Corporate Strategy
Chair of Management
Friedrich-Alexander-Universität Erlangen-Nürnberg
Summer term 2012
Prof. Dr. Harald Hungenberg
Friedrich-Alexander-Universität Erlangen-Nürnberg
Lehrstuhl für Unternehmensführung
1
Corporate Strategy
Chapters of course package
1.
Fundamentals of strategic management in
multibusiness firms
2.
Diversification strategies as end product
of portfolio planning
3.
Portfolio planning and portfolio concepts
4.
Merger and acquisition as an instrument
to execute portfolio changes
Prof. Dr. Harald Hungenberg
Friedrich-Alexander-Universität Erlangen-Nürnberg
Lehrstuhl für Unternehmensführung
2
Business and corporate strategy are core elements of
strategic management
Concept of strategy
Strategic
Decision
At corporate
level
Strategic
management
= Multibusiness
firm
At business
level
= Single business
(firm)
Portfolio
design/
diversification,
executing
portfolio
changes
Market
positioning,
resource
exploitation
Advantage
Success
Parenting
Success of the
advantage
whole corporation
(as an owner
of businesses)
Competitive
advantage
(in a single
industry)
Success
(stand-alone)
of single
businesses
3
Mannesmann had a long and successful history
History and development of Mannesmann
1900
…
• Founded in 1890
based on the innovation to produce seamless
steel tubes
• Vertical integration into steelworks and coal
mines to ensure
supply
1960
• Transformation
into a technology
conglomerate
through acquisitions in machinery
and engineering,
automotive supply
measurement and
control, and others
1990
• Licence to operate
the first private
mobile communication network in
Germany
• Expansion and
internationalization of telecom
business through
acquisitions
2000
• Acquisition by
Vodafone
• Split-up of
company
4
Mannesmann was a multibusiness firm with unrelated
businesses
Structure of Mannesmann Group in 1999
Mannesmann Corporate Center
Machinery and
Engineering
Automotive
Engineering
Telecommunications
Mannesmann
Demag
Mannesmann
VDO
Mannesmann
Mobilfunk
Mannesmann
Dematic
Mannesmann
Sachs
Mannesmann
Arcor
Mannesmann
Rexroth
Mannesmann
Eurocom
Krauss-Maffei
Infostrada
Tubes
MannesmannRöhrenwerke
Omnitel
5
Why is this situation representing a strategic problem?
Value creation of Mannesmann's business units (1999)
MachiAutonery and motive
engineering
TeleTubes
Cost
Benefit Corporate
communicorporate corporate
value
cation
center
center
6
The concept of parenting advantage provides the guideline
for corporate strategy
Prerequisites for parenting advantage
1
2
All businesses must
have a positive
business value
3
The whole must be more
than the sum of its parts
The parent's contribution must exceed the
best alternative parent's
contribution
Own value
contribution
Parenting C
advantage
A
B
Contribution
of alternative
parent
Value
Value
Value
Cost
Benefit Corporate
business business business corporate corporate value
A
B
C
center
center
Value contribution
compared to
other parents
7
Value can be created at business and at corporate level
Levers to create shareholder value
Maximize
value
contribution
of parent!
Design the
corporate
portfolio of
businesses
Manage
businesses
Corporate
strategy
Influencing single
businesses
Relating
businesses
Create
shareholder
value
Maximize
business
value
(stand alone)!
Business
strategy
8
The BCG growth-share matrix pioneered the portfolio concept
Structure and background of BCG portfolio
Volume
Market
growth
•
Question
marks
Stars
Poor dogs
Cash cows
•
•
Time
Life
cycle
Experience
curve
•
•
Relative
market share
Cost
per
unit
•
•
Cumulative
output
9
The degree of diversification characterizes strategy options
at corporate level
Types of diversification strategies
Relationship
of businesses
(markets, processes)
Basis of strategy
Heterogeneous
Identify business
opportunities and
share risks
Conglomerate
diversification
Relational
diversification
• Horizontal
• Vertical
Homogeneous
SBF
1
Transfer and use
common resources
and capabilities
Focused
diversification
2
3
Exploit economies
of scale and
experience
4
5
... // ...
