Chapter 7 Acquisition and Restructuring Strategies

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Chapter 7: Acquisition and Restructuring Strategies



7
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Chapter 7

Acquisition and Restructuring Strategies



KNOWLEDGE OBJECTIVES


1.

Describe the popularity of acquisition strategies in firms competing in the global economy.

2.

Discuss reasons firms use an acquisition strategy to achieve strategic competitiveness.

3.

D
escribe seven problems that work against developing a competitive advantage using an acquisition
strategy.

4.

Name and describe attributes of effective acquisitions.

5.

Define the restructuring strategy and distinguish among its common forms.

6.

Describe the short
and long
-
term outcomes of the different types of restructuring strategies.



CHAPTER OUTLINE


Opening Case
Hewlett
-
Packard’s Acquisition of Compaq: IBM Envy or Good Business Acumen?

THE POPULARITY OF MERGER AND ACQUISITION STRATEGIES



Mergers, Acquisit
ions, and Takeovers: What Are the Differences?



Reasons for Acquisitions


Strategic Focus
The Good, the Bad, and the Lucky of Horizontal Acquisitions


Problems in Achieving Acquisition Success


Strategic Focus

Dynegy Should Thank Its Lucky Stars

EFF
ECTIVE ACQUISITIONS


Strategic Focus
Was GE’s Attempted Acquisition of Honeywell a Correct Strategy?

RESTRUCTURING



Downsizing



Downscoping



Leveraged Buyouts



Restructuring Outcomes


SUMMARY


REVIEW QUESTIONS


EXPERIENTIAL EXERCISE


NOTES




LECTURE NOTES





OPENING CASE

Hewlett
-
Packard’s Acquisition of Compaq: IBM Envy or Good Business Acumen?


Though not completed at the time of the writing of the text, H
-
P’s acquisition of Compaq has finally been
achieved. Disagreement over the acquis
ition proposal centered mostly on the question of value. Several
arguments can be presented in favor of the acquisition

achieving economies of scale, increased financial
and market power, cross
-
selling of products, and complementary technological capabili
ties. Others
contend that the negatives are strong

the PC business is competitive, volatile, and low margin; the merger
brings together two massive firms, which is challenging. The goal of the acquisition is to develop its
services and software business
so it can compete with IBM, which is unlikely.




Chapter 7: Acquisition and Restructuring Strategies



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OPENING CASE

The Internet: Driving Mergers and Acquisitions in the Global Economy


Telecommunications companies are using merger and acquisition strategies to develop the
economies of scale that are
important to their competitive success in rapidly changing and
cost sensitive markets, to enter new markets, and to tap into the potentials of the Internet.



SBC Communications recently acquired Sterling Commerce for $3.9 billion, giving
SBC the capability
to expand its reach into the business
-
to
-
business (B2B) electronic
commerce market.



MCI WorldCom’s proposed $115 billion acquisition of Sprint was designed so that the
combined company could be a viable competitor in a global arena by gaining the size
nece
ssary to participate in Internet
-
related business transactions.



Britain’s Vodafone Airtouch acquired Mannesmann of Germany (cost of $190.5 billion)
to gain the power needed to “call the shots” in emerging wireless Internet applications.


America Online w
ants to acquire Time Warner to package service deliverables for
customers, especially the $100 to $150 a month middle
-
class households that pay for cable
TV, local and long
-
distance telephone service, and Internet access.


The financial services industry
uses mergers and acquisitions to bundle services, combining
bank accounts, retirement savings, credit cards, home mortgages, auto loans, and insurance
on a single monthly statement
--
and all of these transactions can be completed via the
Internet. Because
acquisitions permit quicker market entry (as compared to developing
capabilities internally), it is likely that financial services firms will merge with or acquire
other companies to take in Internet
-
based skills that support comprehensive customer
-
related

transactions.


Numerous acquisitions are taking place among Internet companies themselves, many of
these designed to gain first
-
mover advantages. They are generally purchasing Internet
ventures with strong brand names:



to gain access to a critical mass o
f customers



to cross
-
sell products



to build a market defense since a firm with a strong brand name is harder to dethrone


Amazon.com continues to acquire Internet ventures (e.g., Pets.com and Drugstore.com) to
expand and diversify its operations. This acq
uisition activity is facilitated by:



high valuations of these companies (allowing use of co. stock as acquisition currency)



the record
-
setting availability of venture capital funding


Experts predict that merger and acquisition activity among Internet com
panies and
transactions for the sake of access to an acquired firm’s Internet capabilities are likely to
continue.





1

Describe the popularity of acquisition strategies in firms
competing in the global economy.



THE POPULARITY OF MERGER AND ACQUISITIO
N STRATEGIES


Firms from different industries decide to use an acquisition strategy for several reasons; however,
acquisition strategies are not without problems. When acquisitions contribute to poor performance, a firm
may deem it necessary to restructur
e its operations.

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Merger and acquisition trends:



There were five waves of mergers and acquisitions in the 20th century, the last two in the 80s and 90s.



