Applied Research Methods - Mergers and acquisitions (M&A)

Table of content

1 Introduction

2 Literature Review

3 Research question

4 Research objectives

5 Philosophy Research Design
5.1 Epistemology
5.2 Ontology

6 Research Approach
6.1 Quantitative vs. Qualitative
6.2 Data collection
6.2.1 Sample size
6.2.2 Collecting data
6.2.3 Data analysis

7 Ethical considerations

8 Conclusion

Appendix

List of References

1 Introduction

Throughout the last decades, mergers and acquisitions (M&A) are achieving increasing importance in the corporate world. There are many motives such as to increase the market power and competitive advantage, to reduce dependence on suppliers, to gain fast access to new market etc. why managers adopting an acquisitions strategy. Nevertheless, many M&As have been unsuccessful in the past due to incompetent managers, poor ethics, inadequate analysis prior the deal, and diversification away from the core business of the company. Therefore, a careful industry, target company, and product portfolio analysis must be made before the deal. The literature provides different frameworks and analytical tools that can be used in the M&A process in order to avoid typical risks. However, because of the uniqueness of each M&A deal, it is important to gain further insights in these transactions in order to provide an appropriate guideline on how to select an optimal M&A target.

2 Literature Review

According to Porter (1998), competition determines the success or failure of companies. In addition, he outlines that a corporate strategy is the search for a favourable competitive position in an industry, the fundamental arena in which competition occurs. Furthermore, he argues that the purpose of strategy is to establish a profitable and sustainable position against the forces that determine industry competition. In his framework, Porter's five forces model of industry competition he describes five forces-threat of new entrants, bargaining power of supplier, bargaining power of customer, rivalry among current competitors, and threat of substitute products and services-in detail, which must be analysed to formulate a strategy successfully. The strength of each of the five competitive forces is a function of the industry structure or the underlying economic and technical characteristic of an industry (De wit & Meyer, 2004). Although this framework has been widely accepted in literature as one of the most pervasive analytical tool, there has been some criticisms in the past. Henry (2008) argues that Porter's framework is a static analysis which assumes relatively stable markets. In this context, he outlines that it does not provide enough information about how players in the industry interact wit each other and criticize that it represents a traditional view of strategy, which is no longer applicable in today's rapidly changing environment. Prahalad (2000) supports Henry's view by arguing that today companies are facing significant and discontinuous change in the competitive environment such as the impact of the internet on the way in which companies conduct their business. In this context, Mintzberg and Waters (1985) outlined that many strategies are not only deliberate but also emergent. Unexpected changes in the environment force companies to abandon a deliberate strategy. Due to this, they argue that in emerging industries it is difficult to identify the rivals, which makes the use of the framework problematic. Furthermore, Henry also criticized that in Porter's framework companies only can succeed at the expense of other players in the industry. However, companies are increasingly aware of the added value that other players may contribute which has led to collaborative relationships especially in the automobile industry in the past (Please refer to appendix to find Porter's three generic competitive strategies in context to this framework).

Referring to Porter's five forces, Sudarsanam (2003) has outlined in his book creating value from mergers and acquisitions that “competition is a dynamic process and firms can re-shape the industry structure through creating new technologies, substitute products or distribution channels.” Further he explained that companies faced with the five forces configuration might attempt to change the configuration to increase their competitive advantage and their profitability through mergers and acquisitions (M&As). In context to this he emphasised that companies need to understand the key structural factors that need to be changed and companies must analyse whether they can be changed through M&As or not. For instance, if profitability is depressed due to threat of new entrants, a M&A that generates substantial scale of economies might raise entry barrier to new entrants. In addition, a merger with an rival can enhance the bargaining power of the merged companies against both companies’ suppliers in case the merger reduces the overall number of companies in this business sector. Furthermore, a M&A can provide a privileged access to suppliers or distribution channels, which in the best case reduces current rivalry. Nevertheless, Sudarsanam also highlight that rivals “may emulate the first firm and carry out copy-cat mergers to achieve the same scale economies.”

Besides Porter's framework, the literature also provides certain generic analytical frameworks, which are vital in the context of strategic decisions for M&As (Please refer to appendix).

Moreover, Peffer (1972) argued that M&A is one possible strategy for a company to gain control of environmental interdependence stating, “there also exists the possibility for organisations to deal with uncertainty or interdependence by absorbing it completely through M&A”.