15
Number of
businesses
10
Corporate centers can create value by influencing and
relating their businesses
Options for corporate center value creation
Corporate center
„Leading“
Business
Unit 1
„Synergy“
Influencing single businesses
(objectives/incentives, investment,
management, initiatives, …)
Business
Unit 2
Business
Unit 3
Business
Unit 4
Relating businesses
(bundling resources, transfering of skills,
coordinating market presence, …)
11
Focus of strategy making is to achieve advantages in
competition
Parenting versus competitive advantage
Competitive
advantage
Parenting
advantage
Cause of
advantage
Better management at the
business level leading to
serving customers
• better
• cheaper
Better management at the
corporate level leading to
• Exploitation of crossbusiness relationships
• Positive influences on
single businesses
Standard of
comparison
Other companies operating
as suppliers of same/similar
products ("do we serve
customers in a superior
way"?)
Other companies as
potential owner of
businesses a firm owns
("do we contribute value
to our businesses in a
superior way"?)
Decision by /
focus on
Customer
Owner / investor
12
Multibusiness firms have received attention from different
angles
Stages of management thinking on multibusiness firms
Stages
1950
Decentralization
'Businessfocused era'
1960
Diversification
Governing thought
How can a single business/
all businesses contribute to
the overall corporate
success?
1970
Portfolio
Management
thinking on multibusiness firms
1980
Value
'Corporatefocused era'
1990
Focus
How can the corporation
contribute to the success of
single businesses?
2000
Parenting
13
Economic theory offers different explanations for bringing
businesses together under common ownership
Economic theories and multibusiness firms
Why do
multibusiness
firms
exist?
Multibusiness firms
can, under certain
circumstances, be
economically more
efficient/successful
than singlebusiness firms ...
Managers are
motivated to create
multibusiness firms
even if they are not
economically
justified ...
... because of
transaction cost
Transaction Cost
Theory (Oliver
Williamson, 1975)
... because of
specialized resources
and market failures
Theory of Specialized Resources
(David Teeze, 1980)
... because managers
Theory of
are motivated to increase Managerialism
the size of their firms
... because managers in
general act according to Principal Agent
their own personal goals Theory
14
Corporate Strategy
Chapters of course package
1.
Fundamentals of strategic management in
multibusiness firms
2.
Diversification strategies as end product
of portfolio planning
3.
Portfolio planning and portfolio concepts
4.
Merger and acquisition as an instrument
to execute portfolio changes
Prof. Dr. Harald Hungenberg
Friedrich-Alexander-Universität Erlangen-Nürnberg
Lehrstuhl für Unternehmensführung
15
Which diversification strategy is more successful?
Types of diversification strategies
Relationship
of businesses
(markets, processes)
Basis of strategy
Heterogeneous
Identify business
opportunities and
share risks
Conglomerate
diversification
Relational
diversification
• Horizontal
• Vertical
Homogeneous
SBF
1
Transfer and use
common resources
and capabilities
Focused
diversification
2
3
Exploit economies
of scale and
experience
4
5
... // ...