There were 55,000 acquisitions valued at $1.3 trillion in the 1980s.



Acquisitions in the 1990s exc
eeded $11 trillion in value.



World economies, particularly the U.S. economy, slowed in the new millennium, reducing the number
of mergers and acquisitions completed.



The annual value of mergers and acquisitions peaked in 2000 at about $3.4 billion and fe
ll to about
$1.75 billion in 2001.



Slightly more than 15,000 acquisitions were announced in 2001 compared to over 33,000 in 2000.



The proposed acquisition of Compaq by HP was the second largest acquisition announced in 2001.


Evidence suggests, however, t
hat at least for acquiring firms, acquisition strategies may not result in
desirable outcomes. Studies by academic researchers have found that shareholders of acquired firms often
earn above
-
average returns from an acquisition, while shareholders of acquir
ing firms are less likely to do
so. In approximately two
-
thirds of all acquisitions, the acquiring firm’s stock price falls immediately after
the intended transaction is announced, indicating investors’ skepticism about the likelihood that the
acquirer wi
ll be able to achieve the synergies required to justify the premium


This Chapter discusses a number of topics relating to mergers and acquisitions. These topics are:



The definition of merger, acquisition, and takeover



the rationale for mergers and acquis
itions



problems that may be encountered as firms attempt to obtain core competencies through acquisitions



attributes of effective acquisitions



restructuring to become less diversified (why it is used and types of restructuring)



types of restructuring and
their long
-

and short
-
term outcomes



MERGERS, ACQUISITIONS, AND TAKEOVERS: WHAT ARE THE DIFFERENCES?


Before starting the discussion of the reasons for acquisitions, problems related to acquisitions, and long
-
term performance, three terms that will be use
d throughout this Chapter and again in Chapter 10 should be
defined.


A
merger

is a transaction where two firms agree to integrate their operations on a relatively co
-
equal basis
because they have resources and capabilities that together may create a stron
ger competitive advantage.


An
acquisition

is a transaction where a firm buys a controlling or 100% interest in another firm with the
intent of using a core competence by making the acquired firm a subsidiary business within its portfolio.


While most merg
ers represent friendly agreements between the two firms, acquisitions sometimes can be
classified as unfriendly takeovers. A
takeover

is an acquisition
--
and normally not a merger
--
where the
target firm did not solicit the bid of the acquiring firm and oft
en resists the acquisition.



Review question 1. Why are acquisition strategies popular in many firms competing in the
global economy?



2

Discuss reasons firms use an acquisition strategy to achieve
strategic competitiveness.



REASONS FOR ACQUISITIONS


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Firms follow acquisition strategies for a variety of reasons, including:



to achieve a core competence through greater market power



to overcome significant barriers to entry (or to increase the speed of market entry)



to avoid the significant costs of and ri
sks related to new product development



to reduce risks compared to developing new products



to achieve diversification



to reshape the firm’s competitive scope



to learn and develop new capabilities


Increased Market Power


As discussed briefly in Chapter 6,
a primary reason for acquisitions is that they enable firms to gain greater
market power.


While a number of firms may feel that they have an internal core competence, they may be unable to
exploit their resources and capabilities because of a lack of size
.


A firm may be able to gain the size necessary to exploit its core competence by becoming larger in terms of
the size of its market share. And, an increase in market share enables the firm to increase its market power.


Because of this, acquisitions to
meet a market power objective generally involve buying a supplier, a
competitor, a distributor, or a business in a highly related industry.



Horizontal Acquisitions


Buying a competitor or a business in a highly related industry

which increases the firm’s

market power

provides the firm with the size it needs to exploit its core competence and gain a competitive advantage in
its primary market.


When a competitor in the same industry is acquired, a firm has engaged in a
horizontal acquisition
.




STRATEG
IC FOCUS

The Good, the Bad and the Lucky of Horizontal Acquisitions


Internet
-
based startups experienced a high rate of failure at the turn of the 21st century. Many of them had
to combine or fail, which led to a number of largely involuntary horizontal a
cquisitions. Several examples
of well
-
known horizontal acquisitions follow:



Although biotechnology firms Amgen and Immunex are similar, Amgen’s acquisition of Immunex for
approximately $18 billion was not necessary, but it should allow the firm to captur
e economies of
scale, particularly in selling each of the firm’s major arthritis drugs. However, the two firms are so
similar that they are unlikely to capture synergies other than economies of scale

so Amgen may not
be able to recapture the substantial pr
emium it had to pay for the acquisition.



Adolph Coors Company acquired Bass Brewers of the UK. This acquisition does little to help Coors
compete in the much larger U.S. market and may, in fact, take its focus off this important market.
Moreover, the gre
at physical distance between the two firms may constrain economies of scale.



Daimler
-
Benz acquired Chrysler because of the complementary core businesses of the two firms

Chrysler’s mid
-
priced autos and minivans and Daimler’s luxury autos. However, the di
fferences
between the two firms’ corporate cultures and operating processes made integration difficult, and the
performance of the merged firm suffered.



