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Strategic Management Concepts Competitiveness and Globalization 12th Edition Hitt Solutions Manual Full Download
Strategic Management Concepts Competitiveness and Globalization 12th Edition Hitt Solutions Manual Full Download
Strategic Management Concepts Competitiveness and Globalization 12th Edition Hitt Solutions Manual Full Download
Chapter 7
Merger and Acquisition Strategies
LEARNING OBJECTIVES
1. Explain the popularity of merger and acquisition strategies in firms competing in the
global economy.
2. Discuss reasons why firms use an acquisition strategy to achieve strategic
competitiveness.
3. Describe seven problems that work against achieving success when using an acquisition
strategy.
4. Name and describe the attributes of effective acquisitions.
5. Define the restructuring strategy and distinguish among its common forms.
6. Explain the short- and long-term outcomes of the different types of restructuring
strategies.
CHAPTER OUTLINE
Opening Case: Strategic Mergers and Acquisition: Prominent Strategies for Forms Seeking
to Enhance their Performance
THE POPULARITY OF MERGER AND ACQUISITION STRATEGIES
Mergers, Acquisitions, and Takeovers: What Are the Differences?
REASONS FOR ACQUISITIONS
Strategic Focus: A Merger of Equals: Making It Happen Isn’t Easy
Increased Market Power
Overcoming Entry Barriers
Strategic Focus: Different Strategic Rationales Driving Cross-Border Acquisitions
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
Learning and Developing New Capabilities
PROBLEMS IN ACHIEVING ACQUISITION SUCCESS
Integration Difficulties
Inadequate Evaluation of Target
Large or Extraordinary Debt
Inability to Achieve Synergy
Too Much Diversification
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publicly accessible website, in whole or in part.
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Chapter 7: Merger and Acquisition Strategies
LECTURE NOTES
Chapter Introduction: With continued merger and acquisition activity, this chapter is
very important. Much of the chapter’s material is summarized in Figure 7.1, which
can be used to help students mentally organize what they learn in the chapter about
mergers and acquisitions by examining reasons of acquisitions and problems in
achieving success.
OPENING CASE
Mergers and Acquisition: Prominent Strategies for Forms Seeking to Enhance their
Performance
The Opening Case sets up the central theme for Chapter 7—merger and acquisition
strategy. The influences on firms’ decisions to use merger and acquisition strategies are
varied and interesting. The discussion of these influences in the Opening Case reinforces
the discussion in the chapter about specific reasons firms choose to implement these
strategies. The need to create value for stakeholders is a primary influence on firms’
decisions to engage in M&A activity. But companies interested in implementing merger
and acquisition strategies sometimes face hurdles in their attempts to do so, including
trade barriers and local public interest concerns.
Teaching Note:
There are several reasons corporations merge with or acquire other companies.
However, the need to create value for stakeholders is a primary influence on
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publicly accessible website, in whole or in part.
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Chapter 7: Merger and Acquisition Strategies
In the latter half of the 20th century, acquisition became a prominent strategy used by major
corporations to achieve growth and meet competitive challenges. Even smaller and more
focused firms began employing acquisition strategies to grow and enter new markets.
However, acquisition strategies are not without problems; a number of acquisitions fail.
Thus, the chapter focuses on how acquisitions can be used to produce value for the firm’s
stakeholders.
Acquisitions have been a popular strategy among US firms for many years. Some believe
that this strategy played a central role in the restructuring of US businesses during the 1980s,
1990s, and into the 21st century.
Increasingly, acquisition strategies are becoming more popular with firms in other nations
(e.g., those of Europe). In fact, about 40 to 45 percent of the acquisitions in recent years have
been made across country borders (i.e., where a firm headquartered in one country acquires a
firm headquartered in another country).
• Although the frequency of acquisitions has slowed, their number remains high.
• In the latest acquisition boom between 1998 and 2000, acquiring firm shareholders
experienced significant losses relative to the losses in all of the 1980s.
Evidence suggests that at least for acquiring firms, acquisition strategies may not result in
desirable outcomes. Studies have found that shareholders of acquired firms often earn above-
average returns from an acquisition, whereas shareholders of acquiring firms are less likely to
do so. In approximately two-thirds of all acquisitions, the acquiring firm’s stock price falls
immediately after the intended transaction is announced, indicating investors’ skepticism
about the likelihood that the acquirer will be able to achieve the synergies required to justify
the premium.
Before starting the discussion of the reasons for acquisitions, problems related to
acquisitions, and long-term performance, three terms should be defined because they will be
used throughout this chapter and Chapter 10.
A merger is a transaction where two firms agree to integrate their operations on a relatively
co-equal basis because they have resources and capabilities that together may create a
stronger competitive advantage.
An acquisition is a transaction where 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.
Whereas most mergers represent friendly agreements between the two firms, acquisitions
sometimes can be classified as unfriendly takeovers. A takeover is an acquisition—and
normally not a merger—where the target firm did not solicit the bid of the acquiring firm and
often resists the acquisition (a hostile takeover).