Nevertheless, to better understand the motives and reasons behind M&A you need to look at Trautwein who explained those in detail. Trautwein (1990) identified several theories of M&A motives. In his first theory, the efficient theory, M&A are executed in order to achieve synergies. Sirower (2007) defines synergy as “increases in competitiveness and resulting cash flow beyond what the two companies are Alexander Berger - Applied Research expected to accomplish independently.” Ansoff summarised Sirower's approach in the formula “2+2=5” (Wübben, 2007). Moreover, Trautwein (1990) categorised synergies into three types-financial, managerial, and operational synergies. Financial synergy occurs from lower cost of capital as a result of the increased company's size, as larger companies have normally access to cheaper capital due to the lower systematic risk (Bösecke, 2009). According to Bösecke (2009) managerial synergies occur when the management of the target company has superior abilities from which the other company can profit. Finally, operational synergies occur if a company can achieve more economies of scale and scope. “Economic of scale in production means that production at a larger scale (more output) can be achieved at a lower cost (i.e., with economies or savings)” (Hussain, 2010, pp. 149). Here, you can draw a link to Porter five forces where achieving more economy of scale will reduce the threat of new entrants. Furthermore, M&A that expand the product portfolio of a company might produce economies of scope, which occurs if the joint production of two products is less costly than the cost of producing these products separately (Bösecke, 2009). In the second theory, the empire-building, Trautwein (1990) states that managers try to maximize their own utility when executing M&A rather than maximising shareholder’s wealth. Managers often have different interests than shareholders, which might create a strong potential conflict. As the company grows the management’s compensation grows as well, which can lead to M&A that are strategically incomprehensible (Bösecke, 2009). In the third theory, the monopoly theory, M&As are executed to achieve market power. Large companies are more likely able to cross-subsidize products, to achieve economy of scale, to limit competition within a market and to create entry barriers for new entrants (Auerbach, 2009). The fourth theory, valuation theory, assumes that acquirers believe to have more information about the true value of the targeting company than the rest of the Alexander Berger - Applied Research market because of insider information. “The acquisition of such a target company creates value for the acquirer simply through the readjustment of the target's share price to its higher inner value based on the additional insider information” (Wübben, 2007, pp. 22). However, Trautwein mentioned that the valuation theory has been criticised because it is difficult to obtain enough information about the post-acquisition results] meaning that the higher inner value might not be added after the acquisition due to e.g. a failure ofthe integration of the target company (Trautwein, 1990).

Moreover, Pfeffer (1972) argued that companies use M&As to use the power of the government to obtain favourable conditions in the political and economic environment. Examples of various types of state assistance include “direct cash subsidies, restrictions on competitive entries, control over substitutes and complements, and low tax rates” (Connell, 2008, pp. 61). In relation to this, a commonly used and immensely valuable technique to analyse the political and economical environment is the PEST analysis. The PEST analysis divides the external environment into four different categories-political, economical, social, and technological which directly influence a company's decision in the strategic making process (Chapman, 2006).

M&As are also seen as one of the best method of achieving strategic aims of growth and expansion as indicated earlier in the text. Nevertheless, a distinction between an acquisition-based strategy and organic growth strategy must be made to highlight the differences. In the following table, Ray (2010) made fundamental distinctions.

Abbildung in dieser Leseprobe nicht enthalten

Please see appendix to find further motives presented by Bower and Ansoff.

Despite M&As can create value and might lead to a competitive advantage there are few potential problems with M&As which increase the risk of companies. Harrison (2007) has identified two categories of problems: High financial costs and strategic problems. The acquirer often pays higher premiums, which exceeds the market value of the target company. Furthermore, many M&As are financed by debt, which increases the interest cost and can lead to greater financial risk. Another major expense for the acquirer are high advisory fees and other transaction costs. Moreover, according to Hamel and Prahalad (1994) employees are key players contributing to the core competencies of the organisation. Nevertheless, in most cases the employees, managers of the aquired company must leave the company due to restructuring, divestments, etc. In this context, Harrison (2007) asked therefore “If most employees leave, what has the acquiring company purchased?” Furthermore, M&As have been shown to lead to reduced innovative activity, which might affect long-term performance negatively (Harrison, 2007). Another strategic Alexander Berger - Applied Research problem is that the culture, structure, processes of the target and acquiring company do not match with each other. Synergy is therefore unlikely to occur (2+2=3).

Although there are problems with M&A transactions, it does not mean that all M&As are doomed to failure. According to Harrison (2007), researchers have been identified factors that are associated with successful and unsuccessful mergers. Unsuccessful mergers are often associated with “a large amount of debt, overconfidence or incompetent managers, poor ethics, inadequate analysis prior the deal, and diversification away from the core business of the company. Successful mergers are related to low-to-moderate amounts of debt, a high level of relatedness to synergy, a continuous focus on the core business, careful selection and a strong debt position”(Harrison, 2007, pp. 119).

In conclusion, you can see that literature provides a lot of theory on how M&As can create value to the acquirer in order to strengthen its position in the market and to gain competitive advantage. Furthermore, many motives for M&As from the acquirer perspective were presented. Nevertheless, the literature also emphasised on using analytical frameworks and planning carefully M&As to avoid unsuccessful deals.

3 Research question

- How to select an optimal M&A target?

4 Research objectives

- To describe how M&As can deliver value to companies.
- To describe how companies can avoid typical M&A risks
- To determine motives for acquiring companies.

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