McDonald’s acquired Boston Market for its locations, intending to replace Boston Market restaurants
w
ith other types of restaurants. With about 100 of the stores closed and almost 60 converted, the firm
saw unrealized opportunities in a loyal clientele and managers with good ideas, and thus negotiated
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with Heinz to produce and market frozen dinners with
the Boston Market brand. In 2001, Boston
Market had sales of over $700 million and is now consistently profitable. As a result, McDonald’s is
keeping the remaining 700
-
plus Boston Market restaurants.




Vertical Acquisitions


A
vertical acquisition

has oc
curred when a firm acquires a supplier or distributor, which is positioned
either backward or forward in the firm’s cost/activity/value chain.



Related Acquisitions


When a target firm in a highly related industry is acquired, the firm has made a
related
acquisition
.


It is important to note that acquisitions intended to increase market power are subject to regulatory review,
as well as to analysis by financial markets.





STRATEGIC FOCUS

BP Amoco and Atlantic Richfield Co:

A Case of Intentions and Reali
ties in the World of Acquisitions


BP Amoco announced in 1999 that it intended to acquire Atlantic Richfield Co. (Arco), a
horizontal acquisition for the key purpose of increasing BP Amoco’s market power.
Buying Arco was conceived as an integral step to t
ransforming BP Amoco into a “super
major” so it could compete directly against Exxon Mobil and Royal Dutch/Shell. This was
to be an all
-
stock deal valued at approximately $25.6 billion, and it would create the second
largest global oil firm.


This was the

eighth major merger/acquisition in the global oil and gas business in a six
-
month period during 1999. Partly driving these transactions were rapidly declining oil
prices and increasing demands that energy companies produce and distribute cleaner fuels.


The U.S. Federal Trade Commission concluded that the market power that would result
from the transaction was anti
-
competitive in nature, arguing that BP has significant market
power that it has used to maintain higher oil prices on the West Coast by diver
ting exports
to the Far East. Time will determine the outcome of this intended acquisition.




Overcoming of Entry Barriers


As discussed in Chapter 2,
barriers to entry

represent factors associated with the market and/or firms
operating in the market
that make it more expensive and difficult for new firms to enter the market.


For example, it may be difficult to enter a market dominated by large, established competitors. As noted in
Chapter 2, such markets may require:



investments in large
-
scale manufa
cturing facilities that enable the firm to achieve economies of scale so
that it can offer competitive prices



significant expenditures in advertising and promotion to overcome any brand loyalty enjoyed by
existing products



establishing or breaking into exi
sting distribution channels so that goods are convenient to customers


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When barriers to entry are present, the firm’s best choice may be to acquire a firm already having a
presence in the industry or market. In fact, the higher the barriers to entry into
an attractive market or
industry, the more likely it is that firms interested in entering will follow acquisition strategies.


While the acquisition cost might be high (depending on such factors as attractiveness of the business or
market, competing acquis
itions, or the cost of integrating operations), the acquiring firm achieves
immediate market access, gains a brand that has access to existing distribution channels, and may already
have some degree of brand loyalty.


Entry barriers firms face when trying
to enter international markets are often great. Commonly,
acquisitions are used to overcome entry barriers in international markets. It is important to compete
successfully in these markets since global markets are growing at more than twice the rate of
domestic
markets. Also, five of the emerging markets (China, India, Brazil, Mexico, and Indonesia) are among the
12 largest economies in the world with a combined purchasing power that is already one
-
half that of the
Group of Seven industrial nations (Uni
ted States, Japan, Britain, France, Germany, Canada, and Italy).



Cross
-
Border Acquisitions


Historically, U.S. firms have been the most active acquirers of companies outside their domestic market.
However, in the global economy, companies throughout the
world are choosing this strategic option with
increasing frequency. In recent years, cross
-
border acquisitions have represented as much as 45 percent of
the total number of acquisitions made annually.


Acquisitions also represent a viable strategy for firm
s that wish to enter international markets because
acquisitions



may be the fastest way to enter new markets



provide more control over foreign operations than do strategic alliances with a foreign partner



Cost of New
-
Product Development and Increased Spe
ed to Market


Acquisitions also may represent an attractive alternative to developing new products internally because of
the cost and time required to start a new venture and achieve a positive return.


Internal development of new products is often perceiv
ed by managers to be costly and to represent high risk
investments of firm resources. While sometimes costly, it may be in the firm’s best interest to acquire an
existing business because



the acquired firm has a track record with an established sales volu
me and a customer base, yielding
predictable returns



the acquiring firm gains immediate market access


In addition to representing attractive prices, large pharmaceutical firms have used acquisitions to
supplement products in the pipeline with projects fro
m undervalued biotechnology companies; thus, this is
one way to appropriate new products.




STRATEGIC FOCUS


DaimlerBenz and Chrysler Corporation: Will It Be a Successful Union?