The main strategic reasons for acquisition are detailed one at a time in the text after the
Strategic Focus article.
Teaching Note:
You may find it helpful to refer students to Figure 7.1, which lists the reasons for
acquisitions.
STRATEGIC FOCUS
A Merger of Equals: Making It Happen Isn’t Easy!
Teaching Note:
Discuss with students the potential hurdles to successful mergers of equals. What
obstacles do companies face prior to completing the deal? Now that the deal is signed,
what does the future hold for the new combined firm? Review the obstacles to integration
and the pitfalls associated with merger and acquisition strategies.
As discussed in Chapter 6, a primary reason for acquisitions is that they enable firms to gain
greater market power. Acquisitions to meet a market power objective generally involve
buying a supplier, a competitor, a distributor, or a business in a highly related industry.
Though a number of firms may feel that they have an internal core competence, they may be
unable to exploit their resources and capabilities because of a lack of size.
Horizontal Acquisitions
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Chapter 7: Merger and Acquisition Strategies
When a competitor in the same industry is acquired, a firm has engaged in a horizontal
acquisition. Horizontal acquisitions increase a firm’s market power by exploiting cost-based
and revenue-based synergies.
Research suggests that horizontal acquisitions of firms with similar characteristics result in
higher performance than when firms with dissimilar characteristics combine their operations.
Examples of important similar characteristics include strategy, managerial styles, and
resource allocation patterns.
Horizontal acquisitions are often most effective when the acquiring firm integrates the
acquired firm’s assets with its own assets, but only after evaluating and divesting excess
capacity and assets that do not complement the newly combined firm’s core competencies.
Vertical Acquisitions
A vertical acquisition has occurred when a firm acquires a supplier or distributor that is
positioned either backward or forward in the firm’s cost/activity/value chain.
Related Acquisitions
When a target firm in a highly related industry is acquired, the firm has made a related
acquisition.
Teaching Note:
Remind students that, as discussed in Chapter 6, during the 1960s and 1970s, both
horizontal and related acquisitions were discouraged as they were regularly
challenged by agencies of the federal government. The ability of firms to make
horizontal acquisitions increased in the 1980s because of changes in the interpretation
and enforcement of antitrust laws and regulations by the courts and the Justice
Department.
It is important to note that acquisitions intended to increase market power are subject to
regulatory review, as well as analysis by financial markets.
As discussed in Chapter 2, barriers to entry represent factors associated with the market
and/or firms operating in the market that make it more expensive and difficult for new firms
to enter the market.
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publicly accessible website, in whole or in part.
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Chapter 7: Merger and Acquisition Strategies
When barriers to entry are present, the firm’s best choice may be to acquire a firm already
having a presence in the industry or market. In fact, the higher the barriers to entry into an
attractive market or industry, the more likely it is that firms interested in entering will follow
acquisition strategies.
Entry barriers that firms face when trying to enter international markets are often great.
Commonly, acquisitions are used to overcome entry barriers in international markets. It is
important to compete successfully in these markets since global markets are growing faster
than domestic markets. Also, five of the emerging markets (China, India, Brazil, Mexico, and
Indonesia) are among the fastest growing economies in the world.
STRATEGIC FOCUS
Different Strategic Rationales Driving Cross-Border Acquisitions The decision to acquire
a company should be carefully identified, examined, and agreed upon by key decision-
makers throughout the firm prior to finalizing an acquisition decision. The most successful
acquisitions, including cross-border ones, are products of a rational decision-making process
that is grounded in careful analysis of a pro-posed transaction with its strategic rationale as a
guiding force. The strategic rationale sometimes results in firms deciding to acquire
ownership percentages of target firms to see if a full acquisition is warranted at a later date.
This seems to be the situation with Alibaba Group Holding Ltd., the Chinese-based company
that is the world’s largest e-commerce platform. With the strategic rationale of “becoming
more global” as a driver, the firm is acquiring parts of firms outside its home market,
including its 9 percent purchase of U.S. online retailer Zulily, Inc. and its investments in
mobile messaging app-maker Tango, also a U.S. firm.
Teaching Note:
Students may be surprised that cross-border acquisitions of the type described in the
Strategic Focus are taking place. The more accepted scenario is one in which developed
market acquirers purchase firms in emerging markets. Though emerging market acquirers
may have the resources and opportunity to engage in cross-border acquisitions of
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Chapter 7: Merger and Acquisition Strategies
Cross-Border Acquisitions
Acquisitions between companies with headquarters in different countries are called cross-
border acquisitions.
Teaching Note:
Chapter 9 examines cross-border alliances and the justification for their use. Cross-
border acquisitions and cross-border alliances are alternatives firms consider while
pursuing strategic competitiveness. Compared to a cross-border alliance, a firm has
more control over its international operations through a cross-border acquisition.
Historically, US firms have been the most active acquirers of companies outside their
domestic market. However, in the global economy, companies throughout the world are
choosing this strategic option with increasing frequency. In recent years, cross-border
acquisitions have represented as much as 40 percent of the total number of acquisitions made
annually.
