We begin with a short history of mergers and acquisitions. It is useful to track the changes in direction that merger and acquisition activity have gone through over the last 100 years to achieve a sense of perspective on the different strategies employed. Gaughan (2002) refers to five waves of merger and acquisition activity since 1897 (see box), claiming that we are currently in the fifth wave of this ever-evolving field. However activity has slowed recently, with reported figures showing a 26 per cent reduction in global merger and acquisition activity in 2002.
THE FIVE WAVES OF MERGER AND ACQUISITION ACTIVITY
First wave (1897–1904): horizontal combinations and consolidations of several industries, US dominated.
Second wave (1916–29): mainly horizontal deals, but also many vertical deals, US dominated.
Third wave (1965–69): the conglomerate era involving acquisition of companies in different industries.
Fourth wave: (1981–89): the era of the corporate raider, financed by junk bonds.
Fifth wave: (1992–?): larger mega mergers, more activity in Europe and Asia. More strategic mergers designed to compliment company strategy.
It is important to classify types of merger and acquisition to gain an understanding of the different motivations behind the activity. Gaughan (2002) points out that there are three types of merger or acquisition deal: a horizontal deal involves merging with or acquiring a competitor, a vertical deal involves merging with or acquiring a company with whom the firm has a supplier or customer relationship, and a conglomerate deal involves merging with or acquiring a company that is neither a competitor, nor a buyer nor a seller.
So why do companies embark on a merger or acquisition? The reasons are listed below.
Growth
Most mergers and acquisitions are about growth. Merging or acquiring another company provides a quick way of growing, which avoids the pain and uncertainty of internally generated growth. However, it brings with it the risks and challenges of realizing the intended benefits of this activity. The attractions of immediate revenue growth must be weighed up against the downsides of asking management to run an even larger company.
Growth normally involves acquiring new customers (for example, Vodafone and Airtouch), but can be about getting access to facilities, brands, trademarks, technology or even employees.
Synergy
Synergy is a familiar word in the mergers and acquisitions world. If two companies are thought to have synergy, this refers to the potential ability of the two organizations to be more successful when merged than they were apart (the whole is greater than the sum of the parts). This usually translates into:
- Growth in revenues through a newly created or strengthened product or service (hard to achieve).
- Cost reductions in core operating processes through economies of scale (easier to achieve).
- Financial synergies such as lowering the cost of capital (cost of borrowing, flotation costs).
However, there may be other gains. Some acquisitions can be motivated by the belief that the acquiring company has better management skills, and can therefore manage the acquired company’s assets and employees more successfully in the long term and more profitably.
Mergers and acquisitions can also be about strengthening quite specific areas, such as boosting research capability, or strengthening the distribution network.
Diversification
Diversification is about growing business outside the company’s traditional industry. This type of merger or acquisition was very popular during the third wave in the 1960s (see box). Although General Electric (GE) has flourished by following a strategy that embraced both diversification and divestiture, many companies following this course have been far less successful.
Diversification may result from a company’s need to develop a portfolio through nervousness about the earning potential of its current markets, or through a desire to enter a more profitable line of business. The latter is a tough target, and economic theory suggests that a diversification strategy to gain entry into more profitable areas of business will not be successful in the long run (see Gaughan, 2002 for more explanation of this).
A classic recent example of this going wrong is Marconi, which tried to diversify by buying US telecoms businesses. Unfortunately, this was just before the whole telecoms market crashed, and Marconi suffered badly from this strategy.
Integration to achieve economic gains
Another motive for merger and acquisition activity is to achieve horizontal integration. A company may decide to merge with or acquire a competitor to gain market share and increase its marketing strength.
Vertical integration is also an attraction. A company may decide to merge with or acquire a customer or a supplier to achieve at least one of the following:
- a dependable source of supply;
- the ability to demand specialized supply;
- lower costs of supply;
- improved competitive position.
Pressure to do a deal, any deal
There is often tremendous pressure on the CEO to reinvest cash and grow reported earnings (Selden and Colvin, 2003). He or she may be being advised to make the deal quickly before a competitor does, so much so that the CEO’s definition of success becomes completion of the deal rather than the longer-term programme of achieving intended benefits. This is dangerous because those merging or acquiring when in this frame of mind can easily overestimate potential revenue increases or costs savings. In short, they can get carried away.
Feldmann and Spratt (1999) warn of the seductive nature of merger and acquisition activity. ‘Executives everywhere, but most particularly those in the world’s largest corporations and institutions, have a knack for falling prey to their own hype and promotion…. Implementation is simply a detail and shareholder value is just around the corner. This is quite simply delusional thinking.’
Comparison of reasons for embarking on a merger or acquisition
Reason for M&A activity
Advantages
Disadvantages
Organizational implications
Growth
Immediate revenue growth pleases shareholders.
Reduction in competition (if other party is competitor).
Good way of overcoming barriers to entry to specific areas of business.
More work for the top team.
Hard to sustain the benefits once initial savings have been made.
Cultural problems often hard to overcome, thus potential not realized.
Top team required to make a step change in performance. New arrivals in top team.
Probably some administrative efficiencies.
Integration in some areas if beneficial to results.
Synergy
May offer significant, easy cost-reduction benefits.
Attractive concept for employees (unless they have ‘heard it all before’).
More subtle forms of synergy such as product or service gains may be difficult to realize without significant effort.
Cultural issues may cause problems that are hard to overcome.
Top teams need to work closely together on key areas of synergy. Other areas left intact.
Diversification
May offer the possibility for entering new, inaccessible markets.
Allows company to expand its portfolio if uncertain about current business levels.
Economic theory suggests that potential gains of entering more profitable profit streams may not be realized.
May be hard for top team to agree strategy due to little understanding of each other’s business areas.
Loosely coupled management teams, joint reporting, some administrative efficiencies, separate identities and logos
Integration
Buyer or supplier power automatically reduced if other party is buyer or supplier. More control of customer demands or supply chain respectively.
Reduction in competition (if other party is competitor). Increase in market share/marketing strength.
More work for the top team.
In the case of horizontal integration (other party is a competitor), cultural problems often hard to overcome, thus potential not realized.
Integrated top team, merged administrative systems, tightly coupled core processes, single corporate identity
Deal doing
Seductive and thrilling.
Publicity surrounding the deal augments the CEO’s and the company’s profile.
The excitement of the deal may cloud the CEO’s judgement.
Anyone’s guess