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FINANCIAL TIMES
MASTERING
STRATEGY
The Complete MBA Companion in Strategy
Horizontal acquisitions: the
benefits and risk to long-term
performance
by Laurence Capron
orizontal mergers and acquisitions - that is to say, those acquisitions that
involve companies operating in the same industry - are generally explained in
one of two ways. Neo-classical economists and strategy scholars argue that M&A
helps businesses improve their competitive position by exploiting synergies, for
example through asset rationalization or the transfer of specific competences. The
other main “school” (rooted in the industrial organization economy) views M&A as a
means for companies merely to increase market power and capture higher profits at
the consumer’s expense.
Empire building, oversized egos, overconfidence, faddishness, and other emotional
and political factors drive mergers too. But the purpose of this article - based on
research into more than 250 companies in Europe and North America - is to explore
the conditions under which horizontal acquisitions can result in greater efficiency
and long-term performance. This subject has gained more attention in the wake of
studies by academics and consulting firms suggesting that 50 to 70 percent of
H
197
acquisitions end in failure. It has also been shown that stockholders of bidding
companies gain little or nothing from the announcement of an acquisition,
presumably because the market is skeptical of the ability of managers to recoup the
control premium and post-merger integration costs.
It is true that acquirers are often overoptimistic about the scale of potential
synergies, but the poor averages mask the fact that some businesses do manage to
enhance performance and more than offset the implementation cost.
Cost and revenue synergies
Two types of synergy need to be distinguished: cost based and revenue based.
Cost-based synergies generally receive more attention since horizontal
acquisitions are typically seen as a mechanism to reduce costs by acquiring
overlapping businesses. Traditionally, such acquisitions have been considered an
effective means of achieving economies of scale in manufacturing, as well as in R&D,
administrative, logistics, and sales functions. For example, in a mature industry
characterized by severe cost-reduction pressure, product standardization, and high
advertising expenditures, an acquisition makes it possible to increase volume and
standardization, and to spread fixed costs without adding substantial capacity to
the industry.
Revenue-based synergy can be exploited if merging businesses develop new
competences that allow them to command a price premium through higher innovation capabilities (product innovation, time-to-market, etc.) or to boost sales volume
through increased market coverage (geographic market and product line extension).
An acquisition can be an effective means of getting access to skills or competences
that are difficult or time consuming to develop in-house or that are not easily
tradable through a market transaction. Successful technology acquisitions, indeed,
can require command of the culture and processes behind that technology. An
acquisition is a way of buying technical competences along with the corporate
context, people, and mindset that have fostered their development.
For example, UK-based Getty Images, a provider of stock photos and film footage
with 25 brick-and-mortar stores worldwide, wanted to make a quick technical and
cultural transition to e-commerce. Thus in 1998, it acquired Seattle-based
PhotoDisc, a distributor of royalty-free photos over the internet, which provided
both technical expertise and a digital culture that Getty Images worked to infuse in
to its other brands.
Although these two paths toward value creation have been identified as reasons
behind the current wave of acquisitions, few empirical studies have investigated the
extent to which merging companies exploit economies of scale and leverage their
competences after acquisition.
Empirical setting
Method
To investigate post-acquisition consolidation practices (asset rationalization and
competence transfer), we used data obtained through a large-scale international
survey in Europe and North America. For this study, we identified more than 2,000
companies in the manufacturing sector that had acquired competing companies
between 1988 and 1992. The 1988-92 period was chosen to exclude both recent deals
where consolidation had not yet taken place and earlier acquisitions whose principal
Horizontal acquisitions: the benefits and risk to long-term performance
actors might have moved on. The companies represent a wide range of industries
mainly in the UK, France, Germany, and the US.
The data are gathered from the responses of managers at 253 horizontally merged
companies: 70 percent were cross-border, 30 percent domestic. Particularly well
represented were chemicals (15 percent), foods (15 percent), and pharmaceuticals
(12 percent).
Pm-acquisition features
Our data showed that acquisitions, in general, are undertaken by strong companies
that target other strong companies. The acquirers’ performance was in 58 percent of
cases superior to and in 31 percent at least equivalent to the industry average. More
than two-thirds of target businesses also performed as well as or better than their
sector average, even if on the whole they were weaker in this area than their wouldbe parents. The same picture emerged when managers were asked about preacquisition resources. The targets were particularly strong vis-à-vis the competition
in commercial and technical areas like R&D and manufacturing. The operational,
managerial, and financial resources of the target businesses before acquisition,
however, were significantly more limited than those of the acquirer.
Acquisition motives
Acquisitions were seen by sample respondents as an effective way for an acquirer to
grow into new markets and to access complementary products, brands, and skills.
