1. Acquisition and Restructuring Strategies Hitt, Ireland, and Hoskisson
Chapter 7
Acquisition and Restructuring Strategies
Hitt, Ireland, and Hoskisson
As noted in the previous chapter, diversification allows a firm to create value by productively using excess resources. In this chapter, we explore mergers and acquisitions, often combined with a diversification strategy, as a prominent strategy employed by firms throughout the world.

2. Acquisition is increasingly popular
Acquisition strategies are increasingly popular due to
Globalization
Deregulation of many industries in different economies
favorable legislation
Resulting increase in number and size of domestic and cross-border acquisitions, especially from emerging economies.
Acquisition strategies are becoming more popular with firms – particularly those that cross country borders (where one firm is headquartered in one country acquiring a firm headquartered in another country).
An acquisition strategy is sometimes used because of uncertainty in the competitive landscape. A firm may make an acquisition to increase its market power because of a competitive threat, to enter a new market because of the opportunity available in that market, or to spread the risk due to the uncertain environment. In addition, as volatility brings undesirable changes to its primary markets, a firm may acquire other companies to shift its core business into different markets.
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3. Definitions Merger Acquisition Takeover
A strategy through which two firms agree to integrate their operations on a relatively coequal basis. Few true mergers actually occur, because one party is usually dominant in regard to market share or firm size.
Acquisition
A strategy through which one firm buys a controlling, or 100 percent, interest in another firm with the intent of making the acquired firm a subsidiary business within its portfolio.
Takeover
A special type of an acquisition strategy wherein the target firm does not solicit the acquiring firm’s bid.
This slide shows the definitions for three concepts: merger, acquisition, and takeover. On a comparative basis, acquisitions are more common than mergers and takeovers.
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4. Reasons for acquisition strategies
Firms use acquisition strategies to
Increase market power
Overcome entry barriers to new markets or regions
Avoid product development cost; increased speed to market
Reduce the risk of entering a new business
Become more diversified
Avoid excessive competition
Learn and develop new capabilities
The strategic management process calls for an acquisition strategy to increase a firm’s strategic competitiveness as well as its returns to shareholders. Thus, an acquisition strategy should be used only when the acquiring firm will be able to increase its value through ownership of the acquired firm and the use of its assets. This slide shows reasons that support the use of an acquisition strategy. Although each reason can provide a legitimate rationale for an acquisition, the acquisition may not necessarily lead to a competitive advantage.
A primary reason for acquisitions is to achieve greater market power. Defined in Chapter 6, market power exists when a firm is able to sell its goods or services above competitive levels or when the costs of its primary or support activities are lower than those of its competitors. Market power usually is derived from the size of the firm and its resources and capabilities to compete in the marketplace. It is also affected by the firm’s share of the market. Therefore, most acquisitions that are designed to achieve greater market power entail buying a competitor, a supplier, a distributor, or a business in a highly related industry to allow the exercise of a core competence and to gain competitive advantage in the acquiring firm’s primary market.
Barriers to entry (discussed in Chapter 2) are factors associated with the market or with the firms currently operating in it, which increase the expense and difficulty faced by new ventures trying to enter that particular market. Although an acquisition can be expensive, it does provide the new entrant with immediate market access.
Acquisitions are another means a firm can use to gain access to new products and to current products that are new to the firm. Compared with internal product development processes, acquisitions provide more predictable returns as well as faster market entry. Returns are more predictable because the performance of the acquired firm’s products can be assessed prior to completing the acquisition.
Because the outcomes of an acquisition can be estimated more easily and accurately than the outcomes of an internal product development process, managers may view acquisitions as lowering risk.
Acquisitions are also used to diversify firms. Based on experience and the insights resulting from it, firms typically find it easier to develop and introduce new products in markets currently served by the firm. In contrast, it is difficult for companies to develop products that differ from their current lines for markets in which they lack experience. Thus, it is uncommon for a firm to develop new products internally to diversify its product lines.
To reduce the negative effect of an intense rivalry on their financial performance, firms may use acquisitions to lessen their dependence on one or more products or markets. Reducing a company’s dependence on specific markets alters the firm’s competitive scope.
Some acquisitions are made to gain capabilities that the firm does not possess, for example, such as acquiring a special technological capability. Research has shown that firms can broaden their knowledge base and reduce inertia through acquisitions.
