Value Creation in Acquisitions - Essay Example

SOURCES OF VALUE ADDITION IN ACQUISITIONS Name Institution Lecturer Course Date Table of Contents Table of Contents 2 Executive Summary 3 Introduction 4 Background Information 5 Sources of Value Creation 5 Revenue Enhancement Sources 5 Cost Savings 7 Theory Analysis 8 SWOT Analysis 9 Chico Fashion 11 Conclusion 15 References 16 Executive Summary Acquisitions are faced with different challenges in value creation. In most cases managers of business organization make decisions on whether to buy another business enterprise on the fact that they are competitors or have enough resources to boost their financial stability. The sources of value creation in the acquisition are dependent on the reason for the acquisition. . This is to mean that an acquisition can be friendly or hostile. Most of the acquisitions that have taken place have been faced with a number of challenges making them unsuccessful in their business activities. This is because the acquisition process is very complicated and requires a lot of issues to be addressed in order to create value of the acquisition. The different sources of adding value to an acquisition is through economies of scale, economies of scope, diversification, and cost reduction in the acquisition. There is also the need to carry out a SWOT and PESTE analysis to establish the factors that can help create value to the business before the acquisition and after the acquisition. Introduction Firm acquisition is the process in which one organization buys the assets of another company and changes its name or retains the name of the acquired company. This means that the acquisition may either be 100 percent or nearly 100 percent. In other forms acquisition where two different companies combine to form one company is termed as merging. According to Bruner (2004), over the past few decades acquisition is one of the areas in business that have proved to be hard in achieving success. This depends on the terms under which the acquisition was done. This is to mean that an acquisition can be friendly or hostile. Most of the acquisitions that have taken place have been faced with a number of challenges making them unsuccessful in their business activities. This is because the acquisition process is very complicated and requires a lot of issues to be addressed in order to create value of the acquisition. According to Badinger (2007), the acquisition needs to develop and implement different ways and sources that will enable them to create value for their acquisition in order to avoid financial losses. Hence, different acquisitions adopt and implement different sources of creating value in the business organization. This is to say that, acquisitions and mergers should embrace different mechanisms that add value to their business organizations (Epstein, 2004, p. 175). This helps them to avoid financial losses and assure their survival in a competitive industry. This report focuses on the different sources of adding value to the acquisitions. In addition, the report will recommend the best ways in which mergers and acquisitions can adopt in order to create value to their business organizations. Background Information The creation of value to any acquisition is one of the roles of the chief executive officers for these acquisitions. Managers of different acquisitions are tasked with the responsibility of developing and implementing ways in which they can enhance the value of the business organization. Bosecke (2009) argues that most acquisitions are perceived to have the impact of making profits. However, it has turned out that some of the acquisitions that were thought to become profitable turn out to have financial losses due to lack of value creation mechanisms. In fact, most managers have the confidence that their acquisitions will have the effect of long term value creation. This makes the managers to have the confidence of announcing to the public that their acquisition will be able to survive and generate more value (McNamara et al., 2008, p. 114). However, poor identification and implementation of different sources for adding value result to poor performance of the business organizations after acquisitions. Hence, there is the need to identify and recommend the sources of value addition that can be adopted by the chief executive officers of the acquisitions in order to increase the financial performance of the business organization (Teerikangas et al., 2011, p. 632). Sources of Value Creation Value addition or creation of value in an acquisition involved different ways and practices that the management of the business organization should engage in order to generate more finances in the company. The sources of creating value in an acquisition can be categorized differently according to the following categories (Capron and Pistre, 2002, p. 784). Revenue Enhancement Sources These are those sources that enhance the generation of revenue in the business organization. These are the ways and means in which the business organization is able to increase its capital value and become financial stable. The revenue enhancements methods ensure that there is an increased market power for the company. Kale (2004) argues that the acquisition can increase its revenue by ensuring that it combines of merges with a potential company. This means that, chief executives officers of business organizations will ensure that they buy or involved in the acquisition of a company that they have information for the enhancement of revenue. This implies that managers will acquire companies which they know that by combining with these target firms it will add synergy to the business organization. This is done when the firm acquires resources from the other firm that will; ensure that they generate more revenue to the acquisition. It is expected that the private synergy of the two firm will increase the value of the combed firm to be more that the value of the individual firms before the acquisition. Shared experience can also increase or create value for an acquisition (Sethet al., 2000, p. 388). This is seen when a company mergers with a company that has a good command and good market share in the same line of business. This means that acquiring the assets of that company will ensure that the combined company increases its market share than the market share it had before the acquisition. This will make the company to have more revenue hence more value (Seth et al., 2002, p. 