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Chapter 7
Merger and Acquisition Strategies
LEARNING OBJECTIVES
1. Explain the popularity of merger and acquisition strategies in firms competing in the
global economy.
2. Discuss reasons why firms use an acquisition strategy to achieve strategic
competitiveness.
3. Describe seven problems that work against achieving success when using an acquisition
strategy.
4. Name and describe the attributes of effective acquisitions.
5. Define the restructuring strategy and distinguish among its common forms.
6. Explain the short- and long-term outcomes of the different types of restructuring
strategies.
CHAPTER OUTLINE
Opening Case: Strategic Mergers and Acquisition: Prominent Strategies for Forms Seeking
to Enhance their Performance
THE POPULARITY OF MERGER AND ACQUISITION STRATEGIES
Mergers, Acquisitions, and Takeovers: What Are the Differences?
REASONS FOR ACQUISITIONS
Strategic Focus: A Merger of Equals: Making It Happen Isn’t Easy
Increased Market Power
Overcoming Entry Barriers
Strategic Focus: Different Strategic Rationales Driving Cross-Border Acquisitions
Cost of New Product Development and Increased Speed to Market
Lower Risk Compared to Developing New Products
Increased Diversification
Reshaping the Firm’s Competitive Scope
Learning and Developing New Capabilities
PROBLEMS IN ACHIEVING ACQUISITION SUCCESS
Integration Difficulties
Inadequate Evaluation of Target
Large or Extraordinary Debt
Inability to Achieve Synergy
Too Much Diversification
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Managers Overly Focused on Acquisitions
Too Large
EFFECTIVE ACQUISITIONS
RESTRUCTURING
Downsizing
Downscoping
Leveraged Buyouts
Restructuring Outcomes
SUMMARY
KEY TERMS
REVIEW QUESTIONS
Mini-Case: Strategic Acquisitions and Accelerated Integration of Those Acquisitions are a
Vital Capability of Cisco Systems
MINDTAP RESOURCES
LECTURE NOTES
Chapter Introduction: With continued merger and acquisition activity, this chapter is
very important. Much of the chapter’s material is summarized in Figure 7.1, which
can be used to help students mentally organize what they learn in the chapter about
mergers and acquisitions by examining reasons of acquisitions and problems in
achieving success.
OPENING CASE
Mergers and Acquisition: Prominent Strategies for Forms Seeking to Enhance their
Performance
Teaching Note:
There are several reasons corporations merge with or acquire other companies.
However, the need to create value for stakeholders is a primary influence on
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1
Explain the popularity of acquisition strategies in
firms competing in the global economy.
THE POPULARITY OF MERGER AND ACQUISITION STRATEGIES
Acquisitions have been a popular strategy among US firms for many years. Some believe
that this strategy played a central role in the restructuring of US businesses during the 1980s,
1990s, and into the 21st century.
Merger and acquisition trends:
• There were five waves of mergers and acquisitions in the 20th century, the last two in the
1980s and 1990s.
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• Although the frequency of acquisitions has slowed, their number remains high.
• In the latest acquisition boom between 1998 and 2000, acquiring firm shareholders
experienced significant losses relative to the losses in all of the 1980s.
do so. In approximately two-thirds of all acquisitions, the acquiring firm’s stock price falls
immediately after the intended transaction is announced, indicating investors’ skepticism
about the likelihood that the acquirer will be able to achieve the synergies required to justify
the premium.
Mergers, Acquisitions, and Takeovers: What Are the Differences?
Before starting the discussion of the reasons for acquisitions, problems related to
acquisitions, and long-term performance, three terms should be defined because they will be
used throughout this chapter and Chapter 10.
2
Discuss reasons why firms use an acquisition strategy to
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achieve strategic competitiveness.
REASONS FOR ACQUISITIONS
The main strategic reasons for acquisition are detailed one at a time in the text after the
Strategic Focus article.
Teaching Note:
You may find it helpful to refer students to Figure 7.1, which lists the reasons for
acquisitions.
STRATEGIC FOCUS
A Merger of Equals: Making It Happen Isn’t Easy!
