Chapter 7
Merger and Acquisition Strategies
CHAPTER OVERVIEW
LEARNING OBJECTIVES
LECTURE NOTES
7-1 THE POPULARITY OF MERGER AND ACQUISITION STRATEGIES
7-1a Mergers, Acquisitions, and Takeovers: What Are the Differences?
7-2 REASONS FOR ACQUISITIONS
7-2a Increased Market Power
7-3 PROBLEMS IN ACHIEVING ACQUISITION SUCCESS
7-3a Integration Difficulties
7-3b Inadequate Evaluation of Target
7-4 EFFECTIVE ACQUISITIONS
7-5 RESTRUCTURING
7-5a Downsizing
7-5b Downscoping
7-5c Leveraged Buyouts
7-5d Restructuring Outcomes
Chapter 7: Merger and Acquisition Strategies
INSTRUCTOR’S NOTES FOR MINDTAP
What Would You Do?
Video Quiz
Guided Case
Group Project
CHAPTER OVERVIEW
In Chapter 6, students learned that firms use product diversification strategies to create
value for stakeholders and to gain competitive advantages. In this chapter, students
discover how firms around the globe may use mergers and acquisitions to become more
diversified.
Firms use acquisition strategies to increase market power, overcome entry barriers to new
markets or regions, avoid the costs of developing new products and increase the speed of
new market entries, reduce the risk of entering a new business, become more diversified,
reshape their competitive scope by developing a different portfolio of businesses, and
enhance their learning as the foundation for developing new capabilities.
The next section of the chapter explores the characteristics associated with effective
acquisitions. An acquisition is most likely to succeed when the acquiring and target firms
have complementary resources that are the foundation for developing new capabilities; the
acquisition is friendly, thereby facilitating integration of the firm’s resources; the target
firm is selected and purchased on the basis of completing a thorough due-diligence
Chapter 7: Merger and Acquisition Strategies
Chapter 7: Merger and Acquisition Strategies
capacity; the newly formed firm maintains a low or moderate level of debt by selling off
portions of the acquired firm or some of the acquiring firm’s poorly performing units; the
acquiring and acquired firms have experience in terms of adapting to change; and R&D
and innovation are emphasized in the new firm.
The final section of the chapter explores the outcomes of restructuring. Downsizing
typically does not lead to better performance, and it may have a negative impact on stock
prices. The loss of human capital and the knowledge held by long-time employees can
also damage a firm. Downscoping, however, often generates positive short- and long-term
outcomes. LBOs have a positive reputation, but can be complicated and require negative
trade-offs.
LEARNING OBJECTIVES
1. Explain the popularity of merger and acquisition strategies in firms competing in the
global economy.
Chapter 7: Merger and Acquisition Strategies
Lecture Notes
Chapter Introduction: With continued merger and acquisition (M&A) activity, this
chapter is very important. Much of the chapter’s material is summarized in Figure 7.1,
OPENING CASE
Cisco Systems: Strategic Acquisitions to Adapt to a Changing Market
Originally focused on building the infrastructure that allows the Internet to work, Cisco
Systems has evolved over time. Primarily through acquisitions, the firm has moved into
developing infrastructure for social media, mobile and cloud computing, and digital video,
Teaching Note
Begin the discussion by asking students why a company like Cisco might want to
engage in acquisitions. Help students understand that some of the benefits of
1
Explain the popularity of merger and acquisition strategies in
firms competing in the global economy.
In the latter half of the twentieth century, acquisition became a prominent strategy used by
major corporations to achieve growth and meet competitive challenges. Even smaller and
Chapter 7: Merger and Acquisition Strategies
7-1 THE POPULARITY OF MERGER AND ACQUISITION
STRATEGIES
Acquisitions have been a popular strategy among U.S. firms for many years. Some believe
that this strategy played a central role in the restructuring of U.S. businesses during the
1980s, 1990s, and into the twenty-first century.
Increasingly, acquisition strategies are becoming more popular with firms in other nations
(e.g., those of Europe). In fact, about 40 to 45 percent of the acquisitions in recent years
have been made across country borders (i.e., where a firm headquartered in one country
acquires a firm headquartered in another country).
Merger and acquisition trends include the following:
• There were five waves of mergers and acquisitions in the twentieth century, the last two in
the 1980s and 1990s.
• The global volume of announced acquisition agreements was up 41 percent from 2003 to
$1.95 trillion for 2004, the highest level since 2000, and the pace in 2005 was significantly
above the level of 2004.
A firm may make an acquisition to do the following:
• Increase its market power because of a competitive threat
Chapter 7: Merger and Acquisition Strategies
Evidence suggests that at least for acquiring firms, acquisition strategies may not result in
desirable outcomes. Studies have found that shareholders of acquired firms often earn
7-1a 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
achieve strategic competitiveness.
7-2 REASONS FOR ACQUISITIONS
The main strategic reasons for acquisition are detailed one at a time in the text.
Teaching Note
You may find it helpful to refer students to Figure 7.1, which lists the reasons for
acquisitions.
Chapter 7: Merger and Acquisition Strategies
7-2a Increased Market Power
As discussed in Chapter 6, a primary reason for acquisitions is that they enable firms to
gain greater market power. Acquisitions to meet a market power objective generally
STRATEGIC FOCUS
Broadcom’s Failed Hostile Takeover Attempt of Qualcomm
After regulatory uncertainties and lawsuits lowered Qualcomm’s stock market prices,
Broadcom made a hostile takeover bid to purchase Qualcomm for $130 billion. Broadcom
Teaching Note
This is an excellent opportunity to define some of the key terms in the chapter, such as
merger, acquisition, and hostile takeover. This case also helps students understand how
government agencies and other factions (boards of directors, shareholders) can
influence a potential merger or acquisition.