15
Number of
businesses
16
Diversification strategies seem to follow waves of fashion
Empirical results on diversification strategies of companies
Conglomerate
Relational
USA
Germany
3%
9%
19%
19%
11%
28%
33%
45%
39%
33%
Focused
69%
58%
48%
1950
1970
2000
1950
42%
44%
1970
2000
Source: Rumelt (1986); Stratmann (2005)
17
Typically, event studies show better results for focused
diversification
Results of an event study by Comment/Jarrell (1995)
Share price changes
relative to market (%)
+6
Companies
with decreasing
diversification
+4
+2
0
-2
-4
Companies
with increasing
diversification
-6
-8
Months*
-24 -18
-12
-6
0
6
* Months until end of fiscal year of diversification event
Source: Comment/Jarell (1995)
18
Tobin-q-studies also indicate that focused diversification
strategies lead to superior results
Results of a Tobin-q-Study by Lang/Stulz (1994)
Market value
= Tobin q
Reproduction value
1,5
•
1,0
•
•
•
•
•
0,5
•
•
Herfindahl-Index
Segments
Number of segments
Source: Lang/Stulz (1994)
1
2
3
4
1,0
1,0
-0,8
0,8
-0,6
0,6
-0,4
>5
Herfindahl0,4 Index (sales)
-0
19
The criticisms of diversification culminates in the
"conglomerate discount"
Definition of conglomerate discount and calculation at company level
Market value
company
Value
Division 1
Conglomerate discount
Value gap of diversified
firms compared to
focused firms
Value
Division 2
Value
Division 3
Conglomerate
discount
"Stand
alone"
Split-up
costs
Split-up
potential
20
Companies like Siemens are most likely also valued at
a "discount"
External assessment of Siemens' groups values versus market value
June 2000
ICN
22"7
ICM
35"3
SBS
10"9
A&D
9"5
I&S
1"9
SD
1"7
Osram 4"6
SBT
3"6
PG
2"8
PTD
2"2
TS
1"2
SV
2"1
MED
8"9
June 2003
107"4
Conglomerate
discount
85
58"7
44
Sum of
the parts
Market
value
June
2000
Market
value
June
2003
Sum of
the parts
4"2
6"7
2"3
9"6
0"8
1"0
5"5
2"9
6"6
2"1
3"1
4"1
9"8
ICN
ICM
SBS
A&D
I&S
SD
Osram
SBT
PG
PTD
TS
SV
MED
Source: Goldman Sachs (2000), JP Morgan (2003)
21
The "excess-value-study" tries to quantify the conglomerate
discount
Charakteristics of companies studied by Berger/Ofek (1995)
•
•
•
•
3.659 US-companies
1986 – 1991
At least 20 Mio. sales
Segment reporting
Number of segments
Capital (Mill. $)
Indebtedness
Taxes/sales
Investment/sales
Sales per segment (Mill. $)
Assets per segment (Mill. $)
One-segment
companies*
Multiple-segment
companies*
1,0
878
28%
27%
8,7%
776
784
2,9
1.961
31%
24%
10,1%
649
549
* Mean
Source: Berger/Ofek (1995)
22
Multiple-segment companies demonstrate a conglomerate
discount
"Excess values" of single- and multiple-segment companies
Excess value
Single-segment
companies
Multiple-segment
companies
Multiples
Mean
Median
Mean
Median
Market value/Sales
Market value/Assets
Market value/EBIT
0,001
0,014
0,073
0,000
0,000
0,009
-0,097*
-0,122*
-0,061*
-0,106*
-0,162*
-0,079*
* Signifikant at 1 %-level
Market values
are lower than
the "sum-of-theparts"-values
Source: Berger/Ofek (1995)
23
Some conglomerate fulfill capital markets requirements
better than others
Results BCG study "Premium Conglomerates"
Premium
Conglomerates
Stock price
(Index)
500
400
S&P
500
300
200
Weak
conglomerates
100
1987 1989 1991 1993 1995 1997
Source: BCG, 2000
24
What are the drivers of success?
Drivers of success of highly diversified companies
Drivers of success
of diversified companies
Drivers of success
of all companies
+
1
Clear and consistent
portfolio strategy
1
Consistent value
Management
2
Efficient capital allocation
2
Clear corporate governance
3
Appropriate role of the
corporate center
3
Internal and external
transparency
4
Management initiatives
4
Exploiting taxation and
financing advantages
5
Management
development
5
Lead, not follow the
capital market
25
Premium conglomerates are looking for similarity in terms of
management skills needed
Strategic portfolio criteria of General Electric
Concentration on businesses ...
