Question

• Imagine you are the chief financial officer (CFO) of a corporation with plans to complete the acquisition of a key subsidiary this year. Your chief executive officer (CEO) has requested a presentation to the board of directors describing the methods available to account for the acquisition internally and the best method for the company during the acquisition year. Please assess the value of each method identified in your presentation to the board and support your recommendation with examples. Respond to at least one other student.

Answer 1

Companies merge and acquire each other for many different reasons.

From a hostile takeover to a friendly merger or a strategic alliance – there are many ways companies can combine forces.

In this article we look at four of the main types of mergers and acquisitions and provide a mini-case study of a well-known merger that did not turn out as planned.

4 Types of Mergers and Acquisitions

Companies will merge together and acquire each other for a variety of reasons. Here are four of the main ways companies join forces:

Horizontal Merger / Acquisition

Two companies come together with similar products / services. By merging they are expanding their range but are not essentially doing anything new. In 2002 Hewlett Packard took over Compaq Computers for $24.2 billion. The aim was to create the dominant personal computer supplier by combining the PC products of both companies.

Vertical Merger / Acquisition

Two companies join forces in the same industry but they are at different points on the supply chain. They become more vertically integrated by improving logistics, consolidating staff and perhaps reducing time to market for products. A clothing retailer who buys a clothing manufacturing company would be an example of a vertical merger.

Conglomerate Merger / Acquisition

Two companies in different industries join forces or one takes over the other in order to broaden their range of services and products. This approach can help reduce costs by combining back office activities as well as reduce risk by operating in a range of industries.

Concentric Merger / Acquisition

In some cases, two companies will share customers but provide different services. An example would be Sony who manufacture DVD players but who also bought the Columbia Pictures movie studio in 1989. Sony were now able to produce films to be able to be played on their DVD players. Indeed, this was a key part of the strategy to introduce Sony Blu-Ray DVD players.

Purpose of Acquisition

According to Mckinsey, it is also helpful to analyze the acquisition based on the purpose of the same. Therefore the consulting firm has defined following broad heads of such purposes under which acquisitions are categorized. Classification based on the purpose of acquisition:

1. Improvement in Target’s Performance

This is the type of acquisition in which the acquiring company is highly involved in the day to day activities of the target company. It is not an acquisition to use the synergies of the target company but to improve its performance. This is generally done by private equity players who expect high profits from the targets and therefore, invest heavily in the same. So this is a high-risk high reward approach. It involves austerity measures such as those of cost reduction and increasing margins.

2. Remove Duplication

When a company is acquired, it will have certain aspects that the acquirer already has and therefore such duplications cause a drain on profits. Acquirer aims to get rid of such duplication and enhance the profits of the target company and consolidated profits of both the companies. Such duplication might be of having a separate transport fleet. If the acquirer has sufficient for both the companies then the target company’s fleet can be done away with.

3. Acquire Expertise and Technology

It is at times more cost-effective to get hold of new technology and expertise of the target company instead of developing it in house, therefore certain big conglomerates keep a separate budget for such acquisition regularly. These acquire smaller players now and then when they see a new piece of technology being developed by them. One reason is to boost production of such technology at a large scale, another is to prevent the creation of a competitor and yet another reason is to have the new technology in its portfolio.

4. Economies of Scale

This is one of the most important reasons for the acquisition, however, it is not always the case. In a certain acquisition, such economies are negligible. This is when the companies are already very large in themselves that they both have achieved the maximum level of economies possible. However, when a big company acquires several smaller companies, it enables them with such economies for example by reducing their input cost as the large company receives bulk discounts. So it might be beneficial in such cases and effective in increasing the profits of smaller players.

5. Finding Promising Companies in the Seed Stage

Unlike the first purpose of improving the performance of the target company, this purpose comes into play when the acquisition takes place at a very early stage of the target’s life cycle. This is done when the target possesses a disruptive technology or product that can make all existing products obsolete. Therefore, the companies that can assess such possibilities acquire such companies and groom them to their full potential.

Conclusion

Therefore, there can be various types of acquisition and different types of classifications. These classifications are ever-evolving and therefore we can’t say which method of classification is the right one. However, one of the most prominent methods of classification is the one base on the nature of companies involved and not knowing that definition conveys a lack of knowledge. Purpose based classification cannot always be possible because at times the companies do not make it public the real reason for such an acquisition and the information in the public domain might not be sufficient.

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