DaimlerBenz and Chrysler Corp. formed a horizontal merger as a cross
-
border
transaction
to create market power and generate synergies. An immediate outcome from this merger
was greater consolidation of the global auto industry.


Each of the former competitors had needs that the merger was supposed to address.
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Chrysler lacked in
frastructure and management depth and Daimler
-
Benz wanted to
diversify its product line and distribution channels. The two firms had a complementary fit
for several reasons. For example:



Chrysler’s dominant market position was in the United States while
Daimler’s was in
two regions

burope and pouth America

where Chrysler lacked a meaningful
presence.



The companies’ product lines were complementary, with the bulk of Chrysler’s
profitability coming from sport utility vehicles and multi
J
purpose vans while l
uxury
vehicles comprised the foundation of Daimler’s strategic competitiveness.


eorizontal acquisitions can create cost
J

and revenue
J
based synergies. aaimler and
Chrysler expected to generate both types of synergies through their merger.



The integratio
n of separate operations was expected to reduce costs by $1.3 billion in
1999.



The decision to build the Mercedes M
-
Class cars and the Jeep Grand Cherokee on the
same production line in Graz, Austria was one area of integration in the combined firm.



The
new firm seeks cross
-
selling synergies by integrating Daimler
-
Benz’s competencies
in innovation with Chrysler’s ability to rapidly introduce new products into the
marketplace.


On the downside, it appeared that Daimler’s decision style was reducing the sp
eed that
enabled Chrysler to get products to the marketplace quickly. Compounding these issues
was the perception that this was an acquisition Eby aaimler
J
Benz) rather than a merger.


lperating profit for 1VVV was approximately 11 billion euros EA1M.TO b
illion)I up from U.S
billion euros in 1VVUI and future sales volume was predicted to climb from A1R1 billion in
1VVV to at least A1R4 billion in OMMM and A1SU billion by OMMO.


DaimlerChrysler is the world’s fifth largest automaker

with hopes of becoming
the largest
transportation company in the world by OMMP

and intends to acquire other companies and
to form an array of strategic alliances that are mostly cross
J
border in nature.




Lower Risk Compared to Developing New Products


As discussed earlier, in
ternal product development processes can be risky, in that entering a market and
earning an acceptable return on investment requires significant resources and time. All the same,
acquisition outcomes can be estimated easily and accurately (as compared to
the outcomes of an internal
product development process), causing managers to view acquisitions as carrying lowering risk.


Because acquisitions recently have become such a common means of avoiding risky internal ventures, they
even could become a substitu
te for innovation enabling firms to avoid the risk of internal ventures and
overcome constraints on internal resources and capabilities.


Increased Diversification


It should be easier for firms to develop new products and/or new ventures within their curr
ent markets
because of market
-
related knowledge, but firms that desire to enter new markets may find that current
product
-
market knowledge and skills are not transferable to the new target market.


Acquisitions also may have gained in popularity as a relat
ed or horizontal diversification strategy enabling
rapid moves into related markets (or to expand market power) and as an unrelated diversification strategy
because of the changes in court and regulatory interpretation and enforcement of anti
-
trust laws di
scussed
in Chapter 6.

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As discussed in Chapter 8, acquisitions are the most frequently used means for firms to diversify their
operations into international markets.


However, firms must be careful when making acquisitions to diversify their product lines
because
horizontal and related acquisitions tend to contribute more to strategic competitiveness, and thus they are
more successful than diversifying acquisitions.


Reshaping the Firm’s Competiti ve Scope


To reduce intense rivalry’s negative effect on fina
ncial performance, a firm may use acquisitions as a way
to restrict its dependence on a single or a few products or markets. Reducing dependence on single products
or markets results in a different competitive scope for a firm.


Learning and Developing N
ew Capabilities


Some acquisitions are made to gain capabilities that the firm does not possess

e.g., acquisitions used to
acquire a special technological capability. Acquiring other firms with skills and capabilities that differ
from its own helps the ac
quiring firm to learn new knowledge and remain agile, but firms are better able to
learn these capabilities if they share some similar properties with the firm’s current capabilities.


One of Cisco System’s primary goals in its acquisitions is to gain acc
ess to capabilities that it does not
currently possess through its commitment to learning. The firm has developed an intricate process to
quickly integrate the acquired firms and their capabilities (knowledge) after an acquisition is completed.



FIGURE

7
-
1

Reasons for Acquisitions and Problems in Achieving Success


Seven reasons for acquisitions are presented in the left
-
hand bubble
-
column while seven problems in
achieving acquisition success are presented in the right hand bubble
-
column of
Figure 7
-
1
.


To summarize, the seven reasons that firms (and managers) implement acquisition strategies are to:



increase market power



overcome entry barriers



reduce or avoid the cost of new product development



increase speed to market



lower risk compared to developin
g new products



increase diversification



avoid excessive competition


The seven reasons for poor performance of acquisitions or problems faced in attempts to achieve success
are:



integration difficulties



inadequate evaluation of target



large or extraordinar
y debt



inability to achieve synergy



too much diversification



managers overly focused on acquisitions



too large


Note:

Problems encountered as firms try to successfully achieve their objectives and create value from
acquisitions will be discussed in detail

in the next sections of this chapter.


