FREE online courses on Corporate Strategies - Diversification Using Mergers
and Acquisitions - Reasons for following Acquisition Strategies
Companies follow acquisition strategies for a variety of
reasons, including:
1)
Increased Market Power
A primary reason for acquisitions is that they enable
companies to gain greater market power.
While a number of companies may feel that they have an
internal core competence, they may be unable to exploit their resources and
capabilities because of a lack of size. A company may be able to gain the size
necessary to exploit its core competence by becoming larger in terms of the size
of its market share. And, an
increase in market share enables the company to increase its market power.
Because of this, acquisitions to meet a market power objective generally involve
buying a supplier, a competitor, a distributor, or a business in a highly
related industry.
2)
Horizontal Acquisitions
Buying a competitor or a business in a highly related
industry--which increases the company's market power--provides the company with
the size it needs to exploit its core competence and gain a competitive
advantage in its primary market. When a competitor in the same industry is
acquired, a company has engaged in a horizontal acquisition.
3)
Vertical Acquisitions
A vertical acquisition has occurred when a company acquires
a supplier or distributor, which is positioned either backward or forward in the
company's cost/activity/value chain.
4)
Related Acquisitions
When a target company in a highly related industry is
acquired, the company has made a related acquisition. Recent evidence indicates
that horizontal acquisition of companies with similar characteristics--strategy,
managerial styles, and resource allocation patterns--results in higher
performance because generally it is difficult to successfully integrate the
merged companies.
Companies that are able to gain greater market share or
that gain core resources that can be used to gain a competitive advantage have
more market power that can be used against competitors. Acquisitions in the
pharmaceutical industry provide a good example of companies pursuing market
power objectives. While some of these mergers--such as the Merck acquisition of
Medco--represent vertical acquisitions to ensure distribution of product lines,
others have been either related or horizontal acquisitions to enable the
acquiring companies to take advantage of regulatory changes that are challenging
the power of pharmaceutical companies. As a trade-off, it is likely that pharmaceutical companies
are likely to divert funds from R&D into making and managing acquisitions.
5)
Overcoming of Entry Barriers
As discussed earlier, barriers to entry represent factors
associated with the market and/or companies operating in the market that make it
more expensive and difficult for new companies to enter the market. For example,
it may be difficult to enter a market dominated by large, established
competitors. As noted earlier, such markets may require:
Investments in large-scale manufacturing facilities that
enable the company to achieve economies of scale so that it can offer
competitive prices
Significant expenditures in advertising and promotion to
overcome any brand loyalty enjoyed by existing products
Establishing or breaking into existing distribution
channels so that goods are convenient to customers
When barriers to entry are present, the company's best
choice may be to acquire a company already having a presence in the industry or
market. In fact, the higher the
barriers to entry into an attractive market or industry, the more likely it is
that companies interested in entering will follow acquisition strategies.
While the acquisition cost might be high (depending on such
factors as attractiveness of the business or market, competing acquisitions, or
the cost of integrating operations), the acquiring company achieves immediate
market access, gains a brand that has access to existing distribution channels,
and may already have some degree of brand loyalty.
Entry barriers companies face when trying to enter
international markets are often great.
Commonly, acquisitions are used to overcome entry barriers in
international markets. It is
important to compete successfully in these markets since five of the emerging
markets (China, India, Brazil, Mexico, and Indonesia) are among the 12 largest
economies in the world with a combined purchasing power that is already one-half
that of the Group of Seven industrial nations (United States, Japan, Britain,
France, Germany, Canada, and Italy).
6)
Cross-Border Acquisitions
Cross border-acquisitions and cross-border alliances are
alternatives companies consider while pursuing strategic competitiveness.
Compared to a cross-border alliance, a company has more control over its
international operations through a cross-border acquisition.
Acquisitions also represent a viable strategy for companies
that wish to enter international markets because acquisitions
May be the fastest way to enter new markets
Provide more control over foreign operations than do
strategic alliances with a foreign partner
Enable the acquiring company to make changes in the
acquired company's operations
Provide the acquirer with access to the resources and
capabilities of the acquired company
7)
Cost of New-Product Development
Acquisitions also may represent an attractive alternative
to developing new products internally because of the cost and time required
starting a new venture and achieving a positive return. Internal development of
new products is often perceived by managers to be costly and to represent
high-risk investments of company resources.
While sometimes costly, it may be in the company's best interest to
acquire an existing business because the acquired company has a track record
with an established sales volume and a customer base, yielding predictable
returns and the acquiring company gains immediate market access
In addition to representing attractive prices, large
pharmaceutical companies have used acquisitions to supplement products in the
pipeline with projects from undervalued biotechnology companies; thus, this is
one way to appropriate new products.
8)
Increased Speed to Market
Companies also can implement an acquisition strategy to
rapidly gain market entry, establish relative market power over a competitor,
and achieve a new product advantage.
Acquisitions also enable companies to enter foreign markets more rapidly as it is less costly from a time
perspective to acquire companies with established operations and supplier and/or
customer relationships in a foreign market than to develop them.
9)
Lower Risk Compared to Developing New Products
Internal product development processes can be risky, in
that entering a market and earning an acceptable return on investment requires
significant resources and time. All
the same, acquisition outcomes can be estimated easily and accurately (as
compared to the outcomes of an internal product development process), causing
managers to view acquisitions as carrying lowering risk.
Because acquisitions recently have become such a common
means of avoiding risky internal ventures, they even could become a substitute
for innovation enabling companies to avoid the risk of internal ventures and
overcome constraints on internal resources and capabilities.
Although they often enable companies to offset the risk of
internal ventures and of developing new products, acquisitions are not without
risks of their own. Acquisition-related risks will be discussed later in this
chapter.
10)
Increased Diversification
Acquisitions are a common strategy that companies can use
to diversify. This may be because it should be easier for companies to develop
new products and/or new ventures within their current markets because of
market-related knowledge, so companies that desire to enter new markets may find
that current product-market knowledge and skills are not transferable to the new
target market.
Thus, internal ventures and new product development for new
markets are not common means of diversification. (In fact, research indicates that acquisitions are a common
strategy for achieving diversification because this type of acquisition provides
more control and reduces the acquiring company's dependence on another
organization.)
Acquisitions also may have gained in popularity as a
related or horizontal diversification strategy enabling rapid moves into related
markets (or to expand market power) and as an unrelated diversification
strategy. Also, acquisitions are
the most frequently used means for companies to diversify their operations into
international markets.
However, companies must be careful when making acquisitions
to diversify their product lines because horizontal and related acquisitions
tend to contribute more to strategic competitiveness, and thus they are more
successful than diversifying acquisitions.
11)
Reshaping the company's Competitive Scope
To reduce intense rivalry's negative effect on financial
performance, a company may use acquisitions as a way to restrict its dependence
on a single or a few products or markets. Reducing dependence on single products
or markets results in a different competitive scope for a company.
To summarize, the seven reasons that companies (and managers)
implement acquisition strategies are to:
increase market power
overcome entry barriers
reduce or avoid the cost of new product development
increase speed to market
lower risk compared to developing new products
increase diversification
avoid excessive competition
While the focus so far has been on the advantages of
acquisitions, there also are several problems that can prevent acquisitions from
either achieving their objectives or from producing any benefits.
As research tells us, the average returns from acquisitions
for acquiring companies is approximately zero, and some acquiring companies
experience negative returns. This implies that acquisition-related problems
often have equaled or out-weighed any benefits gained.