BUS 499, Week 6: Acquisition and Restructuring Strategies Slide # Topic Narration 1 Introduction Welcome to Business Administration. In this lesson we will discuss Acquisition and Restructuring Strategies. Please go to the next slide. 2 Objectives Upon completion of this lesson, you will be able to: Identify various levels and types of strategy in a firm. Please go to the next slide. 3 Supporting Topics In order to achieve this objective, the following supporting topics will be covered: The popularity of merger and acquisition strategies; Reasons for acquisitions; Problems in achieving acquisition success; Effective acquisitions; and Restructuring. Please go to the next slide. 4 The Popularity of Merger and Acquisition Strategies The acquisition strategy has been a popular strategy among U.S. firms for many years. Some believe that this strategy played a central role in an effective restructuring of U.S. business during the 1980s and 1990s and into the twenty-first century. An acquisition strategy is sometimes used because of the 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. 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. Please go to the next slide. 5 Mergers, Acquisitions, and Takeovers A merger is 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. An acquisition is a strategy through which one firm buys a controlling, or one hundred percent, interest in another firm with the intent of making the acquired firm a subsidiary business within its portfolio. In this case, the management of the acquired firm reports to the management of the acquiring firm. Although most mergers are friendly transactions, acquisitions can be friendly or unfriendly. A takeover is a special type of an acquisition strategy wherein the target firm does not solicit the acquiring firm’s bid. The number of unsolicited takeover bids increased in the economic downturn of 2001 to 2002, a common occurrence in economic recessions; because the poorly managed firms that are undervalued relative to their assets are more easily identified. On a comparative basis, acquisitions are more common than mergers and takeovers. Please go to the next slide. 6 Reasons for Acquisitions There are a number of reasons firms decide to acquire another company. These are: Increased market power; Overcoming entry barriers; Cost of new product development and increased speed to market; Lower risk compared to developing new products; Increased diversification; Reshaping the firm’s competitive scope; and Learning and developing new capabilities. Although each reason can provide a legitimate rationale, acquisitions are not always as successful as the involved parties want to be the case. We will briefly look at each reason next. Please go to the next slide. 7 Reasons for Acquisitions, continued A primary reason for acquisitions is to achieve greater market power. To increase their market power, firms often use horizontal, vertical, and related acquisitions. The acquisition of a company competing in the same industry as the acquiring firm is referred to as a horizontal acquisition. Horizontal acquisitions increase a firm’s market power by exploiting cost-based and revenue-based synergies. Research suggests that horizontal acquisitions result in higher performance when the firms have similar characteristics. A vertical acquisition refers to a firm acquiring a supplier or distributor of one or more of its goods or services. A firm becomes vertically integrated through this type of acquisition in that it controls additional parts of the value chain. The acquisition of a firm in a highly related industry is referred to as a related acquisition. Another commonly used reason for acquisitions is to overcome barriers to enter markets. The barriers could be expenses, pursuing relationship with new customers or entering international markets. Acquisitions made between companies with headquarters in different countries are called cross-border acquisitions. Facing the entry barriers that economies of scale and differentiated products create, a new entrant may find acquiring an established company to be more effective than entering. Please go to the next slide. 8 Reasons for Acquisitions, continued Acquisitions are another means a firm can use to gain access to new products and to current products that are new to the firm with minimum investment of firm’s resources, including time, making it easier to quickly earn a profitable return. Acquisitions can also lower risk compared to developing new products because the outcomes can be estimated more easily and accurately than outcomes of an internal product development process. Increased diversification is another reason for acquisitions. It is usually difficulty for companies to develop products that differ from their current lines for markets in which they lack experience. Therefore, acquisition strategies are used to support both unrelated and related diversification strategies. Please go to the next slide. 