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While the focus so far has been on the advantages of acquisitions, there also are several problems that can
prevent acquisitions from either achieving their objectives or from producing any benefits.


As noted ea
rlier in this chapter, the average returns from acquisitions for acquiring firms is approximately
zero, and some acquiring firms experience negative returns. This implies that acquisition
-
related problems
often have equaled or out
-
weighed any benefits gain
ed.



Review Question 2. What specific reasons account for firms’ decisions to use acquisition
strategies as one means of achieving strategic competitiveness?




3

Describe seven problems that work against developing a
competitive advantage using an acquis
ition strategy.



PROBLEMS IN ACHIEVING ACQUISITION SUCCESS


A number of problems accompany an acquisition strategy. Acquisition
-
related problems presented in
Figure 7
-
1

that will be discussed in this section

are:



difficulties in integrating the two firm
s after the acquisition is completed



paying too much for the target (acquired) firm or inappropriately or inadequately evaluating the target



the cost of financing the acquisition, related to large or extraordinary debt



overestimating the potential for gain
s from capabilities and/or synergy



excessive or too much diversification



management being preoccupied or overly focused on acquisitions



the combined firm becoming too large



Integration Difficulties


Integration problems or difficulties that firms often e
ncounter can take many forms. Among them are:



linking different financial and control systems



building effective working relationships (especially when management styles differ)



problems related to differing status of acquired and acquiring firms’ executi
ves



melding disparate corporate cultures


The importance of integration success should not be underestimated. Without successful integration, a firm
achieves financial diversification, but little else. Consider these points.



The post
-
acquisition integrati
on phase may be the single most important determinant of shareholder
value creation (or value destruction) in mergers and acquisitions.



Managers should understand the large number of activities associated with integration processes.


For example, Intel ac
quired Digital Equipment Corporation’s semiconductors division. On the day Intel
began to integrate the acquired division into its operations, six thousand deliverables were to be completed
by hundreds of employees working in dozens of different countries.


It is important to maintain the human capital of the target firm after the acquisition to preserve the
organization’s knowledge. Turnover of key personnel from the acquired firm can have a negative effect on
the performance of the merged firm.


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Inadequa
te Valuation of Target


Due diligence

is a process through which a firm evaluates a target firm for acquisition. In an effective due
-
diligence process hundreds of items are examined in areas as diverse as the financing for the intended
transaction, differe
nces in cultures between the acquiring and target firm, tax consequences of the
transaction, and actions that would be necessary to successfully meld the two workforces.


Due diligence is commonly performed by investment bankers, accountants, lawyers, and

management
consultants specializing in that activity, although firms actively pursuing acquisitions may form their own
internal due
-
diligence team.




STRATEGIC FOCUS

Dynegy Should Thank its Lucky Stars


In November 2001 Dynegy, Inc., agreed to acquire i
ts former rival Enron, the energy trading company.

Enron’s market value was approximately $70 billion only months before the merger announcement, but
Dynegy agreed to purchase the firm for only $9 billion. As news of financial problems at Enron surfaced,

the firm’s market value fell to less than $270 million. Dynegy claimed that Enron had failed to fully
disclose the scope of its financial woes and withdrew its offer to acquire, which led to Enron’s bankruptcy.
Enron also filed a lawsuit against Dynegy
for withdrawing from the acquisition agreement, demanding $10
billion in damages. Dynegy countersued to acquire Enron’s largest pipeline asset for $1.5 billion

an
amount agreed upon earlier even if the acquisition was not consummated

and eventually receive
d the
asset. Dynegy came out of the transaction the clear winner

the firm obtained a valued asset and dodged a
bullet by not acquiring Enron

but the $9 billion offer to buy Enron initially makes it unclear whether
Dynegy conducted effective due diligence.





Large or Extraordinary Debt


Many acquirers, in addition to overpaying for targets, may be forced, due to market conditions, to finance
acquisitions with relatively high
-
cost debt.


In the 1980s, investment bankers developed a new financing instrumen
t for acquisitions, the junk bond.
Junk bonds

represented a new financing option in which risky investments were financed with money
(debt) that provided a high return to the lender (often referred to as bond holders).


Junk bonds carried relatively high
rates (particularly when compared to rates paid for investment grade
bonds), some as high as 18 to 20% during the 1980s.


Inability to Achieve Synergy


Acquiring firms also face the challenge of correctly identifying and valuing any synergies that are expe
cted
to be realized from the acquisition. This is a significant problem because, to justify the premium price paid
for target firms, managers may overestimate both the benefits and value of synergy.


To achieve a sustained competitive advantage through an

acquisition, acquirers must realize private
synergies and core competencies that cannot easily be imitated by competitors.
Private synergy

refers to
the benefit from merging the acquiring and target firms that is due to a unique resource or set of resour
ces
that are complimentary between the two firms and not available among other potential bidders for that
target firm.


