Can firms gain Competitive advantages and growth from acquisitions?
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Published: Mon, 5 Dec 2016
There has been much discussion of whether firms can achieve growth by acquisitions or not. According to Sudarsanam (2003), an acquisition refers to acquirers use cash, stock or other assets to purchase target firm’s share and gets the operation right while the target firm ceases to exist. According to Gaughan (2007), firms have several motivations to acquire another firm in order to achieve growth such as expansion of market power, financial incentive, and tax motives. Furthermore, compared to internal development of companies, an acquisition is a fast way to achieve the growth. Gaughan (2007) also argue that especially in a slow-growth company, it is much easier to improve sales and gain more revenue by acquisitions. However, not all companies gain their profits after acquisitions. Shareholders in the acquiring firms may have more risks and lose their investments because of imprudent acquisitions. Gaughan’s statistics (2007) from 1980 to 2001 show that on average, acquiring companies lost 25.2 million dollars. It seems clear that most acquirers have some operating problems.
This essay will attempt to demonstrate that not all companies can use acquisitions to achieve growth because there are some factors which limit or prevent growth. In order to demonstrate this, it will be shown that firstly, acquisitions may increase costs and erode the profits and secondly that the market share and synergy do not guarantee to achieve growth. At the same time, the different results in growth because of firm size and payment methods will be discussed.
Competitive advantage – cost-saving
One of the main motivations of acquisition is cost reduction. Some business people claim that if new firms attempt to enter into the new market, they can use acquisitions to save the cost of production and gain the competitive advantage (Sudarsanam, 2003). Indeed, bidding firm can acquire more resources from target firms to produce the new products and gain more profits. According to Sudarsanam (2003), the innovation ability can decide whether companies have sustainable development or not. Acquisitions help companies to acquire some patents or technological skills from target firms and enter into the new market. Moreover, they can save the time cost and budgets for training their employees to operate the machines.
Hill (1999) gives the example of the acquisition of Nixdorf AG by Siemens AG. Nixdorf AG is a computer hardware and software manufacturer. This company owned valuable patents and gained a lot of profits. However, Nixdorf AG experienced the financial crisis during the end of 1980 because the price of computer suddenly dropped. This crisis enforced Nixdorf AG to liquidate their properties. Siemens AG, a communication company, utilized this opportunity to acquire Nixdorf AG and owned the abundant technological resources. Finally, Siemens AG became the largest software company and second-largest hardware manufacturer in Europe.
Reputation of the cost-saving argument
Although Siemens AG succeeds in acquisition and wins the market share of its industry, other experiences of companies may be not fortunate. The cost of acquisitions may negatively influence the shareholders’ rights and restrict the growth. Acquirers take not only the assets of target firm but also the liabilities (Moeller, Schlingemann, Stulz, 2004). For example, Georgia-Pacific paid $3.74 billion to Great Northern Nekoosa Corp, the paper product manufacturer in US, for acquisition in 1990. At the same time, Georgia-Pacific also took $1.3 billion in debt from Great Northern Nekoosa Corp. Finally, the debts in Georgia-Pacific increase to $ 6 billion because of the heavy interest cost and falling paper price. Georgia-pacific has suffered from the enormous losses (Hill, 1999). The debts influence the market value of enterprises and cause acquirers have adverse risks. In this case, Georgia-Pacific lost its opportunity to achieve growth.
In addition, there are some limitations and challenges for acquisitions. The resources from target firms should be rapidly integrated and managed by acquirers. Sudarsanam (2003) defines integration as “the need to maintain the separateness of the acquired business, including systems, processes, procedures, strategy, reporting systems, etc.” However, in fact, the integration of resources between two companies is a difficult task and always takes a lot of time. According to Sudarsanam (2003), integration not only changes the structure of companies but also rebuilds the new human resources, especially in hierarchy of authority. Indeed, acquirers usually allocate their own managers to the acquired company because these managers clearly know the enterprise culture and administration process of the acquirer company. However, it is not easier to change the employees’ attitudes, working habits, and cultures. It seems clear to expect that bidding firms should spend more time to be familiar with the new management system or the production process.