Acquisitions represent a viable strategy for firms that wish to enter international markets
because:
• This may be the fastest way to enter new markets
• They provide more control over foreign operations than do strategic alliances with a
foreign partner
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Chapter 7: Merger and Acquisition Strategies
Also of concern to firms’ managers is achieving adequate returns from the capital invested to
develop and commercialize new products—an estimated 88 percent of innovations fail to
achieve adequate returns. Perhaps contributing to these less-than-desirable rates of return is
the successful imitation of approximately 60 percent of innovations within four years after
the patents are obtained. Because of outcomes such as these, managers often perceive
internal product development as a high-risk activity.
As discussed earlier, internal product development processes can be risky, in that entering a
market and earning an acceptable return on investment requires significant resources and
time. All the same, acquisition outcomes can be estimated easily and accurately (as compared
to the outcomes of an internal product development process), causing managers to view
acquisitions as carrying lowering risk.
Teaching Note:
Not long ago, P&G acquired premium dog and cat food manufacturer Iams Co. to
support the launch of its pet products into supermarket chains and mass
merchandisers such as Walmart. Having assessed the potential of Iams in the
marketplace, P&G managers were confident they would achieve positive results
through their strategy; thus, they may have considered entry into the premium pet-
food market through acquisition to be less risky than entering the market via internal
product development.
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publicly accessible website, in whole or in part.
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Chapter 7: Merger and Acquisition Strategies
Because acquisitions recently have become such a common means of avoiding risky internal
ventures, they could become a substitute for innovation, which has a serious downside (e.g.,
the decline of Cisco systems).
Teaching Note:
Although they often enable firms to offset the risk of internal ventures and of
developing new products, acquisitions are not without risks of their own. Acquisition-
related risks are discussed later in this chapter.
Increased Diversification
It should be easier for firms to develop new products and/or new ventures within their current
markets because of market-related knowledge, but firms that desire to enter new markets may
find that current product-market knowledge and skills are not transferable to the new target
market.
Firms must be careful when making acquisitions to diversify their product lines because
horizontal and related acquisitions tend to contribute more to strategic competitiveness, and
thus they are more successful than diversifying acquisitions.
Teaching Note:
Remember, related diversification seeks lower costs through economies of scope,
synergy, and resource sharing, whereas unrelated diversification hopes to realize
financial economies and better internal resource allocation among diverse businesses.
To reduce intense rivalry’s negative effect on financial performance, a firm may use
acquisitions as a way to restrict its dependence on a single or a few products or markets.
Teaching Note:
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7-10
Chapter 7: Merger and Acquisition Strategies
The following are examples of auto manufacturers that have gone through
acquisitions to reduce dependence of too few businesses:
• General Motors acquired Electronic Data Systems and Hughes Aerospace to lessen
its dependence on the domestic automobile market (where its market share had
declined from approximately 50 percent in 1980 to less than 30 percent 10 years
later) and escape intense competition with Japanese automakers. However, GM
later sold these businesses to focus its efforts on its core automobile business.
• DaimlerChrysler considered expanding into financial and computer services,
aftermarket sales, and electronics and satellite systems to pursue more desirable
operating margins in areas that are more attractive than are alliances or acquisitions
in car manufacturing.
• Ford management considered making the company the world’s leading consumer
services business that specializes in the automotive sector by tapping all sectors in
after-sales markets, including repairs, replacement parts, and product servicing. To
evaluate its success in reshaping the firm’s competitive scope through
diversification, Ford would measure its performance against world-class consumer
firms, regardless of industry (i.e., rather than using the traditional yardsticks of
rival automakers).
Some acquisitions are made to gain capabilities that the firm does not possess—e.g.,
acquisitions used to acquire a special technological capability. Acquiring other firms with
skills and capabilities that differ from its own helps the acquiring firm learn new knowledge
and remain agile, but firms are better able to learn these capabilities if they share some
similar properties with the firm’s current capabilities.
One of Cisco System’s primary goals in its early acquisitions was to gain access to
capabilities that it did not currently possess through its commitment to learning. The firm
developed an intricate process to quickly integrate the acquired firms and their capabilities
(knowledge) after an acquisition is completed.
Figure Note:
Figure 7.1 presents the reasons for making acquisitions and the problems
encountered. A comment that problems are discussed in ensuing sections is
appropriate.
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publicly accessible website, in whole or in part.
7-11
Chapter 7: Merger and Acquisition Strategies
Research suggests that perhaps 20 percent of all mergers and acquisitions are successful,
approximately 60 percent produce disappointing results, and the last 20 percent are clear
failures. Successful acquisitions generally involve a well-conceived strategy in selecting the
target, the avoidance of paying too high a premium, and employing an effective integration
process.
Integration Difficulties
Integration problems or difficulties that firms often encounter can take many forms. Among
them are:
• Melding disparate corporate cultures
• Linking different financial and control systems
• Building effective working relationships (especially when management styles differ)
• Problems related to differing status of acquired and acquiring firms’ executives
Teaching Note:
Several years ago, Intel acquired Digital Equipment’s semiconductors division. On
the day Intel began to integrate the acquired division into its operations, six thousand
deliverables were to be completed by hundreds of employees working in dozens of
countries.
