Critically evaluate why so many mergers and acquisitions continue to be made when so many fail.
The phenomenon of mergers and acquisitions (M&A’s) triggers an array of opinions and viewpoints. Often it is a strategy that is seen as a perfect way of achieving growth. It is by no means an organic or natural route to success, but has tended to be a quick and easy way of increasing an organisations size and power. However although there has been ‘waves’ of popularity and success since its introduction in the 1960’s it has also suffered criticism due to the amount of failures it has accounted for. Despite the strong suggestion that this strategy has been the architect for many an organisations downfall there still remains a propensity in the current business environment for managers to adopt it. Throughout this essay I am going to examine some of the areas that explain M&A’s volatility and attempt to discover why managers are persevering with the strategy when it is seemingly flawed.
Over the last few decades it has become increasing apparent that the effect of mergers and acquisitions is not as beneficial as once thought. When the growth strategy was pioneered in the middle part of the nineteen hundreds it was looked upon as a way of creating an empire across different sectors and countries. Many experienced managers were sucked into the strategy, only having eyes for the apparent synergistical and positive affects of M&A’s. Although over the following years there has been many success stories concerning M&A’s, when the big picture is examined it displays a more ugly side of the phenomenon. Hodge (1998) discovered that ‘in the go-go ’80s, 37% of mergers outperformed the average shareholder return in that period; in the first half of the ’90s, that figure rose to 54%’.
Despite the encouraging increase during the early ’90s there remains a disturbing reality that ‘barely one-half of the m&a deals of recent years delivered shareholder value that outperformed even the relevant industry average, much less provided an adequate return on investment’. Added to this he also highlighted that ‘only a paltry 25% of deals valued at 30% or more of the acquirer’s annual revenues could be counted as success’. These statistics represent the flaws that exist within the strategy of M&A’s and clash with the positive theory that ‘analysts and investors expect the merged enterprises to be greater than the sum of its parts’ (Doitte and Smith 1998). Coopers and Lybrand (1993) along with many other writers have studied and expanded on some of the key factors that limit that usefulness of M&A’s.
Target management attitudes and cultural differences ‘heads the list of impediments to the successful melding of two organisations’ (Davenport 1998). This is appropriate not only in the case of cross-border mergers (Daimler Benz-Chrysler) where there many obvious points of concern such as language and communication, but also within the collaboration of firms based in the same country and even industry. Management often have their own ‘way of working’ that suits both themselves and their employees, which may be generated through national or corporate culture. This is generally characterised by unique and individual working practices amongst different firms nation and worldwide. Therefore when a merger or acquisition takes place the result is the combining of two sets of cultures in an attempt to work together.
In most cases the merge looks both safe and profitable in theory, however management frequently underestimate the power of culture. For example when Mellon Bank and the Boston Co merged in 1993 they failed to consider how ‘cultural conflict could drain the combined company of its most important acquired asset of the talents of Boston Co.’s money-management wizards. Offended by Mellon’s cost-conscious management style, a key executive left the organisation. Within the next three months, he had taken 30 of his co-workers with him, along with $3.5 billion assets and many of the firm’s clients’ (Davenport 1998). I think this example emphasizes the risk associated with M&A’s due to their inevitable degree of unpredictability. For this reason alone it is hard to imagine a full proof argument advocating their use in modern business.
Another factor that makes M&A’s a high-risk strategy is the fact that management often have limited knowledge of the industry they are entering. This is obviously the case when two firms from unrelated backgrounds merge (conglomerate integration). In this case management are unaware of the way the industry works and are restricted to simply understanding the bare bones of the business. ‘Differences in traditions, expectations, buying and specification practices, packaging, logistics, labelling, and legal customs and issues can have a surprisingly profound impact on the post-acquisition viability of a target company’ (Price and Sloane 1998).