Moreover, acquisitions may reduce employee morale (Gaughan, 2007). The employees in acquiring firms and target firms may worry about the negative impacts of acquisitions such as unemployment or job rotation. This probably affects their normal working performance and acquirers may spend more costs on seeking other staffs to replace the original employees of target firms. If happened, they may spend more costs on training the new staffs and reorganize their working teams. These administration cost may be a burden for the acquirers.
Furthermore, the insufficient creative abilities of target firms may become obstacles of acquirers (Sudarsanam, 2003). Das and Teng (2000) provide the example of Research & Development department: if researchers cannot acquire their research resources from their new enterprises, this will affect their working efficiency. These factors probably limit companies to achieve growth. Therefore, these potential costs probably affect the normal operating performance of enterprises and inhibit the growth of companies.
Competitive advantage-market share
Another motivation for acquisitions is the expansion of market power. Compared with internal development in company, expansion in acquisition may be a much rapid way to achieve the growth. It is also a good method to use acquisition to increase the market power. Gaughan (2007) defines expansion as “diversification.” This means companies may have diverse business or enter the new market through acquisitions. They may acquire new technologies or a new product line from target firms to produce the new products. Acquirers also perhaps occupy the original market power of target firm and expand their market share. This may earn more money and achieve the growth of sales. Hill (1999) gives the successful example of the acquisition. Volkswagen, an automobile producer, planed to enter a luxury car market to compete with Bavarian Motor Works (BMW). Volkswagen acquired Rolls-Royce Motor Cars and got the professional production technology. Finally, the sales of automobiles increased 13.2 percent for the first six months of 1999 and rose 84.7 percent in North America alone. Therefore, bidding firm can expand their market power and may achieve the growth.
Refutation of the market share argument
However, this is not a guarantee that an acquirer can always maintain the market advantage. The business environment changes fast and commercial activities develop rapidly. In the short tern, the acquirer may gain the marker power. However, in the long tern, the competitors may occupy the acquirer’s market share by using other marketing methods. For example, the competitors may adopt much lower price of commercial products or provide aftercare service to attract the consumers. Therefore, acquirers not only improve their competitive advantages by acquisition but also seek for other ways to achieve growth. Sudarsnam (2003) also indicates that non-acquired firms have 88 percent of market share. However, acquired companies merely have 18 percent of market share in the US. This means that the non-acquired firms have more market share than acquired companies have. It seems clear that only relying on the acquisition is not enough to achieve growth.
The competitive advantage – synergy
Another motivation of acquisition is synergy. According to Das and Teng (2000), synergy can be defined as “an integration of supplementary resources”. Through synergy, companies can easily gain economies of scale or reduce the cost of capital without needing to spend additional money on equipment or land. Moreover, acquirers can use some methods to reduce their costs. For example, they may change the methods of production in order to improve work efficiency. Bidding firms may have some competitive advantages so that they are qualified to acquire other companies. Bidding firms may share their successful experience or provide some technologies to the target firms. If two companies can corporate well, this may help acquirers gain more profits.
Refutation of the synergy argument
However, acquisitions bring more demands on management (Gaughan, 2007). It tests administrators’ capabilities to manage more resources and to operate the bigger companies. Lack of effective corporate governance may lose investors’ confidence and influence market valuation of firms (Philippe and Jemison, 1993). Therefore, synergy is not a guarantee that companies will gain more profits. If resources are insufficient, it may waste more costs to maintain the basic expenditure. Moreover, the unsuitable management perhaps threatens the normal operation of acquirers and negatively influences the shareholders’ returns. Therefore, in order to reach the growth of firms, managers not only consider the value by acquisitions but also ensure that whether the cost of acquisitions far outweigh the creating value or not (Sudarsanam, 2003).
