The aim of most of the companies is to make profits. For this they follow different tactics or strategies. And over the past few decades we have seen numerous examples where companies made huge success by mergers and acquisitions. It is an important tool to grow fast and earn money. The organisations spend millions of dollars for this. They do this to achieve synergy and have competitive advantage over their competitors. In other words this is usually done to add new product line, customer segment, geographical region or to better understand product. M&A also attracts a great attention from the media. But in reality the success rate is not satisfactory. And sometimes the incompatible environment or situations makes a sure success a complete fiasco.
What are Mergers and Acquisitions?
The mergers and acquisitions in broader sense mean either to combine with other company or take hold over it.
“A cross-border merger is a transaction in which two firms with their home operations in different countries agree to an integration of the companies on a relatively equal basis.” These companies take decision to combine their individual operations on a relatively equal basis to create combined competitive advantage that will contribute to success in the global marketplace.
“A cross-border acquisition is a transaction in which an expanding firm buys either a controlling interest or all of an existing company in a foreign country.” Often, the acquired firm becomes a business unit within the acquiring firm’s portfolio of businesses. Typically, managers in the acquired firm then report to the acquiring firm’s management team. The aim of the mergers and acquisitions is generally to create synergy i.e. to create value that is more than the combined value of the individual firms. (Hitt, et al., 2001)
Types of Mergers:
Mergers from the economic perspective can be categorized as: horizontal, vertical, or conglomerate.
“Horizontal mergers involve firms operating in similar businesses (e.g., Chevron and Texaco). Vertical mergers occur in different stages of production operations (e.g., AOL and Time Warner). In conglomerate mergers, the firms are in unrelated business activities (e.g., Tyco International has been acquiring companies in diverse activities).”(Weston & Weaver, 2001)
- It enhances industry consolidation when the overall market is mature and where market opportunities are flat or shrinking.
- It enables geographic expansion into neighbouring regions for adding new areas in its basket.
- It enhances expansion into new markets, for revenue growth, in which the opportunities are very less for the internal development.
- It involves acquisition of new technology or products or knowledge when the firm doesn’t have the resources to itself develop the product or technology
- It involves combining with one or more other firms in order to realize a synergy that will form a preeminent firm with superior market advantages or economies of scale. (Briscoe & Schuler 2004)
Circumstances which may make cross border merger and acquisition (M&A) activity the most appropriate entry mode for a firm considering entry into a new international market.
There are many different modes of entering into the new areas. Many companies are involved in these and are also very successful in taking advantage from them.
The common choices include trade-based entry modes (indirect, direct agent/distributor, direct branch/subsidiary), contractual entry modes (licensing, franchising, technical agreements, service contracts, management contracts, construction/turnkey contracts, co-production agreements), investment entry modes (direct entry, acquisition, joint venture).
Johanson and Vahlne (1977) believed that in the post-war era firms usually internationalized in a typical sequence of exporting, allying, and investing. However, as the trade became more complex, this pattern is less commonly seen. (Rugman 2008)
Each mode of entry has its own pros and cons. For choosing the entry mode, the firm has to do analysis of the situation and decide the choice by considering the overall situation and which mode of entry is giving the maximum advantage with respect to other modes.
The Mergers and Acquisition supersede when the other options are not feasible and this option is fitting well in the current situation for profits and growth of the firm
The option of exporting is not feasible in the following circumstances:
- When production in host country is cheaper than in home country.
- When transportation cost is too expensive.
- When companies lack domestic capacity or skills
- When products and services need to be altered substantially to gain acceptance from the consumers.
- When government inhibit the imports of the foreign products
- When buyers prefer products originating from a particular country. (Daniels, et al., 2009) In this situation, exporting is generally avoided.
The main disadvantage of licensing as an entry mode is the licensor’s lack of control over the licensee’s marketing program. Although the licensor ordinarily maintains the quality of the product, he does not control the licensee’s volume of production or marketing strategy. Therefore the performance of the licensed product mainly depends on the motivation and ability of the licensee. If the firm wants to have a good control on the product then this mode of entry is not a good option for it.
The other disadvantage is that it fetches lower returns than the returns gained from export or investment. In the agreement, the licensing revenues usually take the form of running royalties over the life of the agreement. Today royalty rates rarely exceed five percent of the licensee’s net sales, and agreement rarely run beyond 5-10 years.