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7-12
Chapter 7: Merger and Acquisition Strategies
FIGURE 7.1
Reasons for Acquisitions and Problems in Achieving Success
Seven reasons for acquisitions are presented in the left column whereas seven problems in
achieving acquisition success are presented in the right hand bubble-column of Figure 7.1.
To summarize, the seven reasons that firms (and managers) implement acquisition strategies
are to:
• Increase market power
• Overcome entry barriers
• Reduce the cost of new product development and increase speed to market
• Lower risk compared to developing new products
• Increase diversification
• Avoid excessive competition
• Learn and develop new capabilities
The seven reasons for poor performance of acquisitions or problems faced in attempts to
achieve success are:
• Integration difficulties
• Inadequate evaluation of target
• Large or extraordinary debt
• Inability to achieve synergy
• Too much diversification
• Managers overly focused on acquisitions
• Too large
Note:
Problems encountered as firms try to successfully achieve their objectives and create value
from acquisitions are discussed in detail in the next sections of this chapter.
It is important to maintain the human capital of the target firm after the acquisition to
preserve the organization’s knowledge. Turnover of key personnel from the acquired firm
can have a negative effect on the performance of the merged firm.
Teaching Note:
The following are examples of firms and the steps they took to preserve human
capital through the acquisition process.
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7-13
Chapter 7: Merger and Acquisition Strategies
Due diligence is a process through which a firm 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.
Teaching Note:
For the reasons below, firms often pay too much for acquired businesses:
• Acquiring firms may not thoroughly analyze the target firm, failing to develop
adequate knowledge of its true market value.
• Managers’ overconfidence may cloud the judgment of acquiring firm managers.
• Shareholders (owners) of the target must be enticed to sell their stock, and this
usually requires that acquiring firms pay a premium over the current stock price.
• In some instances, two or more firms may be interested in acquiring the same
target firm. When this happens, a bidding war often ensues and extraordinarily
high premiums may be required to purchase the target firm.
Teaching Note:
Some acquirers overpaying for target firms include the following:
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7-14
Chapter 7: Merger and Acquisition Strategies
• British retailer Marks & Spencer paid $750 million for Brooks Brothers of the
United States, but the acquisition was still unsuccessful after more than ten years
of integration.
• Sony paid a 28 percent premium for CBS Records and a 60 percent premium for
Columbia Pictures.
• Bridgestone paid a 60 percent premium for Firestone, and its winning bid was 38
percent higher than a competing bid from Pirelli.
• National City Corporation agreed to acquire First of America for a price that was
3.8 times book value and 22.9 times First’s estimated 1998 earnings—National
City’s stock fell 5.9 percent.
• First Union Corp. paid 5.3 times book value when it acquired CoreStates Financial
Corp.
• Federated paid $10 per share for Broadway Department Stores when Broadway’s
stock was selling for $2 per share, a 400 percent premium in a transaction valued
at $1.6 billion to acquire Broadway’s prime West Coast real estate locations.
Firms sometimes allow themselves to enter a “bidding war” for a target even though they
realize their current bids exceed the parameters identified through due diligence.
In addition to overpaying for targets, many acquirers must finance acquisitions with
relatively high-cost debt.
In the 1980s, investment bankers developed a new financing instrument for acquisitions, the
junk bond. Junk bonds represented a new financing option in which risky investments were
financed with money (debt) that provided a high return to lenders (bond holders). Junk bonds
offer relatively high rates, some as high as 18 to 20 percent during the 1980s.
Teaching Note:
Junk bonds are considered by many to be a new financing option, not because they
are new, but because they represented the first instances in which non-investment
grade (below a B rating) securities were used to raise funds by companies whose
securities were normally rated as investment grade.
Teaching Note:
A number of well-known and well-respected finance scholars argue in favor of firms
utilizing significantly high levels of leverage because debt discourages managers
from misusing funds (for example, by making bad investments) because debt (and
interest) repayment eliminates the firm’s “free cash flow.”
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Chapter 7: Merger and Acquisition Strategies
Acquiring firms also face the challenge of correctly identifying and valuing any synergies
that are expected to be realized from the acquisition. This is a significant problem because to
justify the premium price paid for target firms, managers may overestimate both the benefits
and value of synergy.
Teaching Note:
As pointed out earlier, the average return to acquiring firm shareholders is near zero,
and many of these lead to negative returns for acquiring firm shareholders.
Firms experience transaction costs when using acquisition strategies to create synergy. Direct
costs include legal fees and charges from investment bankers. Managerial time to evaluate
target firms and then to complete negotiations and the loss of key managers and employees
post-acquisition are indirect costs.
In general, firms using related diversification strategies outperform those using unrelated
diversification strategies. However, conglomerates (i.e., those pursuing unrelated
diversification) can also be successful.