9 Reasons for Acquisitions, continued Firms sometimes use acquisition strategies to reduce the negative effects of an intense rivalry on their financial performance and to lessen their dependence on one or more products or markets. Reducing a company’s dependence on specific markets shape the firms competitive scope Some acquisitions are made to gain capabilities that the firm does not possess. For example, acquisitions may be used to acquire a special technological capability. Research has shown that firms can broaden their knowledge base and reduce inertia through acquisitions. Therefore, acquiring a firm with skills and capabilities that differ from its own helps the acquiring firm to gain access to new knowledge and remain agile. For example, research suggests that firms increase the potential of their capabilities when they acquire diverse talent through cross-border acquisitions. This greater value is created through international expansion versus a simple acquisition without such diversity and resource creation potential. Of course, firms are better able to learn these capabilities if they share some similar properties with the firm’s current capabilities. Thus, firms should seek to acquire companies with different but related and complementary capabilities in order to build their own knowledge base. Please go to the next slide. 10 Check Your Understanding 11 Problems in Achieving Acquisition Success Research suggests that twenty percent of all mergers and acquisitions are successful, approximately sixty percent produce disappointing results, and the remaining twenty percent are clear failures. Some of the potential problems include: The difficulty of effectively integrating the firms involved; Incorrectly evaluating the target; Creating large or extraordinary debt; Inability to achieve synergy; Creating too much diversification; Creating an internal environment where mangers become overly focused on acquisitions; and Developing a combined firm that is too large, necessitating extensive use of bureaucratic, rather than strategic, controls. Please go to the next slide. 12 Effective Acquisitions Acquisition strategies do not always lead to above-average returns; however the probability of success increases when the firm’s actions are consistent with the attributes the following attributes. One. Acquired firm has assets or resources that are complementary to the acquiring firm’s core business Two. Acquisition is friendly; Three. Acquiring firm conducts effective due diligence to select target firms and evaluate the target firm’s health; Four. Acquiring firm has financial slack. Five. Merged firm maintains low to moderate debt position Six. Acquiring firm has sustained and consistent emphasis on R&D and innovation; and Seven. Acquiring firm manages change well and is flexible and adaptable. Please go to the next slide. 13 Restructuring Defined formally, restructuring is a strategy through which a firm changes its set of businesses or its financial structure. From the 1970s into the 2000s divesting businesses from company portfolios and downsizing accounted for a large percentage of firms’ restructuring strategies. Restructuring is a global phenomenon. Three restructuring strategies are used: downsizing, downscoping, and leveraged buyouts. Once thought to be an indicator of organizational decline, downsizing is now recognized as a legitimate restructuring strategy. Downsizing 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. Downscoping has a more positive effect on firm performance than downsizing does. Downscoping refers to some 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. 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, or LBO, is a restructuring strategy whereby a party buys all of a firm’s assets in order to take the firm private. Downsizing does not commonly lead to higher firm performance. Still, in free-market-based societies at large, downsizing has generated an incentive for individuals who have been laid off to start their own business. An unintentional outcome of downsizing is that laid-off employees often start new businesses in order to live through the disruption of their lives. Downsizing also tends to result in a loss of human capital in the long term. Please go to the next slide. 11 Summary We have reached the end of this lesson. Let’s take a look at what we have covered. First, we discussed mergers, acquisitions, and takeovers. A merger is a strategy through which two firms agree to integrate their operations on a relatively coequal basis. An acquisition is a strategy through which one firm buys a controlling, or one hundred percent, interest in another firm with the intent of making the acquired firm a subsidiary business within its portfolio. In this case, the management of the acquired firm reports to the management of the acquiring firm. A takeover is a special type of an acquisition strategy wherein the target firm does not solicit the acquiring firm’s bid. Next, we went over reasons for acquisitions. These include: Increased market power; Overcoming entry barriers; Cost of new product development and increased speed to market; Lower risk compared to developing new products; Increased diversification; Reshaping the firm’s competitive scope; and Learning and developing new capabilities. . We then discussed problems in achieving acquisition success Some of the problems include Integration difficulties; Inadequate evaluation to target; Large or extraordinary debt; Inability to achieve synergy; Too much diversification; Mangers overly focused on acquisitions; and Too large. Then, we went over the attributes of successful acquisitions. The attributes are Acquired firms has complementary resources; Acquisitions is friendly; Effective due diligence is conducted; Merged firm maintains low to moderate debt position; and Acquiring firm has financial slack, consistent emphasis on R&D and innovation, and is flexible and adaptable. We concluded the lesson with a discussion on restructuring. Restructuring is a strategy through which a firm changes its set of businesses or its financial structure. Some of the strategies used in restructuring are downsizing, downscoping, and leveraged buyouts. This completes this lesson.