• ... that require substantial investment
in product development or
infrastructure
• ... that compete against a limited
number of big competitors
• ... that rely on long-running
technologies
• ... that periodically require billions of
investment
• General Electric is engaged in
different product businesses
• Concentration on one dominant
category of management skills
(at least 70 % of businesses)
• Applying common management
processes and systems
Theory:
"Diversity" not diversification
destroys value/determines
conglomerate discount
26
Premium conglomerates invest more in high-performing
businesses
Differences between high- and low-performing conglomerates
High-performing
conglomerates
Investment in
businesses
with ...
ROCE >
Cost of capital
+ 115 %
+6%
+ 14 %
Neutral
ROCE <
Cost of capital
Low-performing
conglomerates
- 29 %
+ 72 %
+ 22 %
Source: BCG, November 1998
27
Corporate Centers can create value by influencing and
relating their businesses
Options for corporate center value creation
Corporate Center
„Leading“
Business
Unit 1
„Synergy“
Influencing single businesses
(objectives/incentives, investment,
management, initiatives, …)
Business
Unit 2
Business
Unit 3
Business
Unit 4
Relating businesses
(bundling resources, transfering of skills,
coordinating market presence, …)
28
GE is probably the best example for successful management
initiatives
Management initiatives of GE (1980 – 2008) - examples
"Be number one or number two"
"Elimination of all non-value-adding costs"
"Globalization"
Crossbusiness
management
initiatives
"6-sigma"
"Service"
"Destroy your business"
"Leaner, faster, more customer focused"
1980
2008
29
Management development can become a core value driver
Management development in diversified firms
Personnel management
• Recruiting, development
incentives
• Performance culture
Rotation of managers
• Regional and
functional mobility
• Rotation based on
experiences / skills
Corporate universities
• Qualification
• Network-building and
exchange
• Internal communication
30
At Siemens, the situation has changed dramatically
External assessment of Siemens' groups values versus market value
22"7
ICN
35"3
ICM
10"9
SBS
9"5
A&D
1"9
I&S
1"7
SD
Osram 4"6
3"6
SBT
PG
2"8
2"2
PTD
TS
1"2
2"1
SV
8"9
MED
June 2000
107"4
85
Sum of
the parts
Market
value
June
2000
June 2008
Conglomerate
discount
92"8
89
Market
value
June
2008
Sum of
the parts
8"6
NSN
1"8
21"6
4"0
SIS
A&D
I&S
5"4
3"5
14"0
6"6
2"2
6"6
18"5
Osram
SBT
PG
PTD
TS
SV
MED
Source: Goldman Sachs (2000), Siemens AG , CD S
31
Corporate Strategy
Chapters of course package
1.
Fundamentals of strategic management in
multibusiness firms
2.
Diversification strategies as end product
of portfolio planning
3.
Portfolio planning and portfolio concepts
4.
Merger and acquisition as an instrument
to execute portfolio changes
Prof. Dr. Harald Hungenberg
Friedrich-Alexander-Universität Erlangen-Nürnberg
Lehrstuhl für Unternehmensführung
32
The BCG growth-share matrix pioneered the portfolio concept
Structure and background of BCG portfolio
Volume
Market
growth
•
Question
marks
Stars
Poor dogs
Cash cows
•
•
Time
Life
cycle
Experience
curve
•
•
Relative
market share
Cost
per
unit
•
•
Cumulative
output
33
Almost 45% of GE's revenues were achieved in markets with
low growth by businesses in weak positions
Portfolio of General Electric in 1984
30
Nominal
annual
25
market
growth
(1984- 1994)
Mobile communications(1)
= $1.0B
GE 1984 revenue
20
Engineered plastics
Military aircraft engines
15
10
Commercial aircraft engines
Lighting (ROW) *
Small household appliances
Semiconductors*
Station TV
6.0% market
growth for all GE
markets
Revenue by quadrant ($B)
5
0
Lighting (USA)
Natural resources
-5
0.33
2%
23%
44%
31%
Major appliances
Aerospace
1
3
GE relative market share (1984)
Source: The Boston Consulting Group
34
Market leadership in almost all business activities
Portfolio of General Electric in 1994
Nominal
annual
market
growth
(‘94- ‘00)
30
25
= $1.0B
GECS
Silicones
GE 1994 revenue
20
Industrial gas turbines
Engineered plastics
Lighting USA
15
Network TV (NBC)
Station TV
10
6.0% market
growth for all GE
markets
5
Revenue by quadrant ($B)
0
Motors/components
-5
1
52%
11%
29%
3
Medical systems
Source: The Boston Consulting Group
8%
Major appliances
GE relative market share (1994)
35
Assess the balance of this portfolio and define strategic
thrusts for businesses
Portfolio of RWE 2003 - unofficial
Market
growth
Business units
2
1.