However, private synergies are rare. In fact, misinterpreting
common

synergies as private may explain why
acquiring firm shareholders r
arely receive significant positive returns.

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Anheuser
-
Busch: A Case Example


Anheuser
-
Busch acquired Eagle Snacks and Campbell Taggart with a stated purpose of
achieving synergies. Anheuser
-
Busch believed that this distribution
-
related synergy between
sn
ack foods, bakery products, and beer that could be leveraged while its expertis e in the us e
of yeas t in t he brewing proces s could be applied t o Campbell Taggart ’s bread
J
making
process.


eoweverI distribution synergies were not available as beerI breadI and

snack foods were
ordered by different store product managers. crito
J
iay responded with new products and
improved distribution to offset the threat of bagle pnacks. fn factI distribution became more
complex and more expensive.


fn additionI competition i
n the beer industry increased and Anheuser
J
Busch management felt
that bagle and Campbell qaggart diverted their attention away from their core businessI
resulting in delays in new product introduction and a loss of momentum.


As a resultI Anheuser
J
Busch so
ld bagle pnacks and spun off the Campbell qaggart unit so
that it could focus its efforts on expanding its presence in international beer markets where
synergies are more likely to be available with its domestic beer market.


qhese general problems may be
encountered in many acquisitions. eoweverI there are many
other causes of the poor long
J
term performance of acquisitions. fn factI some of the reasons
for poor long
J
term performance also may lead to the problems already discussed.



Firms experience tra
nsaction costs when using acquisition strategies to create synergy. Direct costs include
legal fees and charges from investment bankers. Managerial time to evaluate target firms and then to
complete negotiations and the loss of key managers and employees p
ost
-
acquisition are indirect costs.



Too Much Di vers i fi cati on


In general, firms us ing relat ed divers ificat ion s t rat egies out perform t hos e us ing unrelat ed divers ificat ion
s t rat egies. However, conglomerat es (i.e., t hos e purs uing unrelat ed divers ificat ion
) can als o be s ucces s ful.


In t he drive t o divers ify t he firm’s product line, many firms overdivers ified during t he 60s, 70s, and 80s.


As det ailed in Chapt er 6, informat ion proces s ing requirement s are great er for a relat ed divers ified firm
(compared t o it
s unrelat ed count erpart s ) due t o it s need t o effect ively and efficient ly coordinat e t he linkages
and int erdependencies upon which value
-
creat ion t hrough act ivit y s haring depends.


In addit ion t o increas ed informat ion proces s ing requirement s and managerial
expert is e, overdivers ificat ion
may res ult in poor performance when t op
-
level managers emphas ize financial cont rols over s t rat egic
cont rols.


Financial cont rols may be emphas ized when managers feel t hat t hey do not have s ufficient expert is e or
knowledge o
f t he firm’s various bus ines s es. When t his happens, t op
-
level managers are not able t o
adequat ely evaluat e t he s t rat egies and s t rat egic act ions t hat are t aken by divis ion or bus ines s unit managers.
As a res ult,



Top
-
level managers t end t o emphas ize t he fi
nancial out comes of s t rat egic act ions rat her t han t he
appropriat enes s of t he s t rat egy it s elf.



This forces divis ion or bus ines s unit managers t o become s hort
-
t erm performance
-
orient ed.

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The problem becomes more serious when managers’ compensation is tied to
achieving short
-
term
financial outcomes.



Long
-
term, risky investments (such as R&D) may be reduced to boost short
-
term returns.



In the final analysis, long
-
term performance deteriorates.


As noted earlier in this chapter, acquisitions can have a number of
negative effects. They may result in
greater levels of diversification (in products, markets, and/or industries), absorb extensive managerial time
and energy, require large amounts of debt, and create larger organizations. As a result, acquisitions can
ha
ve a negative impact on investments in research and development and thus on innovation.


Reducing the emphasis on R&D and on innovation may result in the firm losing its strategic
competitiveness
unless

the firm operates in mature industries in which inno
vation is not required to
maintain strategic competitiveness.



Managers Overly Focused on Acquisitions


If firms follow active acquisition strategies, the acquisition process generally requires significant amounts
of managerial time and energy.


For the
acquiring firm

this takes the form of:



searching for viable candidates



completing effective due diligence



preparing for negotiations with the target firm


The last two steps

due diligence and negotiating with the target

often include numerous meetings
bet
ween representatives of the acquirer and target, as well as meetings with investment bankers, analysts,
attorneys, and in some cases, regulatory agencies.


As a result, top
-
level managers of acquiring firms often pay little attention to long
-
term, strategi
c matters
because of time (and energy) constraints.



Too Large


In the vast majority of cases, acquisitions result in acquirers increasing in size even after some of the
acquired firm’s assets are sold.


Firms can reach economies of scale by growing. But
, after a certain size is achieved, size can become a
disadvantage as firms reach a point where they suffer from what is called “
dis
economies of scale.” This
implies that problems related to excess growth may be similar to those that accompany overdiversi
fication.