Another main disadvantage of the licensing is its exclusivity. Ordinarily, a licensing agreement grants to license the exclusive rights to use this technology or trademark in the manufacture and sale of the products in the licensee’s country. When the agreement is valid, the licensor is prevented from marketing these products in the licensee’s country by using another entry mode, such as export or investment. (Walter & Murray 1988)
The main drawback is that it requires a huge sum of financial resources to build a factory and offices. Moreover establishing subsidiaries is a lengthy business, particularly with regard to construction and staff recruitment.
Apart from the financial issue, usually very less knowledge on the host economy is available, since the new subsidiary commences operations with no resources transferred from a local company, contrary to the situation regarding joint ventures and acquisitions. The lengthy start-up time plus less knowledge and experience can increase the uncertainties and risks in the business. (Ando 2005)
But a merger is expected to be a hit if it satisfies the following conditions:
It means the value created after the merger is more than the individual values of the independent firms before merging. This is usually a significant factor for the firms entering into the business. This is usually achieved through economies of scale.
The factors which can contribute to the economies of scale are:
- Some production processes are efficient usually when the production is in the bulk. For example automation industry.
- Large scale can allow use of more specialized or more efficient factors of production (land, labour, capital)
- Firms can spread their costs over larger number of output units and thus experience falling long-run average costs.(Lindeman 2002).
If there are companies that can take advantage of this situation by merging with the appropriate companies, then the option of mergers and acquisition is generally very prudent. Example, Compaq and HP combined together to take the advantage of economies of scale and generated synergy.
Firms can take advantage of synergies between their different operations and product lines. For example, when Tata Steel acquired Corus in 2007, it gained access to Corus rolling mills and distribution channels in Europe, while Corus gained access to Tata Steel’s in-house sources of iron ore. (Haberberg & Rieple 2008)
Complement each other
Sometimes both the firms are good in totally different activities or form a complete unit when they come together.
The most prominent example was the acquisition of Time-Warner, a film, TV, and publishing conglomerate, by AOL, a provider of internet services and content. It got finalized in 2000. The deal gave Time Warner access to AOL’s expertise in internet distribution, which was expected to grow in importance, while AOL gained proprietary access to all the media in Time-Warner’s stable, and also to its cable networks. Although this merged unit AOL-Time Warner recorded a loss of $99 billion in 2002. It tried to take advantage of AOL’s ability to charge subscriptions for its content and services. (Haberberg & Rieple 2008)
Knowledge of the local market
Mergers and acquisitions becomes very attractive choice if the company has a very insufficient knowledge of the local market. They can then merge with the local units to better understand the market and take advantage of the local skilled labour.
One common context in which mergers and acquisitions fits is in a mature industry where competition is intensifying and there are strong pressures to reduce costs. Horizontal mergers between companies in the same industry are a natural response, reducing the number of competitors and also the intensity of competition. (Haberberg & Rieple 2008) Moreover if the competitors unite then it also saves the extra money that they were spending on their promotions. This could then be used in some constructive work.
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Sometimes the company wants to have a full control in the foreign market. But it does not want to take the risk involved. This can still be achieved by first setting up a merged unit with a local firm, understanding the market, forming social and professional networks and testing its products. Once the company becomes comfortable in the new environment then it can set up the unit with its complete control.
Less Finance and Risk
The main drawback with Greenfield investment is that it requires huge finance and not all companies can afford this. Even if a company has sufficient amount, it may not be in a mood to risk that money. In this situation M&As becomes a very attractive choice. By merging with already established unit, reduces the risk and money involved. Sometimes the firm does not have sufficient capital to set up new units by its own. Under this situation, mergers and acquisitions is a good choice.
Culture also plays a very important role in the success of the mergers. If the cultures of the merging units are compatible then they have to face few hurdles otherwise it can risk the success of the mergers.
Brand image of the other company
Sometimes a firm wants to enter into new area where it is not well known. In this circumstance it usually faces high risk. This risk can somewhat be abated by merging with a unit that has a good brand image and take advantage of its name.
In brief we can say that each mode of entry into the foreign land has its own merits and demerits. The selection of the mode depends on many factors. The chief among them are: the financial status of the company, its aims and objectives, the level of risk it can involve, its social and professional network, management expertise and many more. All the factors vary from company to company and also the current situation of the market.
Reasons why many cross border M&As are deemed to have failed or underperformed
There are many advantages of Mergers and Acquisitions. But giving them a practical shape is not that easy. The success rate of cross-border mergers is very low. Apart from the general risks of M&As, it also have to face additional obstacles.
