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Why Do Firms Undertake Mergers & Acquisitions?

With many large corporations taking on M&A as a potential growth  strategy, business leaders are tempted to adopt the acquisition path to  build a business empire. However, according to Mark Sirower, renowned  M&A consultant in BCG, most acquisitions end up in spectacular  failures. Many firms fail to see how new acquisitions fit into their  overall strategy and have yet to find a way to build M&A  capabilities that consistently harness value for shareholders. As such,  it is imperative for top management to deliberate the M&A process to  ensure long term success. In this article, we will explore the common  motives of M&A and how it fits into the strategy of the firm.

Horizontal Integration

A horizontal M&A involves acquiring a target firm with a similar  business, operating in the same market. The target is likely to be a  direct competitor of the acquiring firm with comparable products and  services. The main reason for doing so is to enhance revenue by  increasing market share and, at the same time, reducing competition.

Market Extension

This M&A strategy finds target firms with a similar product line  but operate in a different territorial market as compared to the  acquiring firm. The benefit of such acquisitions is the opportunity to  enter a new market while staying in the core competency of the acquiring  firm.

Vertical Backward Integration

A vertical backward acquisition seeks to combine the acquiring firm  to its suppliers. The advantage is through cost savings arising from the  purchase of supplies needed to run the business. A prime example is a  clothing manufacturer taking over a yarn producer.

Vertical Forward Integration

Contrastingly, a vertical forward integration seeks to buy over the  acquiring firm’s customer. The combined firm can value-add to their  existing product portfolio and charge a higher margin to extract value.  An example is a clothing manufacturer acquiring a fashion retailer.

Product Extension

Acquiring firms seeking product extension will look for potential  targets in the same geographical areas but with different product lines.  The main purpose is to add additional ranges of products and cross-sell  them in the same geographical market. This strategy is best executed  with complementary goods that increases the likelihood of cross-sell.

Free-form Diversification

Under this form of strategy, acquiring firms take on all other  opportunities to undergo M&A. The target firm typically offers  different product lines while servicing an entirely separate  geographical market. The main purpose is to diversify income into  alternative sources which might smoothen the impact of economic cycles.  However, this represents the highest risk of M&A failure as the  management team would have to operate the two businesses quite  independently which potentially limit the synergies of the combined  firm.

Although M&A is a complex process and is not the answer for every  strategic goal, executives can still realize the full potential for  synergy of an acquisition. It is highly beneficial to enter the deal  fully knowing the rewards and risks involved and, more importantly,  knowing when to walk away when things no longer make economic sense.

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