Summary
In the article M&A Needn’t be a Loser’s Game, which was published in the June, 2003 issue of the Harvard Business Review, the authors Larry Selden and Geoffrey Colvin (2003) described the results of their study where they identified some of the reasons behind the failure of most mergers and acquisitions (M&A). Based on their findings, they also provided recommendations on how to ensure the success of these endeavors.
Selden and Colvin (2003) cited that 70 to 80 percent of acquisitions failed, which meant that these acquisitions failed to create wealth for the acquiring company’s shareholders. The authors indicated that even the biggest and most established companies were not spared from this pitfall even after being advised by the best investment bankers. However, despite the high rate of M&A failures, Selden and Colvin (2003) asserted that this did not mean that M&As were entirely unfruitful and that if the acquiring companies would take a customer-based approach to their acquisitions then such efforts are likelier to become profitable.
Selden & Colvin (2003) pointed out that the main reason behind the failure of M&As is that when considering prospective companies for acquisition, most CEOs focus only on the merger’s potential benefits from the perspective of the income statement and do not consider the merger’s effects on the acquiring company’s balance sheet. Company executives are mostly just concerned about the operating profits, but while the merger may indicate an increase in the operating profits, a closer look at the balance sheet may indicate that the merger would cause declines in the company’s return on investment capital (ROIC) and economic profit. However, as suggested by Selden & Colvin (2003), investors should be more concerned about declines in the ROIC and in the economic profit than in the earnings.
Furthermore, because CEOs are often under pressure to increase the company’s reported earnings through the reinvestment of capital, being able to complete the acquisition is in itself considered a success even without considering the acquisition’s impact on the acquiring company’s balance sheet. Moreover, CEOs believe that they can gain profit from the acquisition either through cost-saving or revenue-increasing initiatives. However, as Selden and Colvin (2003) pointed out, neither of these strategies is effective.
In particular, costs can be reduced by combining the two company’s functions; by closing one of the target company’s branches; by laying off some executives and employees; or by obtaining bigger discounts from the purchase of more raw materials, services, and supplies. However, although such initiatives can result in profit for some acquiring companies, it would usually take a very high amount of cost savings to make a difference in the acquiring company’s bottom line. In most cases, the achievement of the necessary amount of savings is unrealistic. On the contrary, instead of saving on costs, the acquiring company is bound to incur even more costs from the merging of incompatible systems and from all the reorganization efforts. Moreover, it’s possible for severe cost-cutting initiatives to impact the critical operations that involve customer service and customer care, which can further stunt growth. As well, the supposed savings from the acquisition may have already been allocated to the negotiated selling price of the target company, especially when there are other bidders.
In the same manner, even initiatives to increase revenue through cross-selling may fail because the merger would result in more silos; sales representatives won’t be familiar with the other company’s products; or the sales representatives won’t be properly compensated for their cross selling efforts.
In this regard, Selden and Colvin (2003) recommended that a better approach to handling M&As would be to consider the customer profitability of the target company. Although companies have various reasons for wanting to acquire another company, in the end, it all boils down to the customers. As such, it is important for the acquiring company to determine whether the acquiring company’s customers are profitable or not. Even when a target company has a mix of profitable and unprofitable customers, the acquiring company can still make the acquisition a winning investment by acquiring only the target company’s profitable customers; by letting go of the acquired company’s worst customers; by turning them into profitable customers; or by selling these customers to less knowledgeable competitors.
Conclusion
Selden and Colvin (2003) reiterate that although CEOs resort to making an acquisition in order to grow their companies, it isn’t the only way of doing so nor is it the best way. They recommend that a more effective strategy for achieving growth is to organically grow a company in a manner that also increases the share-owner’s value.
In addition, Selden and Colvin (2003) contend that the most successful companies are those that understand their customers’ profitability. As such, they assert that customer profitability should be a major factor to be considered when acquiring companies. More specifically, acquiring companies should use the target company’s customer profitability to determine a price that will still enable the acquiring company to gain a profit; to identify the financial characteristics of the target company and the distribution of its customer profitability; and to decide whether it would be sensible to acquire only some of the target company’s customer segments. However, even after the acquisition is completed, customer profitability should still be considered in order to ensure that the acquisition becomes a worthwhile investment. In particular, the unprofitable customers can either be discouraged from further patronizing the company’s products and services or they can be sold. Alternatively, the acquiring company can find ways to turn the unprofitable customers into profitable ones.
Although employing a customer-centered approach in M&As does not completely guarantee their success, Selden and Colvin (2003) are confident that it would at least reduce the number of unsuccessful M&As and would lead to better results for the shareholders.
References
Selden, L. and Colvin, G., 2003. M&A needn’t be a loser’s game. Harvard Business Review.