Teaching Note:
Discuss with students the potential hurdles to successful mergers of equals. What
obstacles do companies face prior to completing the deal? Now that the deal is signed,
what does the future hold for the new combined firm? Review the obstacles to integration
and the pitfalls associated with merger and acquisition strategies.
Increased Market Power
Horizontal Acquisitions
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When a competitor in the same industry is acquired, a firm has engaged in a horizontal
acquisition. Horizontal acquisitions increase a firm’s market power by exploiting cost-based
Vertical Acquisitions
Related Acquisitions
When a target firm in a highly related industry is acquired, the firm has made a related
acquisition.
Teaching Note:
Remind students that, as discussed in Chapter 6, during the 1960s and 1970s, both
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It may be difficult to enter a market dominated by large, established competitors. As noted in
Chapter 2, such markets may require:
When barriers to entry are present, the firm’s best choice may be to acquire a firm 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 firms interested in entering will follow
acquisition strategies.
STRATEGIC FOCUS
Different Strategic Rationales Driving Cross-Border Acquisitions The decision to acquire
a company should be carefully identified, examined, and agreed upon by key decision-
makers throughout the firm prior to finalizing an acquisition decision. The most successful
acquisitions, including cross-border ones, are products of a rational decision-making process
Teaching Note:
Students may be surprised that cross-border acquisitions of the type described in the
Strategic Focus are taking place. The more accepted scenario is one in which developed
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developed market companies, capabilities to manage/integrate the acquired firms is
another issue. Ask students to identify the skill sets/capabilities that emerging market
acquirers should possess to ensure that their developed market acquisitions perform at
acceptable levels.
Cross-Border Acquisitions
Acquisitions between companies with headquarters in different countries are called cross-
border acquisitions.
Teaching Note:
Chapter 9 examines cross-border alliances and the justification for their use. Cross-
border acquisitions and cross-border alliances are alternatives firms consider while
pursuing strategic competitiveness. Compared to a cross-border alliance, a firm has
more control over its international operations through a cross-border acquisition.
Historically, US firms have been the most active acquirers of companies outside their
domestic market. However, in the global economy, companies throughout the world are
choosing this strategic option with increasing frequency. In recent years, cross-border
acquisitions have represented as much as 40 percent of the total number of acquisitions made
annually.
Some trends in cross-border acquisitions:
Acquisitions represent a viable strategy for firms that wish to enter international markets
because:
Cost of New Product Development and Increased Speed to Market
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Acquisitions also may represent an attractive alternative to developing new products
internally due to the cost and time required to start a new venture and achieve a positive
return.
predictable returns.
• The acquiring firm gains immediate market access.
In addition to representing attractive prices, large pharmaceutical firms have used
acquisitions to supplement products in the pipeline with projects from undervalued
biotechnology companies; thus, this is one way to appropriate new products.
Lower Risk Compared to Developing New Products
Teaching Note:
Not long ago, P&G acquired premium dog and cat food manufacturer Iams Co. to
support the launch of its pet products into supermarket chains and mass
merchandisers such as Walmart. Having assessed the potential of Iams in the
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Because acquisitions recently have become such a common means of avoiding risky internal
ventures, they could become a substitute for innovation, which has a serious downside (e.g.,
the decline of Cisco systems).
Teaching Note:
Increased Diversification
It should be easier for firms to develop new products and/or new ventures within their current
markets because of market-related knowledge, but firms that desire to enter new markets may
find that current product-market knowledge and skills are not transferable to the new target
market.
Teaching Note:
Remember, related diversification seeks lower costs through economies of scope,
synergy, and resource sharing, whereas unrelated diversification hopes to realize
financial economies and better internal resource allocation among diverse businesses.
Reshaping the Firm’s Competitive Scope
To reduce intense rivalry’s negative effect on financial performance, a firm may use
acquisitions as a way to restrict its dependence on a single or a few products or markets.