In the drive to diversify the firm’s product line, many firms over-diversified during the 60s,
70s, and 80s.
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7-16
Chapter 7: Merger and Acquisition Strategies
Teaching Note:
Controls are discussed in more detail in Chapters 11 and 12.
Financial controls may be emphasized when managers feel that they do not have sufficient
expertise or knowledge of the firm’s various businesses. When this happens, top-level
managers are not able to adequately evaluate the strategies and strategic actions taken by
division or business unit managers. As a result,
• When they lack a rich understanding of business units’ strategies and objectives, top-
level managers tend to emphasize the financial outcomes of strategic actions rather
than the appropriateness of the strategy itself.
• This forces division or business unit managers to become short-term performance-
oriented.
• The problem is more serious when manager compensation is tied to short-term
financial outcomes.
• Long-term, risky investments (such as R&D) may be reduced to boost short-term
returns.
• In the final analysis, long-term performance deteriorates.
Teaching Note:
The experiences of many firms indicate that over-diversification may lead to
ineffective management, primarily because of the increased size and complexity of
the firm. As a result of ineffective management, the firm and some of its businesses
may be unable to maintain their strategic competitiveness. This results in poor
performance.
As noted earlier in this chapter, acquisitions can have a number of negative effects. They
may result in greater levels of diversification (in products, markets, and/or industries), absorb
extensive managerial time and energy, require large amounts of debt, and create larger
organizations. As a result, acquisitions can have a negative impact on investments in research
and development and thus on innovation.
Reducing the emphasis on R&D and on innovation may result in the firm losing its strategic
competitiveness unless the firm operates in mature industries in which innovation is not
required to maintain competitiveness.
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publicly accessible website, in whole or in part.
7-17
Chapter 7: Merger and Acquisition Strategies
If firms follow active acquisition strategies, the acquisition process generally requires
significant amounts of managerial time and energy.
The desire to merge is like an addiction in many companies: Doing deals is much more fun
and interesting than fixing fundamental business problems.
Due diligence and negotiating with the target often include numerous meetings between
representatives of the acquirer and target, as well as meetings with investment bankers,
analysts, attorneys, and in some cases, regulatory agencies. As a result, top-level managers of
acquiring firms often pay little attention to long-term, strategic matters because of time (and
energy) constraints.
Too Large
Firms can reach economies of scale by growing. But after a certain size is achieved, size can
become a disadvantage as firms reach a point where they suffer from what is called
“diseconomies of scale.” This implies that problems related to excess growth may be similar
to those that accompany over-diversification.
Other actions taken to enable more effective management of increased firm size include
increasing or establishing bureaucratic controls, represented by formalized supervisory and
behavioral controls such as rules and policies designed to ensure consistency across different
units’ decisions and actions.
On the surface (or in theory), bureaucratic controls may be beneficial to large organizations.
However, they may produce overly rigid and standardized behavior among managers. The
reduced managerial (and firm) flexibility can result in reduced levels of innovation and less
creative (and less timely) decision making.
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publicly accessible website, in whole or in part.
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Chapter 7: Merger and Acquisition Strategies
EFFECTIVE ACQUISITIONS
Research has identified attributes that appear to be associated consistently with successful
acquisitions:
• When a firm’s assets are complementary (highly related) with the acquired firm’s
assets and create synergy and, in turn, unique capabilities, core competencies, and
strategic competitiveness
• When targets were selected and “groomed” through earlier working relationships
(e.g., strategic alliances)
• When the acquisition is friendly, thereby reducing animosity and turnover of key
employees
• When the acquiring firm has conducted due diligence
• When management is focused on research and development
• When acquiring and target firms are flexible/adaptable (e.g., from executive
experience with acquisitions)
• When integration quickly produces the desired synergy in the newly created firm,
allowing the acquiring firm to keep valuable human resources in the acquired firm
from leaving
Table Note:
The attributes or characteristics of successful acquisitions and their results are
summarized in Table 7.1.
TABLE 7.1
Attributes of Successful Acquisitions
Successful acquisitions generally are characterized by the following attributes and results:
• Target and acquirer having complementary assets and/or resources that result in a high
probability of achieving synergy and gaining competitive advantage
• Making friendly acquisitions to facilitate integration speed and effectiveness and reducing
any acquisition premium
• Effective due diligence - target selection and negotiation processes that result in the
selection of targets having resources and assets that are complementary to the acquiring
firm’s core business, thus avoiding overpayment
• Maintaining financial slack to make acquisition financing less costly and easier to obtain
• Maintaining a low to moderate debt position, which lowers costs and avoids the trade-offs
of high debt and lowers the risk of failure
• Possessing flexibility and skills to adapt to change to facilitate integration speed and
achievement of synergy
• Continuing to invest in R&D and emphasizing innovation to maintain competitive
advantage
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Chapter 7: Merger and Acquisition Strategies
Note:
The table also lists seven “results” of successful acquisitions.