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5. Problems Problems with using an acquisition strategy include
Integration difficulties
Inadequate evaluation of target
Large or extraordinary debt
Inability to achieve synergy
Too much diversification
Managers overly focused on acquisitions
Too large, resulting in bureaucracy
Acquisition strategies are not risk-free, as shown in this slide. Research suggests that perhaps 20 percent of all mergers and acquisitions are successful, approximately 60 percent produce disappointing results, and the remaining 20 percent are clear failures.
Integrating two companies following an acquisition can be quite difficult. Integration challenges include melding two disparate corporate cultures, linking different financial and control systems, building effective working relationships (particularly when management styles differ), and resolving problems regarding the status of the newly acquired firm’s executives.
Due diligence is a process through which a potential acquirer 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 and target firm, tax consequences of the transaction, and actions that would be necessary to successfully meld the two workforces. Due diligence is commonly performed by investment bankers, accountants, lawyers, and management consultants specializing in that activity, although firms actively pursuing acquisitions may form their own internal due-diligence team. The failure to complete an effective due-diligence process may easily result in the acquiring firm paying an excessive premium for the target company.
Junk bonds are a financing option through which risky acquisitions are financed with money (debt) that provides a large potential return to lenders (bondholders). Junk bonds are now used less frequently to finance acquisitions, and the conviction that debt disciplines managers is less strong. Nonetheless, some firms still take on significant debt to acquire companies.
Synergy exists when the value created by units working together exceeds the value those units could create working independently. That is, synergy exists when assets are worth more when used in conjunction with each other than when they are used separately. For shareholders, synergy generates gains in their wealth that they could not duplicate or exceed through their own portfolio diversification decisions. Synergy is created by the efficiencies derived from economies of scale and economies of scope and by sharing resources (e.g., human capital and knowledge) across the businesses in the merged firm.
Diversification strategies can lead to strategic competitiveness and above-average returns. At some point, however, firms can become overdiversified. The level at which overdiversification occurs varies across companies because each firm has different capabilities to manage diversification. Overdiversification leads to a decline in performance, after which business units are often divested. Even when a firm is not overdiversified, a high level of diversification can have a negative effect on the firm’s long-term performance. Another problem resulting from too much diversification is the tendency for acquisitions to become substitutes for innovation.
Typically, a considerable amount of managerial time and energy is required for acquisition strategies to contribute to the firm’s strategic competitiveness. Both theory and research suggest that managers can become overly involved in the process of making acquisitions.
Many firms seek increases in size because of the potential economies of scale and enhanced market power. At some level, the additional costs required to manage the larger firm will exceed the benefits of the economies of scale and additional market power. The complexities generated by the larger size often lead managers to implement more bureaucratic controls to manage the combined firm’s operations.
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6. Characteristics of effective acquisitions
Characteristics include:
the acquiring and target firms have complementary resources that can be the basis of core competencies in the newly created firm
the acquisition is friendly, thereby facilitating integration of the two firms’ resources
the target firm is selected and purchased based on thorough due diligence
What makes some acquisitions more effective than others? Said another way, what are the characteristics of effective acquisitions?
Results from a research study shed light on the differences between unsuccessful and successful acquisition strategies and suggest that a pattern of actions can improve the probability of acquisition success. The study shows that when the target firm’s assets are complementary to the acquired firm’s assets, an acquisition is more successful. With complementary assets, the integration of two firms’ operations has a higher probability of creating synergy. In fact, integrating two firms with complementary assets frequently produces unique capabilities and core competencies. With complementary assets, the acquiring firm can maintain its focus on core businesses and leverage the complementary assets and capabilities from the acquired firm.
Studies also show that friendly acquisitions facilitate integration of the firms involved in an acquisition. Through friendly acquisitions, firms work together to find ways to integrate their operations to create synergy.
Effective due-diligence processes involving the deliberate and careful selection of target firms and an evaluation of the relative health of those firms (financial health, cultural fit, and the value of human resources) and how it contributes to successful acquisitions.
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7. Characteristics, continued
the acquiring and target firms have considerable slack in the form of cash or debt capacity
the merged 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.