Teaching Note:
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The following are examples of auto manufacturers that have gone through
acquisitions to reduce dependence of too few businesses:
• General Motors acquired Electronic Data Systems and Hughes Aerospace to lessen
its dependence on the domestic automobile market (where its market share had
declined from approximately 50 percent in 1980 to less than 30 percent 10 years
Learning and Developing New Capabilities
Some acquisitions are made to gain capabilities that the firm does not possess—e.g.,
acquisitions used to acquire a special technological capability. Acquiring other firms with
Figure Note:
Figure 7.1 presents the reasons for making acquisitions and the problems
encountered. A comment that problems are discussed in ensuing sections is
appropriate.
3
Describe seven problems that work against developing a
competitive advantage using an acquisition strategy.
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PROBLEMS IN ACHIEVING ACQUISITION SUCCESS
Research suggests that perhaps 20 percent of all mergers and acquisitions are successful,
approximately 60 percent produce disappointing results, and the last 20 percent are clear
failures. Successful acquisitions generally involve a well-conceived strategy in selecting the
target, the avoidance of paying too high a premium, and employing an effective integration
process.
A number of problems accompany an acquisition strategy. Acquisition-related problems
shown in Figure 7.1 that are discussed in this section are:
Integration Difficulties
Integration problems or difficulties that firms often encounter can take many forms. Among
them are:
Teaching Note:
Several years ago, Intel acquired Digital Equipment’s semiconductors division. On
the day Intel began to integrate the acquired division into its operations, six thousand
deliverables were to be completed by hundreds of employees working in dozens of
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FIGURE 7.1
Reasons for Acquisitions and Problems in Achieving Success
Seven reasons for acquisitions are presented in the left column whereas seven problems in
The seven reasons for poor performance of acquisitions or problems faced in attempts to
achieve success are:
Note:
Problems encountered as firms try to successfully achieve their objectives and create value
from acquisitions are discussed in detail in the next sections of this chapter.
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• When AllliedSignal acquired Honeywell, the firm set an aggressive timetable to
merge their operations into a $24 billion industrial powerhouse in six months,
despite the great diversification involved. This required a team to develop and
implement the integration.
Inadequate Evaluation of Target
Due diligence is a process through which a firm evaluates a target firm for acquisition. In an
effective due-diligence process hundreds of items are examined in areas as diverse as the
Teaching Note:
For the reasons below, firms often pay too much for acquired businesses:
• Acquiring firms may not thoroughly analyze the target firm, failing to develop
adequate knowledge of its true market value.
Teaching Note:
Some acquirers overpaying for target firms include the following:
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• British retailer Marks & Spencer paid $750 million for Brooks Brothers of the
United States, but the acquisition was still unsuccessful after more than ten years
of integration.
Firms sometimes allow themselves to enter a “bidding war” for a target even though they
realize their current bids exceed the parameters identified through due diligence.
Large or Extraordinary Debt
In addition to overpaying for targets, many acquirers must finance acquisitions with
relatively high-cost debt.
In the 1980s, investment bankers developed a new financing instrument for acquisitions, the
junk bond. Junk bonds represented a new financing option in which risky investments were
financed with money (debt) that provided a high return to lenders (bond holders). Junk bonds
offer relatively high rates, some as high as 18 to 20 percent during the 1980s.
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Inability to Achieve Synergy
Teaching Note:
As pointed out earlier, the average return to acquiring firm shareholders is near zero,
and many of these lead to negative returns for acquiring firm shareholders.
Firms experience transaction costs when using acquisition strategies to create synergy. Direct
costs include legal fees and charges from investment bankers. Managerial time to evaluate
target firms and then to complete negotiations and the loss of key managers and employees
post-acquisition are indirect costs.
Too Much Diversification
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In addition to increased information processing requirements and managerial expertise, over-
diversification may result in poor performance when top-level managers emphasize financial
controls over strategic controls.
Teaching Note:
Controls are discussed in more detail in Chapters 11 and 12.
Financial controls may be emphasized when managers feel that they do not have sufficient
expertise or knowledge of the firm’s various businesses. When this happens, top-level
managers are not able to adequately evaluate the strategies and strategic actions taken by
division or business unit managers. As a result,
Teaching Note:
The experiences of many firms indicate that over-diversification may lead to
ineffective management, primarily because of the increased size and complexity of
the firm. As a result of ineffective management, the firm and some of its businesses
may be unable to maintain their strategic competitiveness. This results in poor
performance.