Chapter 7 Acquisition and Restructuring Strategies Diane M. Sullivan, Ph.D. 2012 Sections modified from Hitt, Ireland, and Hoskisson, Copyright © 2008 Cengage Sections modified from Gentner (2009)

The Strategic Management Process Firms determine the mechanism(s) for implementing corporate-level strategies 3 possible mechanisms: Mergers Acquisitions Restructuring Goals: Diversifying Achieving growth Meeting competitive challenges Insert figure 1.1 graphic

Mergers & Acquisitions: Key Definitions Strategy where firms integrate their operations on a coequal basis Example : 1997 Guinness merged with Grand Metropolitan, to form Diageo, plc, the world’s largest spirits company Takeover A special type of acquisition strategy where the acquired firm does not solicit the acquiring firm’s bid Example: Guinness took over Arthur Bell to pursue Spirits Acquisition (our main focus today) Strategy where one firm buys a controlling (or 100%) interest in another firm and makes the acquired firm a subsidiary Acquisitions are more common than mergers or takeovers

Acquisition: Examples Example Horizontal Acquisition 2004: Oracle acquired PeopleSoft to facilitate growth by acquiring a rival; gained access to customers, sales force, and software applications Example Vertical Acquisition 2007: CVS Corp. acquired a PBM customer, Caremark RX, Inc. Buyer Target Competitors Oracle People-Soft Forward Integration (firm buys customer) Buyer CVS Target Care-mark 4

The Triple Sevens of Acquisitions 7 reasons firms pursue acquisitions 7 problems with acquisitions 7 ways to increase likelihood of success

7 Reasons Firms Pursue Acquisition Strategies 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 firm’s competitive advantage Learning and developing new capabilities

7 Reasons Firms Pursue Acquisition Strategies 1. Increased Market Power (main reason) Sources of market power include Size of the firm, resources and capabilities to compete in the market, share of the market These are achieved through: Horizontal Acquisitions Acquirer and acquired companies compete in the same industry Example: McDonald’s acquisition of Boston Market in 2000 Vertical Acquisitions Firm acquires a supplier or distributor of one or more of its goods or services; leads to additional controls over parts of the value chain Example: Google’s purchase of DoubleClick in 2007 Related Acquisitions Firm acquires another company in a highly related industry Example: Chapter 6 – P&G and Gillette

7 Reasons Firms Pursue Acquisition Strategies 2. Overcoming Barriers to Entry Acquiring established firms may help overcome Economies of scale enjoyed by competitors Differentiated products by competitors Competitors that enjoy customer loyalties Acquisitions may be more effective than entering the market as a new competitor with an unfamiliar good Acquisitions can provide a new entrant with immediate market access

7 Reasons Firms Pursue Acquisition Strategies 3. Cost of New Product Development & Increased Speed to Market Significant investments are required to Develop new products internally Introduce new products into the marketplace Acquisition of a competitor may result in Lower costs relative to developing internally Faster market entry Rapid access to new capabilities Often benefits firms in knowledge-intensive industries (e.g., pharmaceuticals)

7 Reasons Firms Pursue Acquisition Strategies 4. Lower Risk Compared to Developing New Products Outcomes more easily and accurately estimated compared to internal product development process Therefore acquisitions viewed as lowering risk More predictable returns and lower risk 5. Increased Diversification If lack experience, acquisitions easiest way to gain expertise Faster to diversify and change a firm’s portfolio Example: Conglomerates (e.g., Jarden Corporation)

7 Reasons Firms Pursue Acquisition Strategies 6. Reshaping a Firm’s Competitive Scope To lessen dependence on a particular market Example 1: GE reducing dependence on electronics market by making acquisitions in financial services Example 2: Microsoft trying to reduce dependence on software, to enter search engine and web content markets 7. Learning and Developing New Capabilities Acquisitions help gain capabilities firm does not possess Acquisitions may be used to Acquire a special technological capability (e.g., IBM moving into software) Broaden a firm’s knowledge base Reduce inertia

Most M&As Fail to add value! Headline: October 24, 2012 Most M&As Fail to add value! 20% successful; 60% produce disappointing results; 20% clear failures

7 Problems in Achieving Acquisition Success Integration difficulties Inadequate evaluation of target Large or extraordinary debt Inability to achieve synergy Too much diversification Managers overly focused on acquisitions Too large

7 Problems in Achieving Acquisition Success 1. Integration Difficulties Melding two companies can be difficult Corporate culture clashes Different financial and control systems Status of newly acquired executives Example: UPS and Mailboxes, Inc. 2. Inadequate Evaluation of Target A lack of due diligence may result in paying a premium Especially problematic when firms are performing well Investment banks can help in obtaining effective valuation Must assess both business model and financial value Enter the dot com boom! Example: 1999 Yahoo! acquired Geocities.com for $3.57 billion and it never turned a profit!

7 Problems in Achieving Acquisition Success 3. Large or Extraordinary Debt When firm’s take on high levels of debt to acquire a firm Increases the likelihood of bankruptcy Leads to a downgrade in the firm’s credit rating Precludes investments that may contribute to long-term success 4. Inability to Achieve Synergy Synergy exists when assets are worth more when used together versus when used separately Firms also incur “transaction costs” to create synergy that when estimated inaccurately can lead to problems If unable to achieve expected synergy, acquisitions can fail Example: PepsiCo, Inc.

7 Problems in Achieving Acquisition Success 5. Too much Diversification Managers absorptive capacities can lessen their abilities manage highly diversified firms Diversification is often substituted for innovation 6. Managers Overly Focused on Acquisitions Focusing too much on acquisitions at the expense of managing the firm’s day-to-day activities 7. Too Large Large companies require more standardized management Bureaucratic controls This can lessen innovative capacities and reduce firm performance

How Can Firms Increase Likelihood of Success? 7 considerations to increase M&A success Complementary assets or resources Friendly acquisitions facilitate integration of firms Effective due-diligence process (assessment of target firm by acquirer, such as books, culture, etc.) Financial slack Low debt position Innovation Flexibility and adaptability

7 Considerations to Increase M&A Success 1. Complementary Assets or Resources Buying firms with assets that meet current needs to build competitiveness 2. Friendly Acquisitions Facilitate Integration of Firms Friendly deals make integration go more smoothly 3. Effective Due-diligence Process Deliberate evaluation and negotiations are more likely to lead to easy integration and building synergies 4. Financial Slack Provide enough additional financial resources so that profitable projects would not be foregone

7 Considerations to Increase M&A Success 5. Low Debt Position Acquiring firm maintains financial flexibility when incurring lower debt in acquisition 6. Innovation Continue to invest in R&D as part of the firm’s overall strategy 7. Flexibility and Adaptability Executives who have experience at managing change and with acquisitions are more flexible and adaptable to acquisitions

What if an M&A Fails? Restructuring Strategies Strategy where a firm changes its set of businesses or financial structure 3 main types Downsizing An intentional reduction in the number of a firm’s employees and/or operating units Frequently used when excessive premium paid for acquired firm Downscoping The divestiture, spin-off, or other means of eliminating businesses unrelated to the firm’s core business Example: American Standard Companies Leveraged Buyouts Restructuring strategy where a party buys all of a firm’s assets in order to take the firm private (private equity firms) Example: Gibson Greeting Cards—3rd largest greeting card manufacturer in US—was part of RCA; 1982 RCA sold to The Wesray Corporation (investment group)

Restructuring and Outcomes