These differences along with more obvious changes such as product, market and customers make life awkward for management. In most industries it takes time to develop and form bonds with suppliers, customers and even local communities. These types of bonds are usually a result of personal relationships and even friendships that have grown through dealings and negotiations over a long period. M&A’s break up many of these ties across the industry and leave new management with the task to start fresh alliances. In many cases the change is not well received and an organisation that essentially is unchanged in terms of its core activities can fail.
The art of creating a post-acquisition integration plan is also extremely important, but is difficult to master. ‘Unfortunately, for many companies, it is this phase that the deal fails because the parties focus too much on the financial aspect of the merger or acquisition without adequately addressing the people components that must be considered to forge two organizations into one cohesive entity’ (Doitte and Smith 1998). Employees are often neglected through the process of M&A’s and even if attention is given to them there is generally a lack of meaningful consultation.
Although it is an area that is very tricky to get right from a managerial perspective it is vital if the strategy is to succeed. ‘If managers of each company shut themselves off from their employees, employees will feel adrift. Employees’ resulting low morale and lack of direction will lead to high personnel turnover’ (Heitner 1998). This is simply another factor, which makes the strategy of M&A’s so difficult to implement and along with the previously mentioned problematic areas explains why their success rate is only around 50%. However despite the fact that many investment bankers and journalists believe the difference between their success and failure is ‘a coin toss at best’ (Davenport 1998) organisations continue to utilise them.
A major reason behind M&A’s continued use is the amount of advantages an organisation can potentially gain by undergoing a successful merger or acquisition. Although there are many risks and pitfalls involved when the strategy is undertaken management clearly believe the prospective benefits outweigh these possible drawbacks.
In modern business globalisation has in many cases become a necessity rather than a luxury. Firms are now desperate to expand into foreign countries in order for them to compete in uninhabited lucrative markets and increase their competitive advantage. If global markets are entered successfully it gives organisations the chance to exploit resources, synergies and opportunities. However there is also a sense that in the global marketplace ‘bigger is better’ (Doitte and Smith 1998) and firms have to be of a certain size to be able to compete. In order to break into global markets organisations need to grow and often quickly so ground is not lost on competitors. In this situation M&A’s are the most attractive option for managers. They represent a ‘leap’ approach whereby firms can experience this desired growth rapidly. Managers are aware that it is the growth strategy that carries the highest risk, but often feel they have little choice. The modern business world demands innovation and expansion and if companies stand still they will simply get left behind.
Firms often use M&A’s as a way of diversifying. A well-executed diversification strategy can widen an organisations product portfolio and therefore spread an organisations risk. This means entering different markets in order to reduce dependence upon current products and customers. Selling a range of different products to various groups of consumers will mean that if any one product fails, sales of the other products should keep the business healthy. As a result firms in this situation are less susceptible in market downturns and recessions. It is unlikely that a slump occurs in two diverse markets, but even in a case of a recession, where there are generally negative affects across the board, the organisation with added critical mass is in a better position to weather the crisis.
The simplest way for management to achieve this diversification is to merge or takeover another company. It saves time and money being spent developing new products for markets in which the firm may have no expertise. Richard Branson and Virgin has been a major exponent of this over the last decade. His brand now covers air travel, music and even soft drinks! This is a perfect example how M&A’s can produce multi-million pound empires extremely quickly. However many organisations can become influenced by such stories and attempt to mirror the success without fully understanding whether it’s the right move in their own business situation.
Market power is also a reason firms adopt M&A’s. This is usually generated when two competitors in the same market merge in what is called horizontal integration. The potential benefits for the purchaser are extremely attractive and hard to ignore. There is huge scope for cost cutting by eliminating duplication of sales force, distribution and marketing overheads and by improved capacity utilisation. There is also the opportunity for major economies of scale and increased prices due to the reduction in competition.
