1. ©2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Strategic Management: Concepts and Cases 9e Part II: Strategic Actions: Strategy Formulation Chapter 7: Merger and Acquisition Strategies

2. ©2011 Cengage Learning. All rights reserved. 7–2 Mergers, Acquisitions, and Takeovers: What are the Differences? Merger  Two firms agree to integrate their operations on a relatively co-equal basis (yeah, right!!!). Acquisition  One firm buys a controlling (or 100%) interest in another firm with the intent of making the acquired firm a subsidiary business within its portfolio. Takeover  A special type of acquisition when the target firm did not solicit the acquiring firm’s bid for outright ownership.

3. ©2011 Cengage Learning. All rights reserved. 7–3 Reasons for Acquisitions Learning and developing new capabilities Reshaping firm’s competitive scope Increaseddiversification Lower risk than developing new products Cost of new product development Overcoming entry barriers Increase speed to market Increased market power Making an Acquisition

4. ©2011 Cengage Learning. All rights reserved. 7–4 Acquisitions: Increased Market Power Market power is increased by:  Horizontal acquisitions: other firms in the same industry  Vertical acquisitions: suppliers or distributors of the acquiring firm  Related acquisitions: firms in related industries

5. ©2011 Cengage Learning. All rights reserved. 7–5 Market Power Acquisitions Acquisition of a company in the same industry in which the acquiring firm competes increases a firm’s market power by exploiting:  Cost-based synergies  Revenue-based synergies Acquisitions with similar characteristics result in higher performance than those with dissimilar characteristics. Horizontal Acquisitions

6. ©2011 Cengage Learning. All rights reserved. 7–6 Market Power Acquisitions Acquisition of a supplier or distributor of one or more of the firm’s goods or services  Increases a firm’s market power by controlling additional parts of the value chain. Horizontal Acquisitions Vertical Acquisitions

7. ©2011 Cengage Learning. All rights reserved. 7–7 Market Power Acquisitions Acquisition of a company in a highly related industry  Because of the difficulty in implementing synergy, related acquisitions are often difficult to implement. Horizontal Acquisitions Vertical Acquisitions Related Acquisitions X

8. ©2011 Cengage Learning. All rights reserved. 7–8 Acquisitions: A Way To Overcome Entry Barriers Entry Barriers  Factors associated with the market or with the firms operating in it that increase the expense and difficulty faced by new ventures trying to enter that market Economies of scale Differentiated products Cross-Border Acquisitions  Acquisitions made between companies with headquarters in different countries Are often made to overcome entry barriers. Can be difficult to negotiate and operate because of the differences in foreign cultures.

9. International M&A Has Challenges Chinese acquisitions (box on page 194) Chinese state-owned companies not always welcome throughout the world  Primarily natural resource companies like Sinopec, CNOCC, Chinalco Rio Tinto mining declined Chinalco’s acquisition bid because it didn’t want to hand over valuable national mining resources to the Chinalco China is using an acquisition strategy to achieve its objectives and create value, and will continue  Gain access and increase market power ©2011 Cengage Learning. All rights reserved. 7–9

10. ©2011 Cengage Learning. All rights reserved. 7–10 Acquisitions: A Way to Reduce Cost of New- Product Development and Increase Speed to Market Internal development of new products is often perceived as high-risk activity.  Acquisitions allow a firm to gain access to new and current products that are new to the firm.  Returns are more predictable because of the acquired firms’ experience with the products.

11. ©2011 Cengage Learning. All rights reserved. 7–11 Acquisitions: A Way to Lower Risk Compared to Developing New Products An acquisition’s outcomes can be estimated more easily and accurately than the outcomes of an internal product development process.  Managers may view acquisitions as lowering risk associated with internal ventures and R&D investments.  Acquisitions may discourage or suppress innovation.

12. ©2011 Cengage Learning. All rights reserved. 7–12 Acquisitions: A Way to Learn and Develop New Capabilities An acquiring firm can gain capabilities that the firm does not currently possess:  Special technological capability  A broader knowledge base  Reduced inertia Firms should acquire other firms with different but related and complementary capabilities in order to build their own knowledge base.

13. ©2011 Cengage Learning. All rights reserved. 7–13 Problems in Achieving Acquisition Success Too large Managers overly focused on acquisitions Extraordinary debt Inadequate target evaluation Too much diversification Inability to achieve synergy Integrationdifficulties Problems with Acquisitions #1--Culture Mismatch

14. ©2011 Cengage Learning. All rights reserved. 7–14 Problems in Achieving Acquisition Success: Integration Difficulties Integration challenges include:  Melding two disparate corporate cultures. Huge problem and usually not addressed by financial wienies doing the acquisition!!  Linking different financial and control systems  Building effective working relationships (particularly when management styles differ). Takes forever!  Resolving problems regarding the status of the newly acquired firm’s executives. Rarely viewed as equitable. Normally just lasts until loser finds a new company.  Loss of key personnel weakens the acquired firm’s capabilities and reduces its value. Downsizing usually involved. The good guys who can get better jobs leave—you get stuck with the B team.

15. ©2011 Cengage Learning. All rights reserved. 7–15 Problems in Achieving Acquisition Success: Inadequate Evaluation of the Target Due Diligence  The process of evaluating a target firm for acquisition Ineffective due diligence may result in paying an excessive premium for the target company. Evaluation requires examining:  Financing of the intended transaction  Differences in culture between the firms  Tax consequences of the transaction  Actions necessary to meld the two workforces

16. ©2011 Cengage Learning. All rights reserved. 7–16 Problems in Achieving Acquisition Success: Inability to Achieve Synergy Synergy (1+1=3)  When assets are worth more when used in conjunction with each other than when they are used separately. Firms experience transaction costs when they use acquisition strategies to create synergy. Firms tend to underestimate indirect costs when evaluating a potential acquisition.

