When a company gets ownership of another business and becomes the new owner by gaining control over running the business, this is known as an acquisition. The company has bought or acquired another company.
The process and motives of acquiring and running another business are complicated and worth a series of blog posts. Today, we will discuss what goals and objectives push a company towards buying another, particularly considering the expenses and long processing times involved.
These goals usually determine the type of acquisition that takes place and helps set the framework for the future of the newly acquired business and how it evolves post-acquisition for the better.
There are multiple types of acquisitions, and they can have different goals and stem from varied business objectives. Many companies launch new concepts, products, and services to grow their business. Then, sell it off to a more prominent firm to take it further. However, for some business owners, their businesses are their pride and joy, and they wouldn't dream of giving it to someone else unless some of their terms are met.
Goals of Acquisitions
Improving Financial Performance
Many companies go to acquire other businesses that are doing well financially or show the potential to do well. Once they have the new business under their control, the new owners will cut costs by reducing overheads, mainly by lowering human resource expenses or adding new markets to sell their products.
The reduction of costs by a few points improves profitability by utilizing existing networks, and personnel can make the difference between success and float along.
The improved access to new ideas, a successful business plan, or a product that is doing well allows larger businesses to fine-tune the acquired company and make it work better. At the end of the tweaking and transitioning, the financial performance improves, and the businesses' combined financials are better than before the acquisition.
A prime example is Cable TV operator Charter Communications. Charter was competing for multichannel subscribers, who were shifting towards bundled services that included broadband subscriptions. By 2014, Charter was threatened by streaming services, direct broadcast satellite providers, and other direct multichannel providers. Charter bought similarly challenged Time Warner Cable and Bright House Networks. This expanded Charters' subscriber base and allowed it to create synergies in overheads, product development, engineering. It also improved pricing due to a more extensive subscriber base and was able to revamp its business and cut costs significantly.
Top 15 Financial Metrics and KPIs
Discover the top financial metrics used to indicate a company's financial results and performance and provide info about expenses, profit, and cash flowREAD MORE
Quick Access to New Markets and Products
For an established company, buying a new company in a region where they are looking to expand into provides a means to get quicker access and speed up their selling process. This acceleration of access to a new market through acquisitions is a strategy that can work exceptionally well for companies offering innovative products as they allow acquired companies to benefit from first-mover advantages.
For example, in the pharmaceutical sector, a large company must get access authorization to manufacture and market new drugs. Having a large size is key to obtaining the licensing and patents to manufacture new medicines. Many pharmaceutical companies acquire existing companies in a unique geographical region. This allows them to access local talent and skillsets and a company on the ground ready to roll out their new and existing products.
Such mergers are common in the tech and pharmaceutical sectors. Large companies like Apple acquire promising businesses, like Beats Music and Beats Electronics. These brands were behind the market's favorite Beats headphones, speakers, and audio streaming service and software.
Apple acquired the Beats business and took their research further to develop further cutting-edge music and headphone products.
Such acquisitions also allow larger businesses to gain access to products that are leading in niche market segments. These enable the acquiring company to grow its market reach with guaranteed success and first-mover gains. The Beats acquisition helped Apple to expand its streaming business significantly.
Achieve Economies of Scale
Economies of scale are commonly cited as a reason for the acquisition. And it is a valid claim. Usually, large companies buy up new businesses that are doing well because they focus on smaller markets (and succeeding in them). Larger businesses buy these successful businesses and use their larger size, budgets, human resources to grow them in better and cheaper ways.
While economies of scale are bound to happen, larger companies acquire profitable products and fit them into their production process to get some mastery over them.
This means that, at times, economies of scale would happen in any case. Still, the main objective of acquisitions is to get access to a promising niche market that the more significant business hadn't bothered to focus on, which may be because of a strategy to focus on better returns elsewhere.
In my opinion, every acquisition is motivated by growth and expansion. The bottom line of expanding into a new product line, new region, achieving economies of scale is to grow your business. This is particularly true for new companies that hit the jackpot with a successful product.
For a company with a radical new product, like audio recognition (what we now know as Siri and Alexa), it makes more economic sense to be "acquired" by a larger and more established company to get access to their management and market expertise, piggyback their service onto their products and benefit from deep pockets for further R&D.
This allows for smooth expansion of the target market for both the smaller business and helps the larger company retain its edge over competitors and expand business reach. For instance, in our Beats and Apple example, Beats grew into Apple's massive market share and benefited from its management, marketing, and R&D infrastructure. Apple got to increase its profits even more and retained its technology edge.
Company Valuation: How to Value Your Business?
Learn what Company Valuation is, the different methods used to value businesses, and the benefits for each technique.READ MORE
Start a new business with merged companies
At times, existing companies, particularly those in the maturity phase of their life cycle, need to explore new options or markets. To do so, they look for other companies with overlapping or complementing skill sets and decide to merge their expertise to explore new businesses. Such mergers were widespread in the pharmaceutical and automotive industries in the late 1990s and early 2000s.
For instance, in 1995, the incoming Chairman of Daimler-Benz decided to restructure the company as most of its business units were not market competitive. The primary focus was to improve profitability and industry relevance. The company merged with Chrysler Corporation to become DaimlerChrysler AG in 1998.
The primary focus of the merger was to extend the core (profitable) businesses of the companies and support them with new products. The primary purpose was to improve competitiveness in the automotive sector globally. The company ended up closing less profitable business segments to strengthen its focus on the main product lines.
Such acquisitions are common in a sector that is saturated with maturing companies or products. It is usual for there to be excess capacity and price competition amongst industry players to sell more. Downscaling productions and merging are adequate to absorb excess capacity and allow producers to control the supply of products (and therefore have some say over the pricing of goods).
Most big businesses can be slow to respond to emerging market trends. This is not necessarily due to a lack of awareness. At times, the message and the process of mobilizing R&D efforts get so cumbersome that people cannot push their ideas through to the appropriate management level.
This means that while the top and bottom levels of a company are aware of the need to grow in a particular direction, they do not end up succeeding in that direction. This is one of the drawbacks of becoming a big business. The layers of management needed to run a big organization become a hindrance to new ideas. As a research analyst, your supervisor won't take kindly to you doing some research on the side (at the company's expense and on company time). However, many new findings and products emerge because of following up on such ideas.
In such cases, big corporations make it a strategy to look for emerging businesses that have products with potential and start acquiring them. In most cases, this allows companies to bypass the lengthy incubation and trial periods and get a hold of approved and tested products to launch and sell.
This approach is also known as consolidation if the company being acquired is of comparable or decent size. It is also known as industry roll-ups. The acquiring company 'rolls up' smaller and diverse businesses to expand its product range. Prime examples are Facebook acquiring WhatsApp. The social media giant didn't need to get the instant messaging app, but it did have a slice of the instant messaging profitability pie.
In an acquisition, both parties (the business being bought and the buying business) must be clear about their future expectations, what they are looking for in an acquisition or an acquirer, and how to proceed with their future growth.
Many acquisitions end up failing in terms of performance or whatever their goals were for the acquisition. This failure is usually due to problems in integrating the acquired business into the main business lines and difficulties in integrating products and plans into a more complex hierarchy or product mix. Issues with the mingling of management, executives, and adjustments can cause problems if they are not adequately planned.
Having a clear vision helps both parties to face the difficulties with a clarity of purpose about what they want to achieve from the entire process.