Also contributing to successful acquisitions is when due-diligence processes involve the deliberate and careful selection of target firms and an evaluation of the relative health of those firms (financial health, cultural fit, and the value of human resources). Financial slack in the form of debt equity or cash, in both the acquiring and acquired firms, also frequently contributes to success in acquisitions. Even though financial slack provides access to financing for the acquisition, it is still important to maintain a low or moderate level of debt after the acquisition to keep debt costs low. When substantial debt was used to finance the acquisition, companies with successful acquisitions reduced the debt quickly, partly by selling off assets from the acquired firm, especially noncomplementary or poorly performing assets. For these firms, debt costs do not prevent long-term investments such as R&D, and managerial discretion in the use of cash flow is relatively flexible.
Flexibility and adaptability are the final two attributes of successful acquisitions. When executives of both the acquiring and the target firms have experience in managing change and learning from acquisitions, they will be more skilled at adapting their capabilities to new environments. As a result, they will be more adept at integrating the two organizations, which is particularly important when firms have different organizational cultures.
Efficient and effective integration may quickly produce the desired synergy in the newly created firm. Effective integration allows the acquiring firm to keep valuable human resources in the acquired firm from leaving.
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8. Restructuring
Restructuring is used to improve a firm’s performance by correcting for problems created by ineffective management.
Restructuring by downsizing involves reducing the number of employees and hierarchical levels in the firm.
Although it can lead to short-term cost reductions, they may be realized at the expense of long-term success, because of the loss of valuable human resources (and knowledge) and overall corporate reputation.
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9. Downscoping
Restructuring through downscoping should reduce the firm’s level of diversification and refocus on core businesses.
Often, the firm divests unrelated businesses to achieve goals.
Downsizing is recognized as a legitimate restructuring strategy. It is a reduction in the number of a firm’s employees and, sometimes, in the number of its operating units, but it may or may not change the composition of businesses in the company’s portfolio. Thus, downsizing is an intentional proactive management strategy, whereas “decline is an environmental or organizational phenomenon that occurs involuntarily and results in erosion of an organization’s resource base.” Downsizing has been shown to be associated with acquisitions, especially when excessive premiums are paid.
Downscoping has a more positive effect on firm performance than does downsizing. Downscoping refers to divestiture, spin-off, or some other means of eliminating businesses that are unrelated to a firm’s core businesses. Commonly, downscoping is described as a set of actions that causes a firm to strategically refocus on its core businesses.
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10. Leveraged buyouts (LBOs)
Definition
a firm is purchased (largely through debt) so that it can become a private entity
Goal
to improve efficiency, performance so firm can be sold successfully in 5-8 years
3 types of LBOs
management buyouts (MBOs)
employee buyouts (EBOs)
whole-firm LBOs.
Traditionally, leveraged buyouts were used as a restructuring strategy to correct for managerial mistakes or because the firm’s managers were making decisions that primarily served their own interests rather than those of shareholders. A leveraged buyout (LBO) is a restructuring strategy whereby a party buys all of a firm’s assets in order to take the firm private.
Usually, significant amounts of debt are incurred to finance a buyout; hence the term leveraged buyout. To support debt payments and to downscope the company to concentrate on the firm’s core businesses, the new owners may immediately sell a number of assets. It is not uncommon for those buying a firm through an LBO to restructure the firm to the point that it can be sold at a profit within a five- to eight-year period.
Management buyouts (MBOs), employee buyouts (EBOs), and whole-firm buyouts, in which one company or partnership purchases an entire company instead of a part of it, are the three types of LBOs. In part because of managerial incentives, MBOs, more so than EBOs and whole-firm buyouts, have been found to lead to downscoping, increased strategic focus, and improved performance. Research has shown that management buyouts can also lead to greater entrepreneurial activity and growth.
Because they provide clear managerial incentives, MBOs have been the most successful of the three.
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11. Restructuring Goal Downscoping
To gain or reestablish effective strategic control of the firm.
Downscoping
Of the three restructuring strategies, downscoping is aligned the most closely with establishing and using strategic controls and usually improves performance more on a comparative basis.
Downscoping generally leads to more positive outcomes in both the short- and the long-term than does downsizing or engaging in a leveraged buyout. Downscoping’s desirable long-term outcome of higher performance is a product of reduced debt costs and the emphasis on strategic controls derived from concentrating on the firm’s core businesses. In so doing, the refocused firm should be able to increase its ability to compete.
Copyright © 2008 Cengage