The influence of firm size
Moeller, Schlingemann, Stulz (2004) demonstrate that there are different effects of acquisitions in firm size. The private firm can be defined as a small firm; the public firm is defined as a large firm. The acquisition of private firms may acquire more returns than the acquisition of public firms. The reason is that the public firm is more likely to be overvalued (Moeller, Schlingemann, Stulz, 2004). This means that a lot of assets in public firms are difficult to measure the accurate real prices. Furthermore, goodwill is also difficult to value in public firms. According to Sudarsanam (2003), goodwill can be defined as “the excess price of the fair values of assets”. Because the public firm owns more resources and expects create more extra value, shareholders are willing to invest more money in this company. They also have more complicated accounting systems than private firms do. Therefore, this is very common to have valuation error because the information in public firms is not fully disclosed (Sudarsanam, 2003). This may affect how much acquirers have to pay in the acquisition. The valuation error will gain more costs and negatively influence the shareholder’s rights.
In addition, most of managers in small companies are much easier to have the common view from the shareholders (Moeller, Schlingemann, Stulz, 2004). The reason is that there are few assets in small firms so that the managers in small firms have more right to manage and allocate the resources. Therefore, the managers in small target firms are much easier to corporate and negotiate with acquiring firm. If bidding firms can get more supports from the target firms, the bidding firms are much easier to achieve the growth.
The influence of payment methods
According to Gaughan (2007), the payment methods influence the benefits of firms, including cash and equity. In addition, because of information asymmetry, investors usually have different views for an acquisition. This phenomenon probably affects the payment method of an acquisition. There is the different effect of cash offer and common stock change. According to Travols (1984), acquirers prefer to purchase the assets or stocks from target firm by cash offer because they believe that their company is undervaluation. Investors usually believe that using cash to acquire another company is a positive signal. Therefore, after the acquisition, the stock price of the bidding firm would rise. The shareholders in the bidding firm also gain more wealth. On the other hand, if the manager of a bidding firm uses stock to do the acquisition, investors may have erroneous valuation. This point is supported by Gaughan (2007) as well. He indicates that paying by cash has obvious effect of improving wealth. It seems clear that different payment methods have different results and affect the growth of companies.
However, the payment methods are related to whether the acquirers can save the tax or not. The price of stock change is depend on the fair market value. If the acquisition is processed by stock change, the acquirers may have tax free. On the other hand, if acquiring firms purchase the assets or stock of target firm by cash, acquiring firms may pay a mount of tax and increase the cost (Gaughan, 2007). The tax payment may be a big burden for the acquirers and negatively influence the growth.
Therefore, pre-acquisition is a very important process to evaluate which purchase method has more competitive advantage. Both stock change and cash have some advantages and drawbacks. This also tests the abilities of managers and accountants to help companies use the lowest cost to acquire the most benefits. The payment methods may influence the different results of the growth.
In conclusion, this essay has attempted to demonstrate that although acquisitions have some benefits to achieve growth, it also leads to many problems. The pre-acquisition is a very important process to analyze the uncertain risks and payment methods. Acquirers should deeply analyze whether acquisition can create more profits and achieve the growth or not. In addition, the managers in bidding firms should expect the possible risks such as the financial position of target firms and investment environment. Moreover, acquirers should carefully calculate the expected returns to prevent the overpayment before an acquisition. Furthermore, Haspeslagh and Jemison (1991) indicate that “Managing the post-acquisition integration process to create the value hoped for when the acquisition was conceived.” The manager should make efforts to reduce the conflicts of two companies. It may be true that through acquisitions, companies may increase their market power. However, acquirers should look for other ways to gain their market share as well. In addition, the size of enterprises may have different results of acquisitions. We have to consider the cost whether surpass margin profits. All of these factors will influence the growth of firms in acquisitions.
Nowadays, mergers and acquisitions become a trend to expand the business. It seems that there are more and more companies will deal mergers or acquisitions in order to increase their competitive advantages. These companies may have solid capitals. It means that people have fewer choices of product and these companies may face the monopoly problems.
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