17. ©2011 Cengage Learning. All rights reserved. 7–17 Problems in Achieving Acquisition Success: Managers Overly Focused on Acquisitions Managers invest substantial time and energy in acquisition strategies in:  Searching for viable acquisition candidates.  Completing effective due-diligence processes.  Preparing for negotiations.  Managing the integration process after the acquisition is completed. Research shows CEOs on average spend 33 hours per week for 4½ months when being acquired. I think it is higher and you have to add the cost of the time of all the other players—CFO, VP Sales, etc., plus all of the water-cooler talk by the non-players. First run the business!!!!

18. ©2011 Cengage Learning. All rights reserved. 7–18 Problems in Achieving Acquisition Success: Managers Overly Focused on Acquisitions Managers in target firms operate in a state of virtual suspended animation during an acquisition.  Executives may become hesitant to make decisions with long-term consequences until negotiations have been completed.  The acquisition process can create a short-term perspective and a greater aversion to risk among executives in the target firm.

19. ©2011 Cengage Learning. All rights reserved. 7–19 Problems in Achieving Acquisition Success: Too Large Additional costs of controls may exceed the benefits of the economies of scale and additional market power. Larger size may lead to more bureaucratic controls. Formalized controls often lead to relatively rigid and standardized managerial behavior. The firm may produce less innovation. X

20. ©2011 Cengage Learning. All rights reserved. 7–20 TABLE 7.1 Attributes of Successful Acquisitions Attributes 1.Acquired firm has assets or resources that are complementary to the acquiring firm’s core business 2.Acquisition is friendly 3.Acquiring firm conducts effective due diligence to select target firms and evaluate the target firm’s health (financial, cultural, and human resources) 4.Acquiring firm has financial slack (cash or a favorable debt position) 5.Merged firm maintains low to moderate debt position 6.Acquiring firm has sustained and consistent emphasis on R&D and innovation 7.Acquiring firm manages change well and is flexible and adaptable Results 1.High probability of synergy and competitive advantage by maintaining strengths 2.Faster and more effective integration and possibly lower premiums 3.Firms with strongest complementarities are acquired and overpayment is avoided 4.Financing (debt or equity) is easier and less costly to obtain 5.Lower financing cost, lower risk (e.g., of bankruptcy), and avoidance of trade-offs that are associated with high debt 6.Maintain long-term competitive advantage in markets 7.Faster and more effective integration facilitates achievement of synergy X

21. ©2011 Cengage Learning. All rights reserved. 7–21 Restructuring A strategy through which a firm changes its set of businesses or financial structure.  Failure of an acquisition strategy often precedes a restructuring strategy.  Restructuring may occur because of changes in the external or internal environments. Restructuring strategies:  Downsizing  Downscoping  Leveraged buyouts

22. ©2011 Cengage Learning. All rights reserved. 7–22

23. ©2011 Cengage Learning. All rights reserved. 7–23 Types of Restructuring: Downsizing A reduction in the number of a firm’s employees and sometimes in the number of its operating units.  May or may not change the composition of businesses in the company’s portfolio. Typical reasons for downsizing:  Expectation of improved profitability from cost reductions  Desire or necessity for more efficient operations

24. ©2011 Cengage Learning. All rights reserved. 7–24 Types of Restructuring: Downscoping A divestiture, spin-off or other means of eliminating businesses unrelated to a firm’s core businesses. A set of actions that causes a firm to strategically refocus on its core businesses.  May be accompanied by downsizing, but not eliminating key employees from its primary businesses. (Intention is not to lose key people.)  Smaller firm can be more effectively managed by the top management team.

25. ©2011 Cengage Learning. All rights reserved. 7–25 Restructuring: Leveraged Buyouts (LBO) A restructuring strategy whereby a party buys all of a firm’s assets in order to take the firm private.  Significant amounts of debt may be incurred to finance the buyout.  Immediate sale of non-core assets to pare down debt.  Sometimes by management with funding from venture capitalists (MBO) Can correct for managerial mistakes  Managers making decisions that serve their own interests rather than those of shareholders. Can facilitate entrepreneurial efforts and strategic growth.

26. Air Line Mergers Don’t Always Help Pax (ADG 081109) Oct 08 study by Justice Dept says loss of potential competitors could drive fares higher by “substantial and significant” amounts. Also, airlines emerging from bankruptcy don’t reduce fares by any meaningful amount Airline mergers help business travelers with more direct flights, but hurt leisure travelers with higher fares US Air acquired Piedmont, American acquired TWA, America West acquired US Airways, SkyWest acquired ASA, TPG Capital acquired Midwest, and now Delta-Northwest merger. ©2011 Cengage Learning. All rights reserved. 7–26

27. Economy Forces New Competitiveness (ADG 081109) Like negative political ads, consumer ads going negative Direct criticism of competitors by name  Called “comparative advertising”  Dunkinbeatsstarbucks.com  Mac Apple vs PC  Fox Business Channel slams MSNBC  Campbell Soup vs Progresso over MSG  Alltel vs all others  Car/Truck ads now heavy on comparison ©2011 Cengage Learning. All rights reserved. 7–27