2.
3.
4.
5.
Electricity Germany
Electricity UK
Gas (Germany)
Water UK
Environmental services
(Germany)
6. Heidelberger Druck (world)
7. Hochtief (world)
1
High
4
5
3
Low
6
7
Relative market share
1.0
36
Assess the balance of this portfolio and define strategic
thrusts for businesses
Portfolio of Deutsche Telekom 2003 (selected businesses) - unofficial
Market
growth
Selected business units
7
8
5
High
1.
2.
3.
4.
5.
6.
7.
8.
9.
9
6
4
2
Low
3
T-Com: Access
T-Com: Basic telephony
T-Com: Handsets
T-Systems: VCN
T.Systems: IP-VCN
T-Mobile: Telephony GSM
T-Mobile: mCommerce
T-Online: Internet access PC
T-Online: Horizontal portals
1
Relative market share
1.0
37
The following portfolio matrices varied or refined the external
and internal factors
Characteristics of important portfolio matrices
Portfolio matrix
External factors
Internal factors
Growth-share matrix
(BCG)
Market growth
Market share
Industry attractivenessbusiness strength matrix
(McKinsey)
Industry attractiveness
determined by critical
structural factors
Business strength
determined by critical
success factors
Life-cycle matrix (Arthur
D. Little)
Industry maturity
(based on life-cycle
approach)
Business strength
determined by overall
competitive position
.
.
.
38
The basic idea of portfolio design is to develop strong
business units in attractive industries
McKinsey's market attractiveness / business strength matrix
Industry
attractiveness
• Market growth
• Market size
• Competitive
structure
• Barriers to
entry
• ...
High
Selective
growth
Investment
and
growth
Medium
Selectivity
Selective
growth
Low
Harvest/
divest
Low
Medium
High
•
•
•
•
•
Business
strength
Market share
Financial resources
R & D-position
Brand identity
...
39
Market attractiveness and competitive position are key
drivers of strategy
Portfolio concept of Roland Berger
Market strategies
Market
A
Defend/Grow
Market C
Market
B
Market
Attractiveness
Market D
Market E
Market Market
I
H
Market
G
• Dedicated efforts to protect
and develop these markets
"Keep and optimize"
• Leverage on good position and
optimize returns with no
significant investment in the
markets
Market
F
Market
K
Swing/Exit
"Defend and grow"
Market
L
Keep/Optimize
Competitive position
"Swing or exit"
• Use to sell-out plants;
opportunistically
re-allocate
Source: Roland Berger Strategy Consultants
40
Businesses are assessed according to market
attractiveness and competitive position
Scoring model – example of relevant factors
Criteria for assessing
market attractiveness
•
•
•
•
•
•
Market size
Growth
Revenue
Cyclicity
Industry structure
Market entry barriers
• Int‘l orientation
10 %
5%
30 %
15 %
10 %
15 %
15 %
100 %
Criteria for assessing
competitive position/fit
Priorisation
of businesses/
resource
allocation
• Relative market
share/leadership
• Relative market
growth
• Relative profitability
• Ability to go
international
• Synergy potential
• Power of raw
materials suppliers
• Cost structure
20 %
20 %
30 %
10 %
10 %
5%
5%
100 %
Source: Roland Berger Strategy Consultants
41
Value-based portfolio planning relies on concepts of value
management
Concepts of value management
Discounted Cash
Flow model
Return on Capital
Employed concept
Economic Value
Added concept
Discounted
cash flow
Spread
EVA
Sum of the discounted future
free cash flows
ROCE (Profit/
capital employed)
- Cost of capital
Profit – capital
charge (WACC*
capital employed)
Value
creation
DCF > O
ROCE > WACC
EVA > O
Profit > Capital charge
Time
frame
Overall life cycle
of an investment/
business
Single year/years
Single year/years
Measure
of success
42
The return/delta capital employed portfolio distinguishes
return and growth as main value drivers
Return/growth portfolio concept
"Spread"
Reasons for changes
"Cash-cow"
"Star"
A growing
business with
a positive spread
creates value
ROCE
>
WACC
=
"Poor dog"
"Question mark"
-
0
+
Investment
Divestment
A growing
business with
negative spread
destroys value
increasingly
ROCE
<
WACC
Improved
efficiency
Declining
efficiency
Changes of capital
employed
43
EVA considers the profitability of a business and its cost of
capital
Concept of Economic Value Added
Operating
profit*
NOPAT
Operating
taxes
EVA
Capital
employed
Capital
charge
EVA
2004
EVA
2005
EVA
2006
EVA
2007
*
WACC
.