Teaching Note:
One way to teach the finer points of the M&A process is to see its parallels with
marriage and courtship. Though the source is rather dated now, Jemison & Sitkin
(1986, Academy of Management Review) offered an interesting analysis based on this
framework. Their points are too extensive to comment on here, but reference to their
writings is helpful.
RESTRUCTURING
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.
Sometimes firms use a restructuring strategy because of changes in their external and internal
environments. For example, opportunities sometimes surface in the external environment that
are particularly attractive to the diversified firm in light of its core competencies. In such
cases, restructuring may be appropriate.
Downsizing
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7-20
Chapter 7: Merger and Acquisition Strategies
Historically, divesting businesses from company portfolios and downsizing have accounted
for a large percentage of firms’ restructuring strategies. Commonly, firms focus on fewer
products and markets following restructuring.
Firms use downsizing as a restructuring strategy for different reasons. The most frequently
cited reason is that the firm expects improved profitability from cost reductions and more
efficient operations.
Downscoping
Downscoping refers to the divestiture, spin-off, or other means of eliminating businesses that
are unrelated to the firm’s core business. In other words, downscoping refocuses the firm on
its core businesses.
Whereas downscoping often includes downsizing, the former is targeted so that the firm does
not lose key employees from core businesses (because such losses can lead to the loss of core
competencies).
Note:
Indicate to students that the requirements and characteristics of strategic leadership by a
firm’s top management team are discussed more fully in Chapter 12.
Teaching Note: There are many examples of downscoping strategies. Two of these
with which students are likely to be familiar are the following:
• General Motors’ successful spin-off of EDS
• PepsiCo’s spin-off of its fast-food businesses (Taco Bell, Pizza Hut, KFC)
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7-21
Chapter 7: Merger and Acquisition Strategies
Teaching Note:
Research has shown that refocusing is not usually successful unless the firm has
adequate resources to have the flexibility to formulate the necessary strategies to
compete effectively.
Leveraged Buyouts
A leveraged buyout (LBO) refers to a restructuring action whereby the management of the
firm and/or an external party buys all of the assets of the business, largely financed with debt,
and thus takes the firm private.
Often, LBOs are used as a restructuring strategy to correct for managerial mistakes or
because managers are making decisions that primarily serve their personal interests rather
than those of shareholders.
In other words, a firm is purchased by a few (new) owners using a significant amount of debt
(in a highly leveraged transaction) and the firm’s stock is no longer traded publicly.
In general, the new owners restructure the private firm by selling a significant number of
assets (businesses) both to downscope the firm and to reduce the level of debt (and
significant debt costs) used to finance the acquisition.
A primary intent of the new owners is to improve the firm’s efficiency. This enables them to
sell the firm (outright to another owner or by a public stock underwriting), thus capturing the
value created through the restructuring. 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.
There are three types of leveraged buyouts: management buyouts (MBO), employee buyouts
(EBO), and whole-firm buyouts where another firm takes the firm private (LBO). Research
has shown that management buyouts can also lead to greater entrepreneurial activity and
growth.
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Chapter 7: Merger and Acquisition Strategies
Restructuring Outcomes
Downsizing often does not lead to higher firm performance; in fact, research has shown that
downsizing contributed to lower returns for both US and Japanese firms. The stock markets
in the firms’ respective nations evaluated downsizing negatively. Investors concluded that
downsizing would have a negative effect on companies’ ability to achieve strategic
competitiveness in the long term. Investors also seem to assume that downsizing occurs as a
consequence of other problems in a company.
Teaching Note:
In free-market based societies, downsizing has generated a host of entrepreneurial
opportunities for individuals to operate their own businesses. In fact, as discussed in
Chapter 13, start-up ventures in the United States are growing at three times the rate
of the national economy.
Downsizing tends to result in a loss of human capital in the long term. Losing employees
with many years of experience with the firm represents a major loss of knowledge. As noted
in Chapter 3, knowledge is vital to competitive success in the global economy. Thus, in
general, research evidence and corporate experience suggest that downsizing may be of more
tactical (or short-term) value than strategic (or long-term) value.
Downscoping generally leads to more positive outcomes in both the short and the long term
than does downsizing or engaging in a leveraged buyout (see Figure 7.2). 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.
Although whole-firm LBOs have been hailed as a significant innovation in the financial
restructuring of firms, there can be negative trade-offs.
• The resulting large debt increases the financial risk of the firm
• The intent of the owners to increase the efficiency of the bought-out firm and then sell it
within five to eight years can create a short-term and risk-averse managerial focus
• These firms may fail to invest adequately in R&D or take other major actions designed to
maintain or improve the company’s core competence.
Figure Note:
Restructuring alternatives—downscoping, downsizing, and leveraged buyouts—and
short- and long-term outcomes are summarized in Figure 7.3.
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Chapter 7: Merger and Acquisition Strategies
FIGURE 7.3
Restructuring and Outcomes
1. Why are merger and acquisition strategies popular in many firms competing in
the global economy?
