Understanding Mergers and Acquisitions: Types and Purposes
Mergers and Acquisitions: An Introduction
Mergers and acquisitions, or M&A for short, involve the process of combining two companies into one. The goal of combining two or more businesses is to try and achieve synergy – where the whole (new company) is greater than the sum of its parts (the former two separate entities). (A + B) > (A + B)
The two processes are different: A merger occurs when two separate entities combine forces to create a new, joint organization. Meanwhile, an acquisition refers to the takeover of one entity by another.
Six Main Categories of Mergers and Acquisitions
- Conglomerate: Firms that are involved in economically unrelated business activities.
- Horizontal Market: One company acquires another company in the same industry and works at the same production stage. The new combined entity may be in a better competitive position due to increased market share or scalability than the standalone companies combined to form it.
- Extension Market: A market extension merger takes place between two companies that deal in the same products but in separate markets. The main purpose of the market extension merger is to make sure that the merging companies can get access to a bigger market and that ensures a bigger client base.
- Vertical Merger: Buying or taking over a firm in the same industry in which the acquired firm and the acquiring firm represent different steps in the production process.
- Product Extension Merger: Two business organizations that deal in products that are related to each other and operate in the same market. The product extension merger allows the merging companies to group together their products and get access to a bigger set of consumers.
Purposes of Mergers and Acquisitions
- Consolidate Companies or Assets: Acquire new assets that cannot be reached in another way (new technologies).
- Stimulate Growth: More customers, more volumes, more profit.
- Gaining Competitive Advantages.
- Increasing Market Shares: Increase customer bases, reduce the power of competition, gain better control of the market.
- Influencing Supply Chains.
- Value Creation: Increase the wealth of the shareholders (revenue synergies of cost synergies/economies of scale).
- Diversification: To offer new products or services to their customers or reduce the risk level.
- Increase Financial Capacity.
Potential Risks and Challenges
Despite the potential benefits of mergers and acquisitions, their financial results often are very disappointing. One study found that more than 60% of mergers and acquisitions erode shareholder wealth, while fewer than one in six increases shareholder wealth (Henry, 2002).
Some of these moves struggle because the cultures of the two companies cannot be meshed. Other acquisitions fail because the buyer pays more for a target company than that company is worth, and the buyer never earns back the premium it paid.
In the end, between 70% to 90% of mergers fail, according to a Harvard Business Review study, often at huge losses (Lakelet Capital, 2009). For example, Mattel purchased The Learning Company in 1999 for $3.6 billion and sold it a year later for $430 million, 12% of the original purchase price. Similarly, Daimler-Benz bought Chrysler in 1998 for $37 billion. When the acquisition was undone in 2007, Daimler recouped only $1.5 billion worth of value—mere 4% of what it paid. Thus, executives need to be cautious when considering using horizontal integration.
