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Acquisitions 101: Why Companies Acquire Other Companies

If you haven’t been involved in an acquisition, then wait a few months; it eventually happens to all of us. In preparation for that event, it’s useful to get an understanding of why companies do acquisitions, so that you can anticipate the effect that an acquisition will have on you. I’ve been lucky enough to represent the acquiring company in more than twenty acquisitions, and so the information in this article is based on real experience. Yet I don’t claim to know all industries or all cultures, and so my understanding is obviously limited to what I’ve observed.

3 Reasons for an Acquisition
In my experience, a company acquires another company for one or more of three reasons:

  1. Vertical integration
    To take control of a key supplier, product or service on which the company depends; or to gain the profits that are otherwise going to these suppliers, products or services
  2. Horizontal integration
    To fill in “holes” in the product line, to add complementary products, or to add customers in new markets
  3. “Synergy”
    That magical situation in which the combined whole is greater than the sum of the two companies separately

Underlying all of these reasons is the assumption that the company wants to grow. The quest for growth is (unfortunately, in my opinion) common to all public companies and most private ones. Investors expect returns from the companies in which they invest, but an increase in stock price only comes from increased revenue per share or, to a lesser extent, increased profitability per share.

Now, looking at the three reasons, we see that the first two types of acquisitions can be done while keeping the two companies at arm’s length—by continuing to run the acquired company as a totally separate business unit. When acquisitions are done that way, the impact on an information technology (IT) organization is pretty much the same as the impact of having to deal with typical partnerships or third-party relationships: mostly interfaces and data feeds.

But I’ve never seen an acquisition where synergy didn’t come up. Attempts to achieve synergy can cause major disruption for IT and almost every other organization in both companies. Since synergy is one of the reasons for almost every acquisition, and because it’s the primary reason in a good number of acquisitions, let’s take a closer look at what synergy is all about. Here are three common synergy scenarios:

Synergy Scenario 1: More revenue, less expense
In this scenario, it is expected that together the two companies will have greater revenues, but that expenses will be lower. Revenues are expected to be higher due to cross-selling between the two customer bases; combining the sales forces; combining marketing and advertising; and due to an enhanced brand. Expenses are expected to be lower due to economies of scale; combining operations; consolidating systems and computers; eliminating duplicate functions and organizations; and in some cases by “centralizing.”

Synergy Scenario 2: Target business is losing money
This is a variation on the first scenario. The “target” company (the one being acquired) has higher expenses than its revenues. But by taking advantage of the techniques listed in scenario 1, the combination of the two companies is expected to be not only profitable, but more profitable than the parent company doing the acquiring.

Synergy Scenario 3: Take the customers
Under this scenario, the parent company doesn’t really want any of the operations of the target company; it just wants their customers. This type of acquisition is common when the parent company is in a business that already provides all of the products or services that the target company’s customers use, and the acquisition is done to add revenue to the parent without going through the cost of acquiring the customers individually.

In a typical acquisition of this type, say in the banking industry, some of the target company’s customers jump ship and refuse to become customers of the parent (the expected percentage of lost customers is factored into the acquisition price). Customer conversion is the key factor here: if customers can be converted to use the parent’s products and services without any disruption or effort on the customer’s part, then most customers will be expected to make the switch.

How does synergy affect IT?
There are a number of questions that an IT organization has to answer in order to deal with an acquisition. First there are the due diligence questions that should be answered before the acquisition takes place. What synergy scenario applies to this acquisition? If it’s scenario 1 or 2, then answer the following questions:

  1. Does the target company really have the technology they say they have? Do they own the rights to it (intellectual property rights, current third-party licenses)?
  2. Can the combined company benefit from technology economies of scale?  If so, where and how?
  3. How easily can data and systems in the two companies be integrated or interfaced to meet company requirements?

If synergy scenario 3 applies (take the customers), then answer these questions:

  1. How difficult will it be to replace customer-facing products, systems and services for target customers with the products, systems and services of the parent?
  2. What migration path should be used for target company systems and data? How long will the process take (long migrations guarantee more lost customers)?
  3. Will the existing parent systems support the increased volume? If not, then what will have to be changed?

Then after the acquisition takes place, there are more questions that have to be answered for all scenarios:

  1. How will roles and responsibilities change? You’ll have to get a feel for the new people with whom you’ll deal: what are they like? Can you trust them?
  2. What technology economies of scale will you actually implement? What systems will be combined? How will data centers and servers be affected? How can this be done to maximize payback while minimizing disruption to the business?
  3. How will data move among the various systems in the two businesses? What integration or interface tools will be used to make the data flow more efficient?

And finally, there’s the question that you ought to be asking yourself whenever you try to take advantage of economies of scale: What’s the likelihood that the acquisition will fail and will have to be spun back off? If we combine systems and organizations, what problems will this create if the business has to be split up again later? Is it worth it?

Acquisitions are a fact of life in business today. Most acquisitions are done in the expectation of some sort of synergy, and the acquisitions that fail usually fail because that synergy wasn’t achieved. With the proper due diligence before an acquisition, you can set more reasonable expectations. And with the proper planning, you can achieve the synergy that your company expects and desires. Acquisitions are like anything else: they’re great if done well and awful if done badly.

[Note: A downloadable PDF version of this post is available.  Click here to get the download.]

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