Canadian M&A activity has continued to rise in 2017, but with the successes come many more stories of failure. Studies indicated that 70% – 90% of acquisitions ultimately fail. How does a company beat these odds? A recent article by McKinsey & Company suggests that companies who enter into acquisitions with a specific value proposition in mind tend to have higher success rates than those with vague, growth strategies. In particular, the authors suggest most successful acquisitions implement one of six strategic models.

Improve the target company’s performance

One acquisition strategy involves purchasing a target company to reduce its costs and improve margins and cash flows. According to McKinsey, many private-equity firms follow this model by buying, improving and selling a target succinctly to achieve greater increases in their operating-profit models. There is one caveat: a company’s ability to improve margins is influenced by how low or high the target’s margins and return on invested capital are pre-acquisition.

Consolidate to remove excess capacity from industry

To reduce capacity while preventing a loss in market share, many companies choose to implement cut-backs post-acquisition rather than create a smaller company by shutting down low-performing segments on their own. The pharmaceutical industry is a prime example, as many companies reduce the capacity of their sales force and R&D teams by re-examining post-merger portfolios. Managers should be aware, however, that the immediate value-add following these acquisitions skews towards seller’s shareholders and also runs the risk of benefiting competitors free of cost.

Accelerate market access for the target’s (or buyer’s) products

This successful model involves purchasing companies to accelerate their sales. Many relatively small companies with unique, innovative products, can expand their sales force through a merger with a larger company. In other cases, the target and acquiror can build each other’s revenue growths by introducing different and previously untapped markets.

Get skills or technologies faster or at lower cost than they can be built

Don’t build it, buy it! A model often seen in the technology sector is purchasing a company that possesses technology the acquiror needs for its own products. McKinsey lists three reasons a company might utilize this strategy: (i) acquisition of technology is faster than development, (ii) companies avoid royalty payments on patented technologies, and (iii) it may keep the technology away from competitors.

Exploit a business’s industry-specific scalability

Companies often cite economies as scale as a motivator for acquisitions, but McKinsey cautions it is best reserved for situations when the deal will result in a large increase in a company’s incremental capacity or when a larger company buys a subscale one. Two large companies, operating efficiently, will not produce the necessary gains to justify an acquisition, nor will generic economies of scale strategies. So, potential acquirors should assess the relative uniqueness and size of the acquisition to ensure its worth.

Pick winners early and help them develop their business

The final strategy involves acquiring targets early in the life cycle of a new industry or product line. This strategy, while having the potential for significant gains, requires disciplined management. To be successful, an acquiror must be willing to make investments before the market sees the industry’s or company’s potential, recognize that it will need to acquire multiple companies, knowing some will fail, and have the skills and patience to help the target reach their potential.

Harder strategies

In addition to the six main strategies McKinsey puts forward, the article also lists several other strategies used to create value that are more difficult to implement:

  1. The roll-up: a strategy used to consolidate highly fragmented markets where the current competitors are too small to achieve scale economies. The strategy often works when a collective group of businesses realize the cost savings or revenue gains of pooling their resources.
  2. Consolidating to improve competitive behaviour: a strategy used to consolidate multiple companies in a highly competitive market with the hopes of lessening price competition. McKinsey warns, however, that unless the acquisitions result in three to four end competitors, pricing behavior is unlikely to change.
  3. Enter into a transformational merger: a strategy used when the reason for an acquisition or merger is management’s desire to transform one or both companies. Here, the combination of businesses only serves as a platform to the larger goal of creating a new company structure.
  4. Buy cheap: a strategy used when an acquiror purchases a target at a price below a company’s intrinsic value. The opportunities for such strategies are rare and McKinsey warns acquirors to beware of overvaluing a target’s worth or falling prey to market bubbles.

While there is no set formula for producing a successful acquisition, it is important for managers to be aware of the potential for failure and keep a specific goal in mind. In addition, the value of any transaction will ultimately be diminished if the price is set too high. These archetypes can help managers evaluate their acquisition decisions by narrowing an acquiror’s focus and measuring the acquisition’s tangible gains.

The author would like to thank Abigail Court, Summer Student, for her assistance in preparing this legal update.

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