm expanding its existing capacity but about

changing the whole scale of its operations - increasing all factors of production. Copyright: Griszka Niewiadomski, from stock.xhcng.

Acquisitions cost money - in some cases, millions of pounds, if not billions. It should be clear from this that an acquisition is not going to 'reduce costs' as is often stated by students. What it will hope is that the increase in output that results from the acquisition will be greater than the increase in costs as a result of it. If a firm doubles its costs as a result of financing an acquisition but output rises by 120%, then its average costs - the costs per unit - will fall.

This is what economies of scale is about. Firms gaining economies of scale from an acquisition will hope to use the benefits it gains from lower unit costs to either boost its profit margins or enable it to be able to compete with its rivals more effectively.

Plugging a gap in the market

A business may feel that its product portfolio is not sufficient to cater for different customer needs in its market. Acquiring another firm that is already in that market enables it to plug that gap. It may be the case that a firm has a seasonal sales trend. Buying a business that has its predominant sales in a different season of the year will also be an example of how the firm's product portfolio might be enhanced through a merger and acquisition. The example of Fuller's and Gales is an excellent example of this.

Some products might be associated with particular times of the year - a cold beer is often appreciated in the summer. Acquiring a business which contributes to the product portfolio might be a reason for an acquisition. Copyright: Luc Sesselle, from stock.xhcng.

Accessing supplies or distribution networks

Some firms develop their business in a particular sector of the production process - primary, secondary or tertiary. An acquisition in a different sector may reduce its reliance on suppliers or give it access to new markets. This can lead to a strengthening of the businesses position and give it a significant competitive advantage over its rivals. It can also mean that it is moving into an area of business in which it does not have expertise so care has to be taken to research the proposed acquisition target carefully.

A brewer acquiring a pub in which to sell its beers gives the brewer a mini-monopoly in that pub. This would be an example of vertical integration forwards. Such pubs are called 'tied houses' - they are tied to the brewer and must sell its beers. Copyright: Bill Graham, from stock.xhcng.

Accessing technology or skills

A firm may be targeted for acquisition because it has specific skills within its staff or has a particular technology that would be useful to another business. Businesses that are relatively new and might have hit upon a new idea or who have developed specific skills in a certain area might be ripe targets for acquisition.

Tax reasons

Businesses are always looking for ways to reduce their tax exposure. The tax laws in most countries are complex but essentially, there may be less tax to pay if a firm uses cash to acquire assets than if it has cash in hand. If, and this is often the case, a firm has large sums of money lying idle, using these sums to acquire another business that would not only enhance its operations but would also reduce its tax liability may be very tempting for the firm to look for a suitable target for acquisition.

The Stakeholder Model

A stakeholder is someone or some organisation/institution that has an interest in the success of a business. Notice the emphasis in this definition on the word 'success'. Some stakeholder models include competitors as a stakeholder. This definition would exclude competitors because they cannot be said to have an interest in the success of a business. That is not to suggest that other stakeholder models are incorrect - they are merely different to the one used in this article.

The key stakeholders in an acquisition are going to be:

Shareholders

Management Customers Suppliers Employees The local community The government/regulatory agencies

When an acquisition is announced, there is likely to be conflicts of interest between these different stakeholder groups. The interests of shareholders are likely to be very different to the interests of the firm's employees. One of the issues that a firm considering an acquisition has to ask itself is whether it can make the acquisition work with its existing business. Different cultures and working practices can cause a number of problems, which might stop the merger from delivering the benefits the firm might hope for. Finding ways of satisfying these competing stakeholder interests, therefore, might be crucial to the success of the merger.

Questions

Choose one example of a recent acquisition that has taken place or which is planned. (You can use the Fuller and Gales case study, for example).

Try to identify which of the reasons given above is relevant to the case that you are looking at. What evidence is there to support your choice?

Of the reasons that you have identified, which do you think is the most significant reason for the acquisition and why?

Discuss the extent of the impact on the different stakeholders of the business that you have selected.

Mark Scheme

Try to identify which of the reasons given above is relevant to the case that you are looking at. What evidence is there to support your choice?

o The answers to this question will, of course, depend on the case study that you have chosen. The intention of the question is to encourage you to look at the reasons for acquisitions given in the theory section and apply them to a particular case. Not all of the reasons given above will be applicable and there might be other more specific reasons that you identify - the list we have given is not exhaustive. The important part of the answer will be the support that you give to the choice of reasons you select. This implies that you will have had to do some research on the acquisition. Don't expect to find a nice convenient list of reasons given to you - you will have to extract and make judgements about the reasoning from the information you gather. This is a good skill to practice.

Of the reasons that you have identified, which do you think is the most significant reason for the acquisition and why?

o There are likely to be more than one reason for any acquisition. This question is attempting to focus your attention on making a judgement about which of the reasons you have identified is the most significant. There is likely to be one overriding reason for the acquisition that takes precedence over the other reasons. You have to decide which it is and explain your reasoning. There is not any 'right' answer to this type of question. The emphasis is on you demonstrating analysis and evaluation skills.

Discuss the extent of the impact on the different stakeholders of the business that you have selected.

o In this question, you might be tempted to cover all the stakeholders - that is not necessary. Invariably if you select around three or four that will be sufficient to enable you to demonstrate the skills required in such a question. The important thing here to consider the impact. What this means is that is the effect on the stakeholder very serious, beneficial or will it hardly affect them at all? This is what is implied by the 'extent' part of the question. The command word is 'discuss' which implies that there is some evaluative comment expected in your answer. To provide some valid evaluation you might have to ask what the impact will depend upon. The effect on a customer of the acquisition of Gales by Fullers will depend on whether the closure of the brewery and the move to Chiswick will affect the taste of the beer, whether the price of the beer will rise (or fall) whether it means that Gales beers are easier to access or become less widespread and so on. By offering evaluation in this way you will avoid the bland analysis that just makes an assumption that customers will be better/worse off with no qualification given for your reason.

References

Meeting the Needs of Stakeholders - Biz/ed presentation [PowerPoint, 113KB]

BBC news articles on the acquisition of Gales by Fuller's: o Gales pubs boost Fuller's profit o Fears for historic Gales brewery o Anger at historic brewery closure o What is fuelling the merger boom?

Fuller says looking for acquisitions - Reuters report The Fuller's Web site:

o Home page o Investor Relations home page

Reasons why mergers and acquisitions can fail - from the Jacksonville Busines Journal Ten reasons supermarket mergers are bad for consumers - Friends of the Earth press

release Seven Reasons Mergers Fail: Evidence from the Banking Industry - from Emerge

International Making Mergers Work - book review from the Society for Human Resource Management Mergers and Acquisitions - Investopedia notes