Acquisition is a fast way to grow a business. When targeting new markets, it also minimizes retaliation from existing companies.
However, some acquisitions fail. The failure rate of merger and acquisition failures is between 70% and 90%. Failure of synergy and cultural conflict are two of the causes of failure.
Definition of acquisition
The acquisition means getting something to have it and take the benefits or generate value from it. In business strategy, it is buying a large portion of the target company’s shares to gain control of it. The acquirer may be an individual, a company, or a government – the latter being known as nationalization.
As part of a purchase agreement, the acquirer often buys company shares and other assets. That allows it to make decisions about newly acquired assets without the approval of the other target company’s shareholders.
Acquisitions can take a long time and involve a frustrating process. The process can take faster (up to three months); but, it can also take up to a year or more.
Difference between acquisition, merger, and acquisition
In the acquisition, both the acquirer and the target, still exist. The target continues to operate its business as an independent organization.
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After the acquisition is complete, the acquirer becomes a holding company, while the target company becomes a subsidiary.
Acquisitions can be friendly or unfriendly (or hostile). When it’s friendly, the target company’s management agrees to the purchase. There was no resistance from them.
Conversely, in hostile acquisitions, management disagrees and often involves resistance. This is what we commonly call “takeover.” To entice existing shareholders, the acquirer will usually bid at a higher price than the company’s fair value.
A merger is to combine two companies into one. Two companies agreed to integrate their operations. One company survives, or both form a new company with a management composition come from both. Such integration increases economies of scale and market power of the surviving company.
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Reasons for acquisition
The principal motive for acquisitions is creating value, i.e., the benefits are higher than the price paid. If the acquisition creates value for public companies, the acquirer’s earnings per share should go up, although not always.
Value creation can take a variety of forms, including:
- Increasing market power through more significant market share and more domination over the supply chain
- Cost reduction through more significant economies of scale and economies of scope
- Business diversification if it involves the acquisition of an unrelated business, avoiding the concentration of risk in one business.
- Synergize core competencies and skills such as in the production technology, financial control, or distribution.
Types of acquisition
Based on the links between the target company’s business and the acquirer’s business, there are three types of acquisitions:
- Horizontal acquisition
- Vertical acquisition
- Related or conglomerate acquisitions
The first two often referred to as related acquisitions. Both involve two companies that are still in the same supply chain.
In horizontal acquisitions, the target company is their competitor. This strategy gives advantages in increasing market power (more significant market share) and reducing costs (economies of scale and economies of scope).
In a vertical acquisition, the acquirer buys a company that is still in the same supply chain. They may be its suppliers, distributors, or retailers. This strategy seeks to exploit the added value of the value chain. For example, the acquirer buys a distributor to dominate the distribution network, forcing competitors to build their own.
The unrelated acquisition involves two completely different businesses and is not in the same supply chain. For example, a mining company acquires an electronics company. The advantage of this strategy is to diversifying the income sources and minimizing risk in one of the businesses. If the mining business fails, the owner still generates income from the electronic business.
Advantages of acquisition
Taking over other companies is one way to grow, besides through an internal growth strategy. Acquirers can increase their companies’ size and value by achieving economies of scale, synergizing core competencies, reducing costs, and securing supply chains.
Following are the acquirer’s advantages:
- Increasing market power. The acquirer can buy their competitors to increase market share. A larger market share should increase its bargaining power over suppliers and buyers.
- Overcoming barriers to entry. Walls come from factors such as brand loyalty, economies of scale, and distribution networks. Setting up a new company means having to build all three from the beginning, and acquisitions are the solution.
- Overcoming time loss. The target company already has an established production facility, market, brand name, and other intangible assets, which is useful in building leadership positions. So, the acquirer doesn’t need to establish a business from the beginning since takeover can help achieve a strong market position immediately.
- Lower risk. Taking over companies minimizes the risks associated with establishing new companies, such as regulation, targeting markets, building distribution networks, securing supplies, and constructing production facilities.
- Cost reduction. The acquiring companies benefit from more significant economies of scale and economies of scope. They, for example, can combine production facilities owned by the target company. Also, companies can minimize the risks and costs of developing new products.
- Synergy of core competencies. For example, the acquirer has core competencies in production technology. Meanwhile, the target company has an extensive distribution network. The acquirer can integrate both competencies.
- Avoid retaliation from existing companies. Buying a company is a painless way to enter new markets that may be difficult to penetrate. Often, when entering new markets, existing companies will try to prevent new companies from entering.
- Diversification. The acquirer can cover losses in one business by buying another company that is not in the same supply chain.
Why did the acquisition fail?
While it can increase, for example, market share, however, the integration failure of the two businesses raises serious problems. That ultimately leads to failure, which may not be apparent in the short term.
The success of an acquisition strategy depends on two factors:
- Value creation
- Successful integration
The clash of two corporate cultures and values often hinders the integration of the target company into the parent company. That causes failure in establishing effective working relationships. In addition to cultural issues, three reasons for the acquisition failed to create value are::
- Incorrect target. Management may overestimate the potential economic benefits and ignore the potential risks from the purchase. It ends by choosing the wrong target.
- High cost. In a hostile takeover, the acquirer often pays the price far higher than the fair value of the target. The aim is, of course, to persuade the target’s shareholders and hand over their shares.
- Large debt. Target’s management often increases the company’s debt when they know it will be acquired. Their goal is to make the company unattractive to buy. If you are not aware, such liability will certainly be a burden in the future.