.
.
* Before interest (Net operating profit, EBIT)
44
Combination of current value assessment and strategic
potential leads to traffic light portfolio
BCG traffic light portfolio
Green
Strategic
assessment
Make profitable
Expansion
Improve efficiency/reduce cost
Set priorities
for growth/
acquisition
Up or out
Big play (acquisition)
Small play (organic)
Yellow
Red
Divest
Keep
opportunistic
Review exit
process/effects
on core businesses
Use as cash
generator/
divest
Red
Source: The Boston Consulting Group
Yellow
Green
Financial
performance
45
Value-based portfolio planning can be directly linked to
objective setting and value management
Value matrix and levers of improvement
Efficiency
ROCE
Growth
EVA
WACC
Capital employed
Financing
EVA
46
Value-based portfolio planning can be linked directly to
objective setting and value management
Value matrix of Deutsche Post Worldnet
Mail
30 %
ROCE
2000
Express
12 %
5
3%
2002
5
3%
* Financial services excluded
Source: Annual reports
Logistics
15
Capital employed
(in bill. €)
5
47
Corporate Strategy
Chapters of course package
1.
Fundamentals of strategic management in
multibusiness firms
2.
Diversification strategies as end product
of portfolio planning
3.
Portfolio planning and portfolio concepts
4.
Merger and acquisition as an instrument
to execute portfolio changes
Prof. Dr. Harald Hungenberg
Friedrich-Alexander-Universität Erlangen-Nürnberg
Lehrstuhl für Unternehmensführung
48
Mergers and acquisitions are important instruments to
execute portfolio changes
Forms of corporate development
Internal
development
Joint
development
• A business unit
is set up and
developed
within the
company
• Two or more companies
develop a business unit
jointly without formal
integration
• Acquisition
A business unit
is bought from an
other company
• Different forms of
cooperation:
• Informal
• Contract-based
• Minority shareholding
• Joint venture
• Merger
Two companies
come together
voluntarily to form
a new business
unit
• Internal growth
External
development
49
Divestment is the logical counterpart of M&A
Forms of divestment
Sell-off
Spin-off
Carve-out
Split-up
Shareholder
Shareholder
Shareholder
Shareholder
Company
Company
Company
New owner*
New owner*
* Company, LBO, MBO, MBI, …
50
Mergers and acquisitions have a long history
M&A waves in the USA 1890 to 2000
Globalisation/
value creation
(93 - 01)
Transactions
Conglomerate
era
(65 - 69)
5000
Creating
monopolies
(87 - 04)
Vertical
integration
(16 - 29)
1000
1890
1900
1910
1920
1930
1940
1950
1960
1970
1980
1990
2000
Source: Müller-Stewens 2000
51
The value of transactions is increasing again
Transaction value M&A, worldwide - in bill. US $
4060
4000
3498
3500
2522
2500
2000
1753
1666
1500
1964
1207 1333
1134
1000
500
2990
3298
3000
373
0
1990
//
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
Source: www.mergers-and-acquisitions.de, www.thomson.com
52
In Germany, the market for corporate control has changed,
but less dramatically
Transaction volume of M&A transactions in Germany
600
Transaction
volume
(in bill. €)
478
400
206
200
34
78
1996
1997
199
163
88
60
63
93
113
2002
2003
2004
2005
2006
0
1998
1999
2000
2001
Source: www.mergers-and-acquisitions.de
53
What are recent examples of mergers and acquisitions?
