Acquisition refers to buying another firm so as to add to the firm’s strengths and also reduce its weaknesses (Henry, 2002). The merger is the same as an acquisition but it mostly refers to the process of combining two firms’ interests into one huge company which facilitates the growth of the firm as well as its profitability. This paper discusses the major reasons that motivate companies to undertake acquisitions and mergers, whether the acquirer pays more for such deals and why the M&A deals tend to fail more often.
Reasons for Acquisition
Companies acquire other firms because of several reasons, these include; first, companies believe that by acquiring other firms the performance of the business will increase while the costs of doing business will reduce through synergy (Henry, 2002). As such, businesses try to acquire firms that have complementary weaknesses as well as strengths. Secondly, diversification or business concentration also motivates firms to acquire others (Henry, 2002); in this case, a firm seeking diversification attempts to acquire a firm in another industry unrelated to the one it is operating in. This enables it to decrease the effect of specific performance of the industry on its earnings while firms attempting to sharpen concentration frequently merge with firms with strong penetration in particular segments of the market.
Thirdly, a firm may acquire another firm for growth purposes (Henry, 2002), since mergers normally give the acquirer a growth opportunity in terms of market share by paying off the competitor. This is generally referred to as the horizontal merger; for instance, a large beer firm may purchase a smaller beer firm thereby allowing the smaller firm to continue selling beer to its loyal clients.
Fourth, backward integration can also play part in that the firm may decide to merge with the supplier in order to reduce the cost of doing business, as the cost margins which the supplier was adding are completely eliminated (Henry, 2002); this is referred as a vertical merger. Finally, the acquisition may be a result of the need to eliminate competition, and in this case, the firm must offer huge sums of money in order to convince the shareholders of the target firm to sell the company (Henry, 2002).
Most of the time, acquirers of a firm pay more than the deal is worth because most of the acquisitions are overvalued due to various factors and motives as we have mentioned above. In reality, however, the determination of the actual value of a firm is not a straightforward process since the merger success and premium size relationship is not linear. Therefore, the issue is whether the acquirer can afford the deal and whether the company has paid more cash than the deal is worth. In any case, what one firm can afford to pay tends to vary even across industries, so for a firm to succeed in the deal it must know the maximum price that it is willing to pay (Eccles, Lanes, and Wilson, 1999).
Why acquisitions or mergers fail
Many M&As fails to increase the value of the shareholders of the acquiring company simply because it paid a higher price to the target firm. Having bid enthusiastically, the acquirer later finds out that the premium paid to the shareholders of the acquired firm has eliminated all gains received from the transaction (Henry, 2002). But even a deal that is sound financially may be disastrous as well if it is executed in such a way that does not incorporate the firm’s employee’s policies and varying cultures. This is because the process of such activities later becomes very costly to implement since restructuring the acquired company can build uncertainty, resentment, and anxiety among the firm’s employees (Appelbaum et al, 2000). This may result in the demoralization of employees leading to low production hence reduction in shareholders’ value.
Firms frequently pay unnecessary attention to short-range financial and legal considerations in M&A while ignoring the repercussions for the firm communication and identity which are both important in influencing employees’ motivation and productivity (Balmer and Dinnie, 1999). In conclusion, the M&A decision should consider the financial, legal, as well as human consequences in both companies as the deal, will depend upon these two different cultural aspects for it to be successful in increasing the shareholders’ value of the acquiring company.
Appelbaum, S., Gandell, J., Jobin, F., Proper, S. and Yortis, H., (2000). Anatomy of a merger: behaviour of organizational factors and processes throughout the pre-during- post-stages. Management Decision, 38: pp. 9-10.
Balmer, J. and Dinnie, K., (1999). Corporate identity and corporate communications: the antidote to merger madness. Corporate Communications: An International Journal, 4(4): pp. 34-43.
Eccles, R., Lanes, K. and Wilson, T., (1999). Are you paying too much for that acquisition? Web.
Henry, D. (2002). Mergers: Why Most Big Deals Don’t Pay Off. Business Week.