Revenue-based synergies seem to drive many acquisitions. For example, 52 percent
of the respondents recognized access to new brands or products as an important
driver of the acquisition. The search for economies of scale seemed less important;
35 percent felt that this was a significant factor in functional areas (R&D, logistics,
administrative). One-fifth of respondents also identified a defensive motive, namely
pre-empting the target at the expense of a competitor, underlining the truth that
strategic motives can be intertwined with tactical ones.
Post-acquisition behavior
Asset rationalization
Figure 1 shows the extent to which the merging company’s assets (facilities and
staff) in R&D, manufacturing, logistics, sales, and administration were significantly
rationalized (divested) after acquisition.
Irrespective of function, significant rationalization measures affect only a small
percentage of merged companies, suggesting that the search for cost-cutting and
downsizing gains motivates only a limited number of horizontal acquisitions. This
interpretation is consistent with the pre-acquisition objectives ranked by managers.
Furthermore, post-acquisition asset rationalization affects the acquiring and
target businesses asymmetrically: the target’s assets are three to five times more
likely to be divested than the acquirer’s assets. For example, 24 percent of the
targets underwent rationalization of manufacturing assets that affected at least 30
percent of their staff or units, while only 7 percent of the acquiring companies faced
an identical experience. Similarly, 26 percent of the targets underwent a
rationalization of administrative services that affected at least 30 percent of staff or
units, while only 5 percent of the acquirers underwent such rationalization.
Manufacturing and administrative functions tend to be the most affected by postacquisition asset divestiture, as their divestiture presents a lower risk of damaging
innovative capabilities, commercial presence, or image.
The asymmetric rationalization of assets supports previous research findings of
economic and behavioral motivations. From an economic standpoint, acquirers in
the same industry as the target can recognize target inefficiencies due to their
experience in managing similar lines of business. From a behavioral standpoint,
acquiring managers are often more confident of their own capabilities than those of
the target. Moreover, it is politically easier for the acquirer to impose divestiture
measures on the target than on its own businesses.
Transfer of competences
Figure 2 shows the extent of competence transfer both to and from the target within
nine competence categories.
competences, either from acquirer to target or target to acquirer. Acquirers transfer
their competences into the target’s businesses, or tap new competences from the
target. This transfer occurs in technical (product innovation, manufacturing),
commercial (sales networks, brand, marketing expertise), and operational areas
(supplier relationship and logistics expertise). For example, 43 percent of
respondents recognized that the acquirer’s network was used to a great extent to
distribute the target’s products, and 35 percent of the respondents reported that the
target’s sales network was used to distribute the acquirer’s products.
Although respondents ranked access to the target’s competences as a more
important motive than the transfer of their competences to the target, in reality the
acquirer is more inclined to transfer its own competences than to use the target’s
competences. There may be several reasons for this: the need for the acquirer’s competences to support the target’s rationalization process; a stronger knowledge and
control of the acquirer’s competence transfer; difficulties in gaining access to the
target’s competences due to information asymmetry; the departure of key target
people and other target disruptions; damaged competences in the post-acquisition
process.
In sum, it seems that time, trust, credibility, and process skills are needed to gain
valuable competences from the target. Only a few businesses, such as NationsBank
(now merged with BankAmerica) or Cisco Systems, the US-based market leader in
data networking, have developed the sophisticated post-acquisition management
processes to retain and leverage the target’s skills and people.
Drivers of performance
Figure 3 shows acquisition performance as assessed by respondents. Respondents
were asked to assess the extent to which the acquisition improved the performance
of both the target and the acquirer, using four performance measures: general
performance; cost savings (cost-based synergies); innovation capabilities (revenuebased synergies); market coverage (revenue-based synergies).
More than half the respondents assessed the acquisition as either unsuccessful or
moderately successful. Only 49 percent of respondents considered the acquisition as
highly successful - consistent with those studies mentioned earlier suggesting that
50 to 70 percent of acquisitions fail to deliver expected benefits. In our research this
result is even more striking as we focus on horizontal acquisitions, or those that
should have higher potential for exploiting synergies due to business relatedness.
This result suggests that, among horizontal acquisitions, there is a huge variation in
acquisition performance. For example, 56 percent of respondents recognized that
the acquisition increased the combined market share of the merging companies.
However, 41 percent reported that the acquisition did not help in developing
additional market share. Similarly, 53 percent of respondents recognized that the
acquisition improved combined profitability, while 47 percent reported that the
acquisition either did not improve, or even damaged, the profitability of the merging
businesses.