Other actions taken to enable more effective management of increased firm size include increasing or
establishing
bureaucratic controls
, represented by formalized supervisory and behavioral controls such as
rules and policies that are designed t
o ensure consistency across different units’ decisions and actions.


On the surface (or in theory), bureaucratic controls may be beneficial to large organizations. However,
they may produce overly
-
rigid and standardized behavior among managers.


Establish
ing and implementing more formalized (bureaucratic) and centralized control systems in acquired
firms is not that uncommon. In fact, such control systems may be used to help facilitate the integration of
acquiring and acquired firms.


But as noted previ
ously, bureaucratic controls may reduce managerial (and firm) flexibility, which can
result in reduced levels of innovation and less creative (and less timely) decision making.

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Review Question 3. What are the seven primary problems that affect a firm’s e
ffort to use
an acquisition strategy successfully?




4

Name and describe attributes of effective acquisitions.



EFFECTIVE ACQUISITIONS


Research has identified attributes that appear to be associated consistently with successful acquisitions.



when a fir
m’s assets are complementary (highly related) with the acquired firm’s assets and create
synergy and, in turn, unique capabilities, core competencies, and strategic competitiveness



when targets were selected and “groomed” by establishing a working relation
ship prior to acquisition
(e.g., through strategic alliances)



when the acquisition is friendly



when the acquiring firm has conducted due diligence



when management is focused on research and development



when acquiring and target firms are flexible and adapt
able (usually the result of executive experience
with previous acquisitions)




TABLE 7
-
1

Attributes of Successful Acquisitions


Successful acquisitions generally are characterized by:



target and acquirer having complimentary assets and/or resources whic
h results in a high probability of
achieving synergy and gaining competitive advantage



making friendly acquisitions to facilitate integration speed and effectiveness and reducing any
acquisition premium



target selection and negotiation processes which resu
lt in the selection of targets having resources and
assets that are complimentary to the acquiring firm’s core business, thus avoiding overpayment



maintaining financial slack to make acquisition financing less costly and easier to obtain



maintaining a low

to moderate debt position which lowers costs and avoids the trade
-
offs of high debt
and lowers the risk of failure



possessing flexibility and skills to adapt to change to facilitate integration speed and achievement of
synergy



continuing to invest in R&D
and emphasizing innovation to maintain competitive advantage





STRATEGIC FOCUS

Was GE’s Attempted Acquisition of Honeywell a Correct Strategy?


In 2001, Honeywell International agreed to be acquired by General Electric (GE). Even though the merger
was
subject to approval by the European Union, GE and Honeywell executives likened the merger of these
two firms to “a match made in heaven.” However, analysts questioned the value of the acquisition based
on Honeywell’s difficulties with a previous acquisiti
on and the drag this had on the firm’s performance.
There seemed to be potential synergy between GE and Honeywell, especially in aerospace (i.e., GE’s jet
engines and Honeywell’s avionics equipment), but it was not to be. EU antitrust regulators rejected

the
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deal. Although 2001 had not been a great year for the company, GE is predicted to grow through
acquisitions and profits are likely to increase. There was no such positive prediction for Honeywell.






STRATEGIC FOCUS

Successful Acquisitions the Cis
co Systems Way


Cisco provides the hardware and software that are behind start
-
of
-
the
-
art Internet networks,
generating over $12 billion in annual sales. Contributing significantly to Cisco’s strategic
competitiveness and its ability to consistently earn
above
J
average returns is its successful
acquisition strategy because advancing technology precludes Cisco from doing everything
itself. qhereforeI corporate growth is achieved by buying products and technologies the
firm cannot Eor does not want to) devel
op internally.


Cisco is very active with its acquisition strategyI acquiring R1 companies during the six and
潮o
J
half year period ending in jarch OMMM Ewith O1 of those completed in the last 1O
months of that period). By mid
J
year OMMM figuresI the firm
was on pace to complete at
least OR acquisitions for the year.


Of all its acquisitions, Cisco’s CEO John Chambers says that only two or three have failed
to meet his expectations. Cisco uses its acquisitions to reshape the firm and to fill gaps in
its
product lineI but the key to the success of its merger and acquisition strategy rests on its
strict adherence to five guidelines.



Shared vision


the acquiring company and the target firm must be in agreement
regarding where the industry is going and the r
ole each party is to play in the industry’s
anticipated future.



Creating short
-
term wins


employees see a culture that is attractive to themI identifying
an opportunity to really do with Cisco what they were doing beforeI or even more.



The target’s strat
egy can blend with Cisco’s


that is, when integrated with Cisco’s
operationsI the acquired firm will create value.



Cultural similarity and compatibility


Chambers and his colleagues are skeptical of
acquisitions that hope to integrate cultures that diff
er dramatically from one another.



Geographic proximity


the target firm must be close to the parts of Cisco’s current
operations with which it would be the most closely associatedI preventing operational
inefficiencies due to distance.