Examples of mergers and acquisitions
Buyer
Target
Objectives of
akquisitions
Type
Success?
54
Most acquisitions are horizontal acquisitions
Anti-trust typology of acquisitions
Horizontal acquisition
Supplier
Producer
Customer
Supplier
Producer
Customer
same products/markets
Vertical acquisition
Supplier
Producer
Customer
Conglomerate acquisition
Producer
Producer
customer/supplier relationship
no special relationship
1970
75 %
8%
17 %
1990
82 %
10 %
8%
Source: Bühner (1993)
55
The typical pattern of up and down
Stock market reaction to anouncement of Seagram / Vivendi acquisition
56
Research clearly supports criticism of mergers and acquisitions
Summary of research studies on success of M&A
• The majority of M&A transactions
does not lead to value creation for
the shareholders of acquiring firms!
• In almost all cases shareholders
of acquired firms benefit from the
acquisition!
"What can fifty years of research
tell us about the profitability of
mergers? Undoubtedly the most
significant results of this research
has been that no one who has
undertaken a major empirical
study of mergers has concluded
that mergers are profitable i.e. in
the sense that they are more
profitable then alternative forms of
investment“
T. Hogarty
57
Acquisitions fail unless additional value is created
Economic logic of an acquisition decision
Price
premium
Value of
company
prior to
acquisition
Value of
acquired
company
Acquisition
price
Restructuring
(standalone)
Synergy
potential
Integration Value of
corporation
costs
after acquisition and
integration
58
How can the low success rates of acquisitions be explained?
Explanations for failure of acquisitions
Because mistakes are made
during the
acquisition
process!
• Overbidding/paying unreasonable
acquisition premia
• Overoptimistic assessment of value
added through integration/restructuring
• Poor post-acquisition integration leading
to high integration costs
Because
managers don't
intend to create
value!
• Principal-Agent-Theory: Managers act
according to their own objectives
• Theory of managerialism: Managers
strive to maximize company size/
reduce risks
• Evolutionary theory: Managers
strive to spread their ideas
Why are
acquisitions in
most cases not
successful?
59
A big price premium can only be justified in case of
exceptional synergies
Dynamic break-even-analysis
10
Break-evenyears
9
8
7
Synergies*
= 2,5 %
Synergies*
=5%
6
5
Synergies*
= 10 %
4
3
2
1
10 %
20 %
30 %
40 %
Acquisition
premium*
* Annual profit growth as % of stand-alone value
60
In reality big premiums are paid for small synergies
Acquisition premia and synergy effects – results of empirical studies
Profit growth p.a. as %
of stand-alone value
Average acquisition premium
36 %
8 - 10 %
6-8%
37 % Ø = 5 %
2-4%
USA
27 %
6%
4-6%
0-2%
31 %
33 %
18 %
EUR
21 %
36 %
2%
2002
2003
2004
Source: Roland Berger Strategy Consultants
61
Benefit and cost of synergy exploitation are not the same for
all types of synergy
Types of synergy
Operational
synergy
Management
synergy
Finance
synergy
Activities
Combining/sharing,
transferring and
coordinating operational resources
Providing access to
unique resources
Portfolio design
and financial
management
Examples
• Shared Service
Center for IT
• Joint sales and
service staff
• Joint product
development
• Best-practice
knowledge
• Managers with
turnaround
experience
• M&A experts
• Risk reduction
through diversification
• Central credit
financing
• Tax policy
Requirements
Homogeneous or
complementary
resources
Strategic similarities
among businesses
Diversification
62
Operational synergies are based on the integration of value
creating activities
Assessment of synergies
Value
chain
1
Sales/market potentials
2
4
5
6
Purchasing
Production
3
Outbound
logistics
Sales/
Marketing
Customer
Customer
R&D
7
Overhead/Administration
Key
questions
1. How to improve market positions?
2. How to capitalize improved
bargaining power'?