Coca-Cola achieved this type of acquisition when taking over Orangina, a distinctive product with very strong distribution in France. Here Coca-Cola identified Orangina’s customer base as one that they struggled to attract and decided for them to increase their market power they needed to acquire the brand. However, this is by no means the correct move for all firms. The merge between car manufacturers Daimler Benz and Chrysler has been ridden with problems since its launch in 1998. Sometimes a merge in this way creates twice the size, but double the problems.
Similar to the idea of joining forces with a competitor to gain market power, management can undertake a merger or acquisition to ‘block’ competitors in doing so. This tactic usually comes in the form of a vertical integration where one firm takes over or merges with another at a different stage in the production process, but within the same industry. An example of this is brewery Whitbread’s purchase of restaurant chain Beefeater. This type of M&A does not only guarantee outlets for your products or develop closer links with suppliers, it can also go some way to freezing out the threat of competitors. However it is not wise for management to undertake a merge with the sole intention to damage competitors. It is important, first and foremost, that the strategy has synergistical affects for them the acquirer as otherwise it may struggle.
As I have highlighted there are undoubted gains offered by successful M&A’s. These attractive advantages can often persuade managers, sometimes wrongly, to implement a mergers or acquisitions of their own. The hope is that their organisation can in practice reap the rewards that the theory says is possible. The reality is that many fail because the strategy is mismatch with other objectives and inappropriate in their current position.
Despite managements good intentions their judgement has been clouded by the large potential gains M&A’s can offer. However it is not always the case that management adopt the strategy strictly because of the apparent advantages it can for their firm. There is a school of thought that justifiably believes that top management frequently have ulterior motives when adopting M&A’s. The belief is that decisions made concerning them are not necessarily in the main interests of the organisation, but more centred on what is best for them as individuals. As a result managers may proceed with poor value acquisitions in order to meet personal goals or even objectives they think ‘should’ be met.
The ’empire-building syndrome’ is a main contributor here. As an organisation grows it becomes a more important player in its industry. Naturally as the size and power of the firm increases as does the importance of its management and with this comes higher remuneration and social status. Also ‘executive compensation may increase as a result of an increase in firm size, even when there is no corresponding increase in shareholders’ wealth’ (Jenson 1986). It is clear that a merger or acquisition strategy can work well for top management regardless of its overall success for the firm.
In the same way management can be influenced by prospective financial and prestige rewards, they may also be interested in satisfying their self-fulfilment goals. In low growth markets management can feel they are not exhausting their full energy and talents. In order for them to experience this type of self or job fulfilment they may choose to grow their firm via a merger or acquisition. This may present the perfect challenge for management, but not necessarily ideal challenge for their organisation.
Finally job security is also an important managerial motive. A merger or acquisition can diverse risk and minimise the costs of financial distress and that of bankruptcy. This added stability helps prevent an organisation becoming an acquisition target themselves. Although the decision might not be in the best interests of the firm and shareholders, management solidify their own position. Along with the other negative managerial motives they represent a clear reason why M&A’s continue to be used in the light of so many failures.
In conclusion I feel the topic of M&A’s and the reasons behind their sustained use in business is now much clearer. It is initially very difficult to fathom any organisation adopting a strategy that only has a success rate of around 50%. Dominant factors such culture and management inexperience seem to make any merger or acquisition an uphill struggle. However when the topic is examined closer the reasons behind these decisions are more obvious. In the modern business environment businesses are constantly looking to better themselves and stay one-step ahead of competition.
It is wrong to claim that as a result organisations are forced into strategies that stimulate rapid growth, but there is a definite feeling that factors such as globalisation and increased market power are the best route to success. As these are two hallmarks of the M&A phenomenon it is no real surprise that management frequently decide that it might be their best strategy regardless of their poor success rate. It is this risk taking mentality, that has become a characteristic of 21st century management, allied with the more cynical decision making habits some managers have adopted has kept the use of M&A’s high. Added to the fact that in the right context M&A’s can be an efficient and highly profitable growth strategy it is easy to see how they have had and will continue to have a great use in business regardless of their failures.
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