432). Seth (1990) argues that Shared experience in the same industry can also increase and create value for acquisition. This is because when two companies have different experiences in the same line of business, they have different strategies of maintaining their customers as well as increasing their sales. Combination of these companies will increase the revenues of the merger since they have combined or synergistic efforts in increasing revenues for the acquisition. Moreover, a company or an acquisition may increase it revenue and create more value by combining or buying competitor. When a company buys the assets of a competitor it is likely to increase its market power. This is because before the merger or the purchase of a competitor, there was an increase in competition in the same industry which resulted in divided market power. This also implies that in order to create value for the acquisition and enhance the revenue of that acquisition, managers should be calculative enough and ensure that they only purchase those companies that are rivals and oppose a threat in terms of market competition. Cost Savings According to Seth et al (2000), an acquisition can also create revenue through different ways that will ensure a reduction of the cost of running the acquisition. A business organization can save costs through a number of ways. An acquisition can create value through economies of scale. The economies of scale are only achieved in horizontal acquisitions. This is because under economies of scale costs such as advertising and production are lower. Under economies of scale the company may decide to increase the capital of the company such that the company is able to produce the large amount of products. This will means that the cost of production w8ill go down when the company produces a large amount of good at once that when its produces a smaller amount of good. In addition, the cost of operation is lower when a firms is large that when it’s smaller. Hence, the acquisition can enjoy the benefits of economies of scale by increasing its scale of operation in order to reduce the costs. The acquisition can also save the cost through economies of scope. According to Powell and Yawson (2005), under economies of scope, the business organization should ensure that it diversifies its operations. This means that production of one product in the business organization is likely to increase the cost of production, as well as cost of operation. When a firm changes the scope of its operation and produces different types of products is likely to reduce the costs in the business organization. In economies of scope, there should be shared inputs which are used in the production of two different products (Huyghebaert & Luypaert, 2013, p. 1820). According to Huyghebaert&Luypaert (2013), the economies of scale become important when there is a divisible factor of production. The economies of scale also create value to the company by reducing cost only if the acquisition consists of related companies in the same industry. This is because the related companies in the acquisition will ensure that they have complementary skills for the production and marketing of the products. The company can also reduce the costs of the business organization through elimination of the inefficient management issues. Some of the operations in the business organization by reduced of assigned to a single individual rather than a group of people in order to reduce costs. Diversification of risks in the acquisition can also help reduce coats and create more value to the acquisition. In the diversification, when a firm acquires or merges with another company, there is a spread of the risks involved in the operation of the business organization. This means that the acquisition will help in the polling of risks such that there is an increase in market value of the business organization. Theory Analysis A critical analysis of the value maximization theories of acquisitions and non value maximization theories suggests that some managers and chief executive officers of business organization involve themselves in merger in order to achieve personal gains (Vermeulen, 2005, p. 46). This means that such managers become motivated by managerial efforts for their own gains. According to the managerial models of mergers and acquisitions, managers of b business organization pursue sales and other growth maximization efforts in order to gain at the expense of the stakeholders of the business organization. This theory claims that the decisions by managers of the business organization to acquire another firm will be able to stabilize the channels of income in the business organization as long as the acquired business organization have a different cycle of business operations. According to Cording (2010), the variance of the business organization returns will go down or reduce. In addition, the acquisitions models suggest that acquisitions take place since they are influenced by the decision of the managers. According to the game theory, one can argue that managers play with the psychology of other stakeholder in acquiring the assets and operations of other business organization. This implies that there is a need for different stakeholders to evaluate the value of acquisitions before the acquisitions in order to establish whether the acquisition will create more value to the company or will benefit a few individuals such as managers of the business organization. Therefore, it is important to analyze the value of the acquisition before decisions are made (Cording et al., 2010, p. 23). This means that stakeholders should carry out an analysis either SWOT Analysis or PEST analysis to evaluates the benefit of the merger or acquisition as establish whether the acquisition will lead to value creation of financial losses to the business organization. SWOT Analysis The creation of value in an acquisition is dependent on the ability of the acquired firm to have different strength and abilities that will provide the necessary channels. This means that before acquiring a business organization, managers of business organization should ensure that they carry out an analysis to evaluate the benefits of acquiring that business organization. In the SWOT analysis the company should consider the strength, weaknesses, opportunities, and threats that may be brought about by the acquisition of the new business organization. Strength: In order to make an acquisition add value to the