3. How to join R&D forces/integrate
innovation portfolio?
4. How to consolidate the plantstructure?
5. Efficiency potentials from combined
logistics?
6. How to strengthen the marketing
sales forces (effectiveness/
efficiency)?
7. How to optimize overhead
structures?
63
What are the financial implications of this acquisition?
Newspaper report on acquisition of BOC by Linde (Süddeutsche Zeitung, March 06)
64
What are the financial implications of this acquisition?
Newspaper report on acquisition of BOC by Linde (Süddeutsche Zeitung, March 06)
Linde Becomes Market Leader
The industrial gas producer Linde has reached its goal, getting the opportunity to acquire the British competitor BOC, which had until
now refused all take over offers. Through this acquisition, Linde is set to become the global market leader for industrial gases. The
share price of the company went up substantially.
Linde had been pushing the BOC acquisition under the internal project name “Phoenix” over the last few months. In January, BOC
rejected a preliminary offer that ranged around 15 pounds per BOC share. Now, the resistance has been overcome. Linde has
increased its offer and now offers 16 pounds per share, which implies a 39% premium on top of the price that the BOC share
commanded in January, prior to the first offer. The total acquisition sum will be around 12,4 billion Euro. BOC has accepted the
increased offer and recommended to its shareholders to do the same.
Through the acquisition of BOC, Linde will become the global leader for industrial gases. Revenues of the merged corporation will be
11,9 billion Euro in this market segment. The previous market leader, Air Liquide, has moved down to second place. Linde CEO
Wolfgang Reitzle comments that this acquisition has historic dimensions, driven by the growth potential of the merger. Both
companies “fit together perfectly”, because their product portfolios and their geographic presence are complementary.
Cutting overhead costs
As a result of the BOC-acquisition, the Linde CEO expects annual synergies of around 250 million Euro, which will take effect
completely for the first time in 2009. These savings stem primarily from improvements in sales and supplier relationships, in addition
to savings in the administration. Reitzle expects one-time expenses, which typically accrue for projects of this type, to amount to a
total of 200 million Euro until the end of 2008.
65
In most cases the costs of implementing synergies are
significant and 'front-loaded'
Categories of integration costs
Employeerelated costs
Facilityrelated costs
• Severance, early
retirement
• Relocation
• Staff expansion
• Stay bonus
• Placement services
• Search fees
•
•
•
•
Typical breakdown of
integration costs
15 %
Hidden
15 %
Facilityrelated
Capital for new plants
Moving costs
Renovating costs
Shutdown costs
Severance
Others
70 %
• Consultant fees
• Transaction costs
'Hidden costs' • Consolidation of
systems (e.g. Mis)
Employeerelated
35 %
35 %
Relocation
66
How can the low success rates of acquisitions be explained?
Explanations for failure of acquisitions
Because mistakes are made
during the
acquisition
process!
• Overbidding/paying unreasonable
acquisition premia
• Overoptimistic assessment of value
added through integration
• Poor post-acquisition integration
leading to high integration costs
Why are
acquisitions in
most cases not
successful?
• Principal-Agent-Theory: Managers act
according to their own objectives
Because
managers don't
intend to create
value!
• Theory of managerialism: Managers
strive to maximize company size/
reduce risks
• Evolutionary theory: Managers
strive to spread their ideas
67
Acquisitions offer growth potential that many companies
could not use otherwise
Connection between company size and acquisitions
Revenue
Company size as managerial motive:
• Positive relation between size and
compensation
Acquisition
• Power of managers increases with
increasing company size (resource
base)
• Big companies are politically
important and create status and
prestige for managers
t
Is acquisition
the prefered option
of weak firms?
68