“Numerous scholars have presented this issue. It is seen that between 45% and 75% of acquisitions failed to deliver the value that is expected to create. According to a study by McKinsey, a management consulting, there is only a 57% rate of success in case of cross-border M&As.
The success or failure of mergers depends on both: pre-mergers activities and post-merger activities. Thus, it all depends on how companies make the M&A decision, give it a value, negotiate the deal, and how integration is managed.
“The most important reasons for failure are:
- Did not anticipate foreseeable events.
- Acquirer paid too much
- Synergies nonexistent or overestimated
- General economies: conditions/external events.
- Incompatible cultures”
These above-mentioned reasons for M&A failures could be avoided by conducting proper due diligence.
Moreover accounting standards could differ from international standards. Thus, several risks in assessing the financial value may exist:
- Inventories may be overvalued
- Real estate has to be valued at market price, and necessarily tax adjustments have to be made
- Hidden liabilities such as legal actions may be uncovered
An incorrect assessment of the financial value of the acquired firms results in overpaying for the assets of the acquired company. And the more a company is interested in buying, the more the price gets increased, independent from the real value of those assets. In addition, the management of the acquiring company is sometimes too optimistic about the value that can be created by the acquisition. This is called “hubris hypothesis” of why acquisitions fail meaning that top managers typically overestimate their ability to create value from an acquisition. (Pahl & Richter 2008)
Role of culture
Culture plays a very significant role on the success rate of cross-border mergers. Many acquisitions fail because the cultures of the acquiring and acquired company are very incompatible.
“It includes both the national culture and organizational culture.
Differences in Country Cultures: For instance, companies differ by nationality in how they evaluate the success of their operations. For example, U.S. companies usually evaluate the performance on the basis of profit, market share, and specific financial benefits. Japanese companies evaluate primarily on how an operation helps build its strategic position, particularly by improving its skills. European companies rely more on a balance between profitability and achieving social objectives. These differences also mean that one partner is satisfied while the other is not. (Daniels, et al., 2009)
This usually creates tensions resulting in a high management turnover in the acquired company. This loss of management talent and expertise can considerably harm the performance of the acquired company. This becomes more severe when the management has valuable local knowledge that is difficult to replace.
Acquisitions sometimes fail because attempts to realise synergies by amalgamating the operations of the acquired and acquiring company were not successful or take much longer than the assumed. This process may be slowed because of the differences in management philosophy, organisation culture or also by the bureaucratic haggling between managers.
Inadequate pre-acquisition screening is also a very important reason why acquisitions fail. Sometime there is no detailed analysing of the potential benefits and costs resulting from the mergers. These are mainly due to time pressure.
Pressure to grow fast and over-confidence by the high officials lead to unrealistic goals about the speed, ease, amount, and rewards of M&As. This usually results in the so called point-of-no-return. Insufficient planning or implementation could lead to many hindrances in the path of success and resulting in the failure of M&A.
All of the above mentioned reasons for the failure of M&As develops a vicious circle from pressure to failure and vice versa
A careful acquisitions strategy and a sound pre-acquisition screening reduce enormous the risk of acquisition failure. A detailed auditing of operations, financial position and management culture helps the acquiring company to make sure:
- Not to pay too much for the acquired unit
- Not to uncover any nasty surprises after the acquisition
- Not to acquire a company whose organisation culture does not fit to that of the acquiring company (Pahl & Richter 2008)
In brief we can say that the failure usually have more to do with the incompatibility of people, cultures, and/or HR systems than with problems with the originally anticipated financial or strategic benefits. These HR complications often include the issues of the overestimation of the abilities of the other firm, an exaggerated assumption of the synergies available from the integration, inadequate attention to the compatibilities of the firms’ ways of conducting business, and cultures, and unwillingness to prepare for the frequently experienced loss of productivity and staff after the merger is completed. Sometimes the differences legal and national cultures also add to these problems. Therefore the role of HR becomes very important. They have to wisely handle the issues prior to any international acquisition or alliance and also pay attention to the necessary post-merger” people integration issues.(Briscoe & Schuler 2004)
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- Briscoe, D & Schuler, R (2004) International Human Resource Management. 2nd ed. New York: Rouledge, p. 91-92
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- Hitt, M Harrison, J & Ireland, R (2001) Mergers and Acquisitions: a Guide to Creating Value for Stakeholders. New York: Oxford University Press, p. 146
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