Firms often choose to follow acquisition strategies (1) to increase market power (by
becoming larger); (2) to overcome entry barriers (by acquiring a firm with a position
in the target industry); (3) to reduce cost of new-product development and increase
the speed to market entry; (4) to reduce the risk associated with developing new
products internally; (5) to diversify both firm and managerial risk by increasing the
level of diversification; (6) to reshape the firm’s competitive scope; and (7) to boost
learning and the development of new capabilities.
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Chapter 7: Merger and Acquisition Strategies
3. What are the seven primary problems that affect a firm’s efforts to successfully
use an acquisition strategy?
Firms following acquisition strategies face seven major problems. (1) They may face
difficulty in successfully integrating the two firms. This is especially true when
integration involves melding disparate corporate cultures, linking disparate financial
and control systems, building effective working relationships when management
styles differ, and when the status of acquired firm executives is uncertain. (2) Owing
to inadequate evaluation of the target firm (a process known as due diligence),
acquirers may pay more for the target firm than it is worth. (3) If the acquisition is
financed with debt, as many were in the 1980s, the costs related to a significant
increase in debt—interest payments and debt repayment—may squeeze the firm’s
cash flow and limit managerial flexibility resulting in the firm passing up attractive
long-term investment opportunities. It is also important to note that debt also has
positive effects since leverage can assist a firm in its development, allowing it to take
advantage of attractive expansion opportunities. (4) Acquiring firms also may
overestimate the existence and value of synergies from combining the two firms. In
many cases, the value to be gained from synergy is overestimated due to a failure to
consider the integration and coordination costs that may be incurred. (5) Too much
diversification may mean that the portfolio of businesses that the firm owns is beyond
the expertise of managers, that management depends too much on financial controls
(rather than more effective strategic controls), and that acquisitions may become a
substitute for innovation. (6) Managers may be overly focused on acquisitions and
neglect the firm’s core businesses. (7) The combined firm may become too large to
manage efficiently and effectively, as the firm experiences diseconomies of scale or
bureaucratic controls stifle decision making.
5. What is the restructuring strategy, and what are its common forms?
Defined formally, restructuring is a strategy through which a firm changes its set of
businesses and/or financial structure. There are three common forms of restructuring
strategies.
6. What are the short- and long-term outcomes associated with the different
restructuring strategies?
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Chapter 7: Merger and Acquisition Strategies
and lower performance. Downscoping leads to reduced debt costs and an emphasis on
strategic controls, which in turn produce higher firm performance as a long-term
outcome. Finally, leveraged buyouts can lead to higher performance (long-term)
through an emphasis on strategic controls, but it also yields high debt costs (short-
term) that produce higher risk for the firm (long-term).
MINI-CASE
Strategic Acquisitions and Accelerated Integration of
Those Acquisitions are a Vital Capability of Cisco Systems
Cisco has perfected the art of acquisition strategy. The technology firm seeks to provide
hardware for connectivity, from the internet to mobile networks to entertainment
services. The next stage of Cisco’s evolution appears to be “the Internet of everything”
connecting people, processes, data, and things. Throughout its history Cisco Systems has
used acquisition strategy to build network products and strategically extend their reach
into new areas – related and unrelated. In this case, several of Cisco’s recent acquisitions
are described. It should be noted that in the IT sector, 90 percent of acquisitions fail.
However, Cisco’s failure rate is only one in three – still significant, but far below
industry norms. Cisco has developed a distinct ability to integrate acquisitions. In
addition to due diligence to make sure they price they pay for companies is reasonable, it
also develops a detailed plan for possible post-merger integration to ensure that
anticipated value is achieved.
Teaching Note:
In fast-cycle industries, like those built around information technology, companies
often lack the time to develop businesses or capabilities that they need to complement
their existing businesses or capitalize on changing external conditions in a timely
manner. Acquisitions can help firms achieve their objectives much faster than other
options. To drive this point home, ask students why Cisco doesn’t just develop
internally the businesses/capabilities that it obtains through acquisitions. Then, ask
students why they think the target firms agreed to be acquired. Students should realize
that truly successful acquisitions provide benefits to both parties.
1. Of the “Reasons for Acquisitions” section in the chapter, which reasons are
the primary drivers of Cisco’s acquisition strategy?
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Chapter 7: Merger and Acquisition Strategies
Cost of new product development and increased speed to market are among the
key reasons for acquisition for Cisco. It also lowers the risk compared to
developing new products by bringing semi-proven products and services into the
Cisco portfolio through acquisition. However, the acquisitions also allow the
company to increase its market power, increase diversification across the
technology sector.
NDS Group and Meraki were both horizontal acquisitions, allowing the company
to expand into cloud services and television network software. Ubiquisys may be
described as a vertical integration because it adds a step in the value-chain. Now,
in addition to the infrastructure for cellular networks, the company offers more
control through traffic-shifting, providing greater value to its existing service. The
success of these acquisitions will be determined based on the integration strategy
and the ongoing evolution of the technology sector.
3. Explain John Chambers’ views about acquisitions. How have his views
affected the nature of Cisco’s acquisition strategy?
