Four reasons why mergers can be a good strategy? What is a merger between two firms? A merger is referred to as a financial operation in which two companies join each other and continue business operations as one legal entity. Generally, mergers can be divided into five different categories: Vertical merger: Merging companies operate along the same supply chain line. A note for this M&A strategy is that the type of merger selected by a company primarily depends on the motives and objectives of the companies participating in a deal.
What are the Different Motives for Mergers? Companies pursue mergers and acquisitions for several reasons. The most common motives for mergers are: Economies of Scale: Underpinning all of M&A activity is the promise of economies of scale. The benefits that will come from becoming bigger: Increased access to capital, lower costs as a result of higher volume, better bargaining power with distributors, and more. While buyers should always avoid the temptation to indulge in ‘empire building,’ as a general rule, bigger companies usually enjoy advantages that small companies do not.
Diversification: Mergers are frequently undertaken for diversification reasons. For example, a company may use a merger to diversify its business operations by entering into new markets or offering new products or services. Additionally, it is common that the managers of a company may arrange a merger deal to diversify risks relating to the company’s operations. Note that shareholders are not always content with situations when the merger deal is primarily motivated by the objective of risk diversification. In many cases, the shareholders can easily diversify their risks through investment portfolios while a merger of two companies is typically a long and risky transaction. Market-extension, product-extension, and conglomerate mergers are typically motivated by diversification objectives.
Acquisition of assets: A merger can be motivated by a desire to acquire certain assets that cannot be obtained using other methods. In M&A transactions, it is quite common that some companies arrange mergers to gain access to assets that are unique or to assets that usually take a long time to develop internally. For example, access to new technologies is a frequent objective in many mergers. Increase in financial capacity: Every company faces a maximum financial capacity to finance its operations through either debt or equity markets. Lacking adequate financial capacity, a company may merge with another. As a result, a consolidated entity will secure a higher financial capacity that can be employed in further business development processes.
Lower Risk because of diversification: This goes hand-in-hand with economies of scope: By having more revenue streams, it follows that a company can spread risk across those revenue streams, rather than having it focus on just one. To return to the example of Facebook: Some analysts suggest that younger eyeballs are turning away from the social media giant towards other forms of social media… Instagram and Whatsapp among them. When one revenue stream falls, an alternative stream of revenue may hold, or even pick up, diversifying the acquiring company’s risk in the process.
High value mergers and acquisitions (M&A) usually to get the biggest headlines in newspapers, but research indicates that executives should be paying attention to all the smaller deals, too. These smaller transactions, when pursued as part of a deliberate and systematic M&A program, tend to yield strong returns over the long run with comparatively low risk. And, based on Mordechai Gal‘s research, companies’ ability to successfully manage these deals can be a central factor in their ability to withstand economic shocks. The execution of such a programmatic M&A strategy is not easy, however.
Know what strategic outcomes you ultimately want from engaging in M&A and consider the implications for both the buyer and seller. Is your goal to enter a new end market? Are you purchasing customers or contacts to geographically expand? To stay focused, always come back to how you answered the first three questions as you consider opportunities. Developing an M&A strategy requires knowing what makes your business successful now and what acquisitions can add to make the business even better in the future. It will help you clearly define the value proposition for both the buyer and the seller, as well as the value drivers that should guide acquisition decisions.
Why Mergers and Acquisitions Fail? There are many reasons so let’s discuss some of them: Overextending : ‘Bolt on’ mergers and acquisitions when target companies which are small in size relative to the acquiring company – are usually considered to be the best type of transactions. One of the main strands of thought behind this is that they don’t require as many resources to be acquired or to be integrated. At the other side of this equation, are those transactions that require significant resources on the part of the acquiring firm. Loading up on debt to acquire any firm creates a pressure from day one to cut costs – never a good start for a deal, and often the beginning of the end.
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