Cisco’s integrati
on team facilitates compliance with the five guidelines by helping
“newcomers” fit into the Cisco family. Because of the pre
J
acquisition work of this groupI
negotiations between Cisco and target companies tend to be very brief.




Review Question 4. What

are the attributes associated with a successful acquisition
strategy?



5

Define the restructuring strategy and distinguish among its
common forms.



RESTRUCTURING


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The next section of the chapter reviews some of the more common restructuring strategies.

Restructuring

refers to changes in the composition of a firm’s set of businesses and/or financial structure.


During this period, restructuring can take several forms:



downsizing
, primarily to reduce costs by laying off employees or eliminating operatin
g units



downscoping

to reduce the level of firm unrelatedness



leveraged buyouts

to restructure the firm’s assets by taking it private


In other words, restructuring strategies often were implemented in response to poor performance and
overdiversification.



Downsizing


Downsizing has been one of the most common restructuring strategies adopted by U.S. firms.


Downsizing

represents a reduction in the number of employees, and sometimes in the number of operating
units, but may or may not represent and a chang
e in the composition of the businesses in the corporation’s
portfolio.


In the late 1980s, early 1990s, and early 2000s, thousands of jobs were lost in private and public
organizations in the United States. One study estimates that 85 percent of Fortune 10
00 firms have used
downsizing as a restructuring strategy. Moreover,
Fortune

500 firms laid off more than one million
employees, or 4 percent of their collective workforce, in 2001 and into the first few weeks of 2002


Firms use downsizing as a restructuri
ng strategy for different reasons. The most frequently cited reason is
that the firm expects improved profitability from cost reductions and more efficient operations.



Downscoping


Downscoping

refers to the divestiture, spin
-
off, or other means of elimin
ating businesses that are unrelated
to the firm’s core business. In other words, downscoping represents establishing a focus on the firm’s core
businesses.


While downscoping often includes downsizing, the former is targeted so that the firm does not lose

key
employees from core businesses (because such losses can lead to the loss of core competencies).


As the discussion of overdiversification earlier in this chapter indicated, reducing the diversity of
businesses in the portfolio enables top
-
level manage
rs to manage the firm more effectively because



the firm is less diversified as a result of downscoping



top
-
level managers can better understand the core and related businesses


Note:

Indicate to students that the requirements and characteristics of strateg
ic leadership by a firm’s top
management team are discussed fully in Chapter 12.


U.S. firms use downscoping as a restructuring strategy more frequently than do European companies.
Research has identified a post
-
war trend toward conglomeration among the la
rgest French, German, and
British industrial companies, and the trend seems to be continuing. However, there has also been an
increase in downscoping by European firms.


Leveraged Buyouts


A

leveraged buyout (LBO)

refers to a restructuring action, whereby

the management of the firm and/or an
external party buys all of the assets of the business, largely financed with debt, and thus takes the firm
private.

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Often, LBOs are used as a restructuring strategy to correct for managerial mistakes or because manage
rs
are making decisions that primarily serve their personal interests rather than those of shareholders
.


In other words, a firm is purchased by a few (new) owners using a significant amount of debt (in a highly
leveraged transaction) and the firm’s stock
is no longer traded publicly.


In general, the new owners restructure the private firm by selling a significant number of assets
(businesses) both to downscope the firm and to reduce the level of debt (and significant debt costs) used to
finance the acquis
ition.


A primary intent of the new owners is to improve the firm’s efficiency. This enables them to sell the firm
(outright to another owner or by a public stock underwriting), thus capturing the value created through the
restructuring.


There are three

types of leveraged buyouts: management buyouts (MBO), employee buyouts (EBO), and
buyouts where another firm takes the firm private (LBO).



Review Question 5. What is the restructuring strategy and what are its common forms?



6

Describe the short and lo
ng
-
term outcomes of the different
types of restructuring strategies.



Restructuring Outcomes


Research has shown that downsizing does not usually lead to higher firm performance

only 41 percent of
downsizing companies have reported productivity increases
, and only 37 percent have realized any long
-
term gains in shareholder value. Another study showed that downsizing contributed to
lower

returns in
both U.S. and Japanese firms.


In general, restructuring will be successful when it enables top management t
o regain strategic control of a
firm’s operations.


Downscoping has been successful because it results in refocusing the firm on its core (and related)
businesses and, in turn, on its core competencies.




FIGURE 7
-
2

Restructuring and Outcomes


As illustr
ated in

Figure 7
-
2
,



Downsizing

reduces labor costs, but the long
-
term results are a loss of human capital and lower
performance.



Downscoping

reduces debt costs and re
-
establishes an emphasis on strategic controls, which result in
higher firm performance.



L
everaged Buyouts

provide a re
-
emphasis on strategic controls but increases debt costs; the long
-
term
outcome is an increase in performance, but also greater firm risk.




Review Question 6. What are the short
-

and long
-
term outcomes associated with the
different restructuring strategies?

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