The Benefits and Pitfalls of Mergers and Acquisitions

1. Synergy
   Synergy refers to the effect created when two single entities work together to create a greater benefit than they would do as separate beings. Simply put, it is similar to an equation where 2 + 2 = 5.
2. Increased market share
   Increasing market share, as well as having the potential to increase revenue, provides an organization with the opportunity to increase its pricing power. A product or organization with a larger share of the market is more likely to be able to set prices in a market than one with a smaller share. A recent example of this would be the heavy discounting by the large supermarkets and online retailers of JK Rowling’s Harry Potter novels, effectively forcing small independent booksellers to sell the books at a loss in order to secure sales.
3. Entry to new markets
   Entry to a new market can be as a result of a desire to offset the decline of a current market, or to exploit the opportunity to broaden a portfolio of products and services. A broader portfolio also has the added benefit of spreading the risk to the organization, in that no one product or service is wholly responsible for the organization’s success.
4. Reduce competition
   The acquisition of a rival organization can reduce the competition in a market, as well as increasing market share.
5. Increased supply or distribution channels
   The merger with, or the acquisition of, a trader within an organization’s supply chain can allow the acquiring organization to reduce the costs associated with the supply or distribution of its products/services.
6. Development of new products
   M&As provide the opportunity to obtain products or services that are already partially developed or almost ready for the market. As a result potential gains may be realized earlier than would be possible if using internal research and development to start from the beginning.
7. New technology
   The acquisition of new technology provides potential gains in quality and product differentiation, as well as cost saving as a result of any increased automation.
8. Improved economies of scale
   As with pricing power, the larger the organization, and, therefore, its buying power, the more it can dictate purchase prices, e.g. buying in bulk is usually cheaper than purchasing individual units.
9. Productive use of spare or underused capital
   Finance that is sitting in a bank may generate improved returns if used to secure the merger with, or acquisition of, a suitable target. It can also be used to asset strip an organization, whereby the acquisition is broken down into its component parts and sold off individually, generating a higher revenue than the original purchase price.
10. Enhanced corporate reputation
    If the target organization is a well-known or household name, market share can be increased by the acquired ‘goodwill’ or brand values.

Synergy

Of all the possible benefits, synergy is the single most important reason for instigating a merger or acquisition process. In order for the integration of two organizations to be successful, the new organization as a whole must be greater than the sum of the two parts. In other words, the value of the new, combined organization must be greater than the combined value of the two original organizations.

A speedy integration of the two entities is, therefore, the primary goal, so that the new organization can perform more efficiently than either of the two original parties as soon as possible. Synergy is measured in terms of increased added value. In Foundations of Corporate Success, John Kay states:

‘Value is added, and only added, if distinctive capabilities or strategic assets are exploited more effectively. A merger adds no value if all that is acquired is a distinctive capability which is already fully exploited, as the price paid will reflect the competitive advantage held.’[3]

Therefore, an integration that doesn’t allow the newly formed organization to improve its market position, or to increase profits, would be deemed unsuccessful.

Planning for Success

In order to achieve the synergy hoped for as the result of a merger or acquisition, there are a number of areas to carefully consider and plan.

1. Thorough research.

Incomplete knowledge of the market, products or circumstances of the target company can result in assumptions being made which may later be found to be false. The process of thoroughly investigating a potential target’s performance, assets and background is known as due diligence. Due diligence should look at all areas of both organizations, including:

• Organizational structure – how the organization works, and any changes that may be necessary as a result of a merger or acquisition.
• Financial health – the previous financial history and existing assets of the target organization, as well as the current financial strength of the organization looking to acquire or merge.
• Employees – including the credibility of the existing owners or board members.
• The potential gains – including an analysis of the strength of existing products or services, as well as future growth possibilities and projected cost savings.
• Risk assessment – covering risks connected to possible market changes, the risks associated with different strategies, and the impact of known future events.

Although a thorough process of due diligence may seem costly, time consuming and intrusive, if the process highlights a potential risk or failure area that had not previously been considered, it can allow the merger or acquisition process to be suitably adapted, or indeed to be stopped altogether.

2. Cultural compatibility.

Cultural incompatibility can arise as the result of organizations from different geographic areas integrating, or can be due to different operating styles. An organization with a relaxed style of management, where employee input is encouraged, will have difficulties adapting if it is the target of an organization with a formal, structured and top-heavy team. It is, therefore, important to consider how the organizations will interact, and what steps need to be taken to integrate them as smoothly as possible.

3. Communication.

Poor communication both within and between the two parties can itself cause failure. Communication at all levels is essential in order to keep all those involved up to date with progress, motivated and productive. Communication should be:

• Continuous. Consider the use of intranet sites, email updates, drop-in sessions and regular meetings to keep everyone up to date, and provide opportunities for problems or concerns to be raised.
• Across all levels. Information needs to be cascaded down as quickly as possible through the organization. Again, a regular email or intranet update can help keep the channels of communication open.
• Relevant. Different areas of the organization will have different information requirements. For example, board members will need a more detailed strategic level of information than someone in customer service.

4. Poor utilization of key personnel.

Prior to any merger or acquisition, the key personnel must be identified and agreed on. Key managers, individuals with specialist knowledge, and those who will assist in the negotiation and integration process will bring confidence and competence to the tasks ahead, and help the new organization to achieve its potential.

5. Overpaying.

Overstretching finances, by overpaying for any acquisition or underestimating the associated costs to the extent that the synergy is lost, will put the new organization at huge financial risk. Care should also be taken to ensure that changes in market trends are considered, so that even if growth is lower than predicted the overall return still merits the initial investment.

A survey about M&As conducted by the Society for Human Resource Management and the consultancy organization Towers Perrin in 2001 polled 600 top HR executives and CEOs about the reasons M&As fail. [4] The majority agreed that a number of factors combine, although an inability to sustain financial performance was cited as the top reason by 65 percent of respondents. Other factors included:

• Loss of productivity (60 percent)
• Incompatible cultures (55 percent)
• Clash of managerial styles or egos (53 percent)
• Slow decision-making (51 percent)
• Wrong people selected for the top jobs (50 percent)

Success Criteria

Given all this information, what can an organization contemplating a merger or acquisition consider in order to make the strategy a successful one? The renowned strategic author, Michael Porter, identifies three success criteria for selecting an organization to merge with or acquire: [5]

Attractiveness

This describes the likelihood of making above-average profits in the target company’s industry or industry segment.

Cost of Entry

This is the overall cost of the merger or acquisition, and includes the major capital sum, legal and banking costs, consultancy fees, as well as indirect costs such as management time and integration costs.

Competitive Advantage

Last, but not least, it must be determined that there will be an overall synergistic gain.