From a cost-based synergy standpoint, acquisitions improved the cost position of
the merging companies in fewer than half the cases. But from a capability and
revenue-based synergies standpoint they provided key benefits, especially in market
coverage. Acquisitions were reported to improve R&D capabilities in 49 percent of
the cases, product quality in 47 percent of the cases, and time to market in 47
percent of the cases. More importantly, 64 percent of respondents acknowledged
that acquisitions broadened their product line, while 70 percent reported that they
increased market coverage.
Performance implications
Several implications can be drawn from the above results.
Lesson 1. Managers should pay more attention to competence transfer and
exploitation of revenue-based synergies.
Furthermore, rationalization measures send a clear signal to the market that the
post-acquisition integration process is under way. However, the research shows that
revenue-based synergies, which rest on a longer process of sharing or transferring
competences into a new organizational context, also account for a significant part of
acquisition performance.
Lesson 2. Rationalizing assets through an acquisition does not automatically lead
to cost savings. There is some evidence that the acquirer is generally more effective
in rationalizing its own assets than those of the target.
Interestingly, although acquisitions are rarely followed by a rationalization of the
acquirer’s assets, such a rationalization increases efficiency. This phenomenon may
reflect several factors. It may be that the acquirer already understands and controls
its own assets, while obtaining information on the target’s assets is contingent on
the willingness of the target’s people to collaborate and share information. As a
result, the acquirer may lack insight into the target’s assets and force a
rationalization that is not accepted by the target’s people. Or it may be that the
decision to divest acquirer assets is motivated by a strong economic rationale, while
HorLzonMI acquis/tions: the benefits aod risk to lonp-term performance
both economic and political motives may drive the divestiture of the target’s assets
(which would also explain why the target is three to five times more likely to be
downsized than the acquirer).
Lesson 3. Excessive rationalization of the target’s assets may damage the
innovation and market capabilities of the merging businesses. As the target bears
the brunt of rationalization measures, there is a risk of destroying valuable existing
competences or impeding the development of new competences if the target is
deprived of the organizational slack necessary to innovate and explore new markets.
The negative impact of excessive rationalization can be seen in mergers like those
between Quaker Oats, the US cereals and sport drinks business, and Snapple, a US
soft drinks company, or of two US banks, First Interstate/Wells Fargo. The
acquisition of FI by Wells Fargo in 1996 led to a significant loss of FI clients. Wells
Fargo chose to close FI’s branch network (considered to be an overlap) and 75
percent of the top 500 FI executives left. In this example, not only were cost savings
less than expected, but revenues declined as Wells Fargo tried to replace FI’s
“relational banking” with its own “transaction banking,” switching FI clients from
traditional branches to smaller mechanized branches in supermarkets. As a result,
a significant proportion of FI clients moved to local competitors. FI was sold to
Minneapolis-based Norwest in 1998.
Lesson 4. Cost savings can be achieved through transfer of competences,
particularly to the target.
Thus, asset divestiture per se may not be the most effective way of reducing costs;
transfer of competences can reduce costs by changing the way the target operates its
businesses.
Lesson 5. Competence transfer both to and from targets improves the innovation
and market capabilities of the merging businesses. Thus, acquisition can be an
effective means to leverage competences.
The data indicate that the flow and effectiveness of competence transfer is bidirectional, suggesting that both target and acquirer competences can be exploited.
For example, the merger of Nortel with Bay Networks in 1998 allows Nortel to share
with Bay its competences in circuit technology, and gain access to the internet
protocol (IP) technologies, routing technologies, and ins and outs of running IP
networks that Bay possesses.
Lesson 6. The transfer of the target’s competences into the acquirer’s businesses is
more challenging and less predictable than that of the acquirer’s competences into
the target’s businesses.
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Summary
Two types of synergy - cost and revenue based - are typically used to justify takeovers. But to what
extent do merging companies exploit economies of scale and leverage their competences after
acquisition? In this article - based on a major study of more than 250 merged businesses - Laurence
Capron compares pre-acquisition motives and post-acquisition behavior. Among the conclusions, she
finds that cost cutting and asset downsizing may not be the most effective ways to increase
performance; that managers need to understand the risks of damaging the takeover target: and that they
should pay more attention to transferring competences and exploiting revenue synergies.
Suggested further reading
Capron, L. (1999) “The long-term performance of horizontal acquisitions,” Strategic Management Journal, 20 (11,
Nov.): 987-1018.
Capron, L. and Hulland, J. (1999) “Redeployment of brands, sales forces, and general marketing expertise following
horizontal acquisitions: a resource-based view,” Journal of Marketing, 63 (April): 41-54.
Haspeslagh, P. and Jemison, D. (1991) Managing Acquisitions, New York: The Free Press.
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