A recent study conducted by McKinsey reports that of the top 75 US companies by market capitalization and the top 75 by revenues as of June 2005, 33 had accumulated at least 30 percent of their market value through acquisitions. It has been reported that between 1996 and 2001 American CEOs signed an acquisition or alliance every hour of every day. The deals totaled 74,000 acquisitions and 57,000 alliances in six years, with a combined value of $12 trillion (822 trillion yuan). These are just cases in point that prove that mergers, acquisitions and alliances have grown into some of the most participated corporate activities.
Faced with ever increasing competition in every sector of the market, companies seem to have unanimously decided that the best way to thwart such competition is to acquire the competing company and thereby establishing a stronger presence in the market place.
The integration of the emerging economies of Brazil, China, India, Russia and others has only made mergers and acquisitions more pronounced in the global market. But not all such activities prove successful. The Daimler-Chrysler partnership lost the two firms $60 billion (411 billion yuan) of market value and AOL Time Warner found themselves worth $54 billion (370 billion yuan) less after the merger. Further, the financial markets are known to react in strange ways in response to any such corporate deals. In February 2001, for instance, Coca-Cola and Proctor & Gamble declared a $4 billion (27 billion yuan) collaboration, which would oversee more than 40 brands and 10,000 staff. Five months later, after Coca-Cola’s stock had dropped and Proctor & Gamble’s share price risen soon after the announcement, the deal was off. In spite of such high profile failures, these governance models seem to be on the rise now more than ever.
This article examines the three main approaches that companies choose from worldwide. Further this article provides a framework that companies can use to decide among the many approaches for market growth and expansion.
Mergers, acquisitions and alliances are so loosely used in the business lexicon that it is only natural that there is a high level of confusion. Before suggesting a framework to choose among the three models, it is very important that conceptualizations of these terminologies are clear.
Merger: A merger refers to a process in which two companies become one by coming together. In such a case, no one company rules over the other. Usually the management of both companies shares the control of the resultant company and names of both companies are retained for the resulting companies. There are many high profile examples of mergers - AOL Time Warner, GlaxoSmithKline (the second largest pharmaceutical company in the world after Pfizer), Hero Honda (the leading motorcycle brand in India), Sony Ericsson (the third largest manufacturer of mobile phones in the world) and many others. In each of these cases, names of both companies were retained in order to leverage the equity of both brand names. Therefore simply put, mergers create a new organization out of two or more organizations of more or less equal stature, pooling all resources.
Acquisition: Acquisitions on the other hand refer to processes in which one company buys the other company. In such a situation the buying company absorbs the bought company into the existing company. Acquisitions can be carried out either to eliminate competition by absorbing the competing company or to expand the corporate portfolio by retaining the acquired company as an independent entity under the overall corporate management. This latter case is at the heart of many conglomerates. News Corp Inc acquired MySpace, the leading online networking site with an estimated 100 million registered users not in order to merge it with the other news businesses, but to expand the corporate portfolio. On the other hand Vodafone Group plc, the world’s largest mobile communications network company with a market capitalization of GBP 86 billion (US$169 billion or 1.16 trillion yuan) recently acquired a 67% stake in Essar Hutchison (one of India’s leading mobile phone network) for US$19 billion (130 billion yuan). The purpose of this acquisition was to enter the highly lucrative Indian mobile phone market. By this acquisition, India became Vodafone’s second largest market after the US. As is evident from the many examples mentioned before, mergers and acquisitions (M&A) serve three main purposes: M&A can serve as a market entry strategy, as a corporate portfolio expansion tool and as a competitive defense mechanism.
Alliance: Alliance is an approach in which two or more companies agree to pool their resources together to form a combined force in the marketplace. Unlike a merger, an alliance does not involve the emergence of a new combined entity. Each participant in the alliance retains their individual entity but choose to compete against competitors as a unified business force. Joint venture is a very popular form of an alliance. Recently, the world’s largest retailer Wal-Mart entered into a joint venture with India’s Bharti Enterprises to get a toe hold in the booming Indian retail market. This move was the only way Wal-Mart could have entered the Indian market as regulatory restrictions prohibit a full owned foreign retail chain to operate in the Indian market. As such, this joint venture was a market entry strategy for Wal-Mart. Consider another example - Costa Coffee, the leading coffee brand across the UK and Western Europe. This brand entered the Chinese market recently with a joint venture with the Yueda Group based in Jiangsu Province in China. This was not because of any regulatory restrictions but more because of its need to learn about an alien market and get a foot hold. Therefore joint ventures are indeed a very common entry strategy for companies. This approach has its own pros and cons. The obvious advantage is that companies entering markets through JVs would benefit from the local knowledge of the local company. The obvious disadvantage is that companies entering new markets may be taken for a ride if joint ventures are not agreed upon carefully. As such, defined simply, Alliances are less risky than acquisitions because they are negotiable, co-operative and easier to walk away from. They bring two firms together with mutual interests but different strengths to work on particular projects that offer benefit to both.
Once the implications are understood, companies will have to consider three key factors that influence the selection among the approaches, which will offer a strategic context for companies to evaluate the three approaches.
1.Level of competition in the market One of the fundamental reasons that companies engage in either M&A or an alliance is to tackle competition in any market. Companies around the world have to come to believe that consolidation with a market would allow them proportionate market presence and power to claim the leadership position. Further, with immense pressure on companies to cut costs and post profits, acquisitions offer a channel to increase scale and leverage the sheer size of the resulting organization. As such, depending on how competitive the market is in any particular sector, companies will have to decide between the three options. Airline industry in the US is one of the most competitive industries. As such, companies have resorted to intense acquisition as consolidation reduces costs, increase occupancy rates, and enhances the underlying profitability. On the contrary, consumer electronics is an industry where due to the highly specialized nature of work, companies prefer collaboration or alliances. Therefore a Samsung works with Sony, a Sony works with Ericsson, Intel works with IBM and so on. These strategic alliances allow companies to leverage each others core competencies.
2.Barriers to entry M&A are usually resorted to either for increasing scale or cutting costs and alliances are preferred to enter new markets or segments. As such, one of the important factors which should be considered is the level of barriers present for entering a new market. Some markets are characterized by high barriers to entry such as regulatory constraints, established competitors, highly volatile markets that does not justify initial entry investments and so on. In such cases, alliances are the preferred option as they allow companies to leverage the existing knowledge and resources through collaboration. On the other hand, where barriers to entry are low, companies can gain a very strong foot hold in the market either through mergers or through acquisitions.
3.Synergies and resources Along with the previous two factors, synergies and resources are equally important in deciding among the three options available to companies. Mergers and alliances between companies have been proven to work efficiently if there is a high level of synergy between companies that come together. Synergies can be in the corporate culture, product portfolio, strategic goals, and supply chain or logistic systems. When such synergies exist, companies can productively implement the purpose of a merger or an alliance. Similarly, for an acquisition option, an important factor is the availability of financial resources. As acquisitions take place at prices much higher than the book values of the companies being acquired, acquiring companies should possess or have access to considerable resources.
Mergers, acquisitions and alliances are all equally powerful corporate growth strategies available for companies. The selection of any single approach depends on both internal and external factors. Given the many successes and failures alike experienced by companies worldwide, it would be advisable for companies to primarily understand the strategic implications of each approach and then to diligently evaluate each approach in light of the above mentioned factors.
As each market and each company is unique, selection amongst these three approaches would substantially differ. But companies can minimize their risk by following the guidelines offered in this article.
Print ed: 02/09