4. Describe the core plan Cisco has in place to guide the integration of an
acquired firm into its operations. What are the strengths of this plan, and
what are its potential weaknesses?
Cisco’s core plan for integration is to begin with identifying how the acquisition
target with add value to the company and develop an individualized plan based on
how best to integrate (or not) that value proposition. The strength of this plan and
the processes surrounding it – including pre-planning, communication and a post-
mortem – is that it is process-oriented and not a one-size fits all. The weakness of
the plan is that it can lead to complexity, with some acquired firms fully
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Chapter 7: Merger and Acquisition Strategies
The following questions and exercises can be presented for in-class discussion or assigned as
homework.
1. Evidence indicates that the shareholders of many acquiring firms gain little or nothing in
value from the acquisitions. Why, then, do so many firms continue to use an acquisition
strategy?
2. Of the problems that affect the success of an acquisition, ask students which one they
believe is the most critical in the global economy. Why? What should firms do to make
certain that they do not experience such a problem when they use an acquisition strategy?
3. Have students use the Internet to read about acquisitions that are currently underway and
to choose one of these acquisitions. Based on the firms’ characteristics and experiences
and the reasons cited to support the acquisition, do they feel it will result in increased
strategic competitiveness for the acquiring firm? Why or why not?
4. Have students research recent merger and acquisition activity that is taking place
throughout the global economy. Are most of the transactions they found between
domestic companies or are they cross-border acquisitions? What accounts for the nature
of what they found?
5. What is synergy, and how do firms create it through mergers and acquisitions? In the
students’ opinion, how often do acquisitions create private synergy? What evidence can
they cite to support their position?
6. What can a top management team do to ensure that its firm does not become diversified
to the point of earning negative returns from its diversification strategy?
7. Some companies enter new markets through internally developed products, whereas
others do so by acquiring other firms. What are the advantages and disadvantages of each
approach?
8. How do the Internet’s capabilities influence a firm’s ability to study acquisition
candidates?
Ethics Questions
1. Some evidence suggests that there is a direct and positive relationship between a firm’s
size and its top-level managers’ compensation. If this is so, what inducement does that
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publicly accessible website, in whole or in part.
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Chapter 7: Merger and Acquisition Strategies
Cengage offers additional online activities, assessments and resources inside MindTap,
our online learning platform. The following activities can be assigned within MindTap
for students to complete.
Directed Case exercises are a series of multiple choice questions designed to focus on the
concepts from the chapter utilizing the case study analysis steps, such as gaining
familiarity, recognizing symptoms, identifying goals, conducting the analysis, making the
diagnosis and doing the action planning.
Equal Exchange
Harley-Davidson, Inc. is an American motorcycle manufacturer, founded in Milwaukee,
Wisconsin in 1903. Harley Davidson claims its brand is successful because its customers
desire more than just motorcycles. Its customers desire the motorcycles and products
because they symbolize the American dream of freedom. This is the company’s
differentiation.
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publicly accessible website, in whole or in part.
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Chapter 7: Merger and Acquisition Strategies
• Restructuring Strategies
• Strategic Competitiveness
The text argues that mergers and acquisitions are a popular strategy for businesses both in
the United States and across borders. However, returns for acquiring firms do not always
live up to expectations. In this group exercise, students will examine the concept of
growth by acquisition by analyzing the results of an actual acquisition.
• Identify a merger or acquisition that was completed in the last few years
• Describe the environment for this arrangement at the time completed
• Determine if the acquirer paid a premium for the target firm, and if so, how
much?
• Search for investor comments regarding the wisdom of the agreement
• Describe the merger or acquisition going forward
• Present finding to the class in 15-20 minutes
In this group project, students will have the opportunity to practice valuable strategic
management skills, including: research, public speaking, teamwork and critical thinking.
Note: Each group must get their M&A company choice approved by your instructor in
advance to avoid duplicates.
To enhance the project, the instructor may also challenge the students to discuss in detail
the short- and long-term outcomes of the different types of restructuring strategies.
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Chapter 7: Merger and Acquisition Strategies
Following months of strong federal government opposition, Comcast pulled the plug on
its $45 billion planned merger with Time Warner Cable. The merger would have created
a company that controlled 30 percent of the U.S. paid TV market and 57 percent of the
broadband internet market. Major regulator concerns included the potential to squeeze
out competitors and raise rates on consumers.
1. Why did the government and consumers have regulatory opposition to the
proposed merger and acquisition to the proposed merger between Comcast
and Time Warner?
If Comcast and Time Warner were to merge and control over half of all
broadband services, Comcast would have too much power within the market to
set prices and limit competition.
As a merger, the two companies would have combined each of their operations to
work together. In an acquisition, one company’s operations take control of the
other’s operations.
3. Although the merger between Comcast and Time Warner didn’t go through,
why might Comcast continue exploring merger options?
By merging with another broadband service company, Comcast can bring its
services to new cities and parts of the U.S. market it is not already serving. The
company gains profitability through economies of scale. The cost of building
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Strategic Management Concepts Competitiveness and Globalization 12th Edition Hitt Solutions
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