Horizontal Acquisitions
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–
and revenue-based synergies.
Chapter 7: Merger and Acquisition Strategies
Vertical Acquisitions
A vertical acquisition has occurred when a firm acquires a supplier or distributor that is
positioned either backward or forward in the firm’s cost/activity/value chain.
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
7-2b Overcoming Entry Barriers
As discussed in Chapter 2, barriers to entry represent factors associated with the market
and/or firms operating in the market that make it more expensive and difficult for new
firms to enter the market.
It may be difficult to enter a market dominated by large, established competitors. As noted
in Chapter 2, such markets may require:
• Investments in large-scale manufacturing facilities that enable the firm to achieve
economies of scale so that it can offer competitive prices
Chapter 7: Merger and Acquisition Strategies
Entry barriers that firms face when trying to enter international markets are often great.
Commonly, acquisitions are used to overcome entry barriers in international markets. It is
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-
Historically, U.S. 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 acquisitions made annually.
Some trends in cross-border acquisitions are as follows:
• Because of relaxed regulations, the amount of cross-border activity among nations within
the European community also continues to increase.
Acquisitions represent a viable strategy for firms that wish to enter international markets
because:
• This may be the fastest way to enter new markets.
• They provide more control over foreign operations than do strategic alliances with a
foreign partner.
Chapter 7: Merger and Acquisition Strategies
7-2c Cost of New Product Development and Increased Speed to Market
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.
Also of concern to firms’ managers is achieving adequate returns from the capital invested
to develop and commercialize new products—an estimated 88 percent of innovations fail
to achieve adequate returns. Perhaps contributing to these less-than-desirable rates of
• The acquired firm has established sales volume and customer base, thus yielding
predictable returns.
• The acquiring firm gains immediate market access.
STRATEGIC FOCUS
Cross-Border Mega Mergers in Agricultural Chemical and Technology Sectors
Three huge global mergers are sure to have an impact on food production around the
globe. Dow merged with DuPont, and the newly formed organization may ultimately be
Teaching Note
Review the list of benefits of acquisitions and mergers with students. Then ask them
which of these benefits Dow-DuPont, ChemChina, and Bayer will realize through their
acquisitions.
Chapter 7: Merger and Acquisition Strategies
7-2d Lower Risk Compared to Developing New Products
As discussed earlier, 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.
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
Teaching Note
Although they often enable firms to offset the risk of internal ventures and of
developing new products, acquisitions are not without risks of their own. Acquisition–
related risks are discussed later in this chapter.
7-2e 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
Chapter 7: Merger and Acquisition Strategies
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.
7-2f 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
The following are examples of auto manufacturers that have gone through acquisitions
to reduce dependence on too few businesses:
• General Motors (GM) acquired Electronic Data Systems and Hughes Aerospace to
lessen its dependence on the domestic automobile market (where its market share
7-2g 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
skills and capabilities that differ from its own helps the acquiring firm learn new
Chapter 7: Merger and Acquisition Strategies
Figure Note
Figure 7.1 presents the reasons for making acquisitions and the problems encountered
in doing so. Such problems are discussed in ensuing chapter sections.
3
Describe seven problems that work against achieving
success when using an acquisition strategy.
7-3 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 as follows:
• Difficulties integrating the two firms after the acquisition is completed
Chapter 7: Merger and Acquisition Strategies
7-3a Integration Difficulties
Integration problems or difficulties that firms often encounter can take many forms.
Among them are:
• Melding disparate corporate cultures
The importance of integration success should not be underestimated. Without successful
integration, a firm achieves financial diversification, but little else. Consider these points.
• The post-acquisition integration phase may be the single most important determinant of
shareholder value creation (or value destruction) in mergers and acquisitions.
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, 6,000 deliverables
were to be completed by hundreds of employees working in dozens of countries.
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
achieving acquisition success are presented in the right column of Figure 7.1.
The seven reasons that firms (and managers) implement acquisition strategies are:
• Increase market power
• Learn and develop new capabilities
Chapter 7: Merger and Acquisition Strategies
The seven reasons for poor performance of acquisitions or problems faced in attempts to
achieve success are:
• Integration difficulties
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.
It is important to maintain the human capital of the target firm after the acquisition to
preserve the organization’s knowledge. Turnover of key personnel from the acquired firm
can have a negative effect on the performance of the merged firm.
Teaching Note
The following are examples of firms and the steps they took to preserve human capital
through the acquisition process.
• When AlliedSignal acquired Honeywell, the firm set an aggressive timetable to
merge their operations into a $24 billion industrial powerhouse in six months,
Chapter 7: Merger and Acquisition Strategies
7-3b 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 financing for the intended transaction, differences in cultures between the acquiring
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
Acquirers overpaying for target firms include the following:
• British retailer Marks & Spencer paid $750 million for Brooks Brothers of the
United States, but the acquisition was still unsuccessful after more than 10 years of
integration.
Chapter 7: Merger and Acquisition Strategies
• First Union Corp. paid 5.3 times book value when it acquired CoreStates Financial
Corp.
7-3c 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.
Teaching Note
Junk bonds are considered by many to be a new financing option, not because they are
Teaching Note
A number of well-known and well-respected finance scholars argue in favor of firms
7-3d Inability to Achieve Synergy
Acquiring firms also face the challenge of correctly identifying and valuing any synergies
that are expected to be realized from the acquisition. This is a significant problem because
Chapter 7: Merger and Acquisition Strategies
19
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.
7-3e Too Much Diversification
In general, firms using related diversification strategies outperform those using unrelated
diversification strategies. However, conglomerates (i.e., those pursuing unrelated
diversification) can also be successful.
In addition to increased information processing requirements and managerial expertise,
overdiversification 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.