company, the management of the business organization should be able to focus on the strength of the company to be acquired. This means that the company should not only focus on the strength of the new company, but also establish the new strength that the company will bring into the acquisition. In addition, the management should also establish in what ways the strength of the company to be bought will eliminate the different weaknesses of their company so as to increase the revenue and financial stability of the business organization. According to Sudarsanan (2010), the strengths of the company can range from the market power of the acquired company, resources such as assets, customer relations and good management practices. This means that acquiring a company that has more strength than the present company will make the acquisition have more market power and shared experience that will enable the acquisition to have more value than before. Acquiring a company that has more valuable resources will ensure that the acquisition has more resources that enable it to increase its financial stability and operate on a large scale. The expansion of the operation will help the company reduce cost and enjoy economies of scale (Hafeez et al., 2008, p. 59). Weaknesses: Before making an acquisition, there is a need to establish the weaknesses of the new company. This will enable the managers of the current company to establish the reasons as to why the company is on sale. In addition, there is necessary to determine the financial position of the new company on sale and establish as to whether it has been making profit or losses. In addition, establishing the weaknesses of the new company will help the purchasing company to develop ways and strategies of eliminating the weaknesses. Moreover, the company should establish whether there are any weaknesses that may arise from the combined business. This will help the company to make a decision as whether it shall buy the business organization or leave it all together. Opportunities: it is also crucial to determine the opportunities that will arise from the combined business organization. For example, the company should establish the missing competition in the market as capitalize on it. In addition, the purchasing company should determine the emerging needs of the customers in the marketplace. Moreover, the company should determine what it can do better as a result of the acquisition in order to create more value to its business organization (Hafeez et al., 2008, p. 59. Threats: these are those activities that may result to poor performance of the acquisition. Therefore, there is a need to establish the threats of the new acquisition. For example, the company should establish as to whether the acquisition will result to stronger competitors or not. In addition, the company should establish as to whether it has the necessary finance to fund the research and development for the creation of value in the combined business organization. Moreover, the company should ask itself whether there is any likelihood of losing employees as a result of the combined business organizations (Hafeez et al., 2008, p. 59). Case study of SWOT Analysis Chico Fashion Chico is among the most successful fashion and design companies in the United States of America. This company was in the process of acquiring Ann Taylors Company in the fashion industry. The company had to carry out a SWOT analysis to ensure that makes a good decision before the acquisition in order to create value to the new business organization. Although the company was not planning the acquisition the SWOT analysis may be helpful in making a decision (Hafeez et al., 2008, p. 58). Strengths Product mix: the company has a product mix consisting of different accessories Trained sales associates who understand the different fashion customers and have good knowledge of the fashion industry in the United States of America. Has a good national brand image that boost its sales Has a strong financial position Weaknesses At some point it e4xperienced a decline in profits despite financial stability Chico has only one distribution facility in the United States. Opportunities Restructuring programme of Ann Taylor may provide a chance to i9ncrase its profitability in the business organization The company will benefit from increased sales through the internet provided at Chico. This is an opportunity for the Ann Taylors. Threats Frequent change in fashions may affect the profitability of the company in future Competition from emerging fashion designers and entry to new markets is challenging for the company. Figure 1: Graph showing Chico’s sales growth against the value created Figure 2: Graph showing operating margin against value created at Chico Fashion PESTE Analysis The acquisition of any business enterprises requires one to evaluate and develop a PESTE analysis which evaluates the political, economic, social and technological factors that are likely to affect the acquisition. This is because PESTE analysis ensures that managers of business organization are able to acquire a company that does not present any political or environmental challenges that are likely to interfere with the financial stability of the acquisition hence lowering the value of the creation. Political It is important to establish the political factors that are likely to emerge as a result of the acquisition. This will help the organization to evaluate as to whether such factors are able to create value to the business organization. This includes home and current legislation that affects the acquired business organization and the merger. In addition, regulatory bodies that affect the acquired company should also be determined to establish whether the are4 extra costs. Economic There is a need to determine the economic situation of the current location in which the combined business is so as to determine whether the acquisition will be affected by such economic situation. In addition, taxation issues that are associated with the acquired company should be evaluated to see whether they will cause more financial loss or they are within the legal ranges. It is also important to determine whether the company has been compliance with payment of taxes. Socio-cultural These are cultural and social factors that are likely to affect the acquisition. These include lifestyles of the customers of the acquisition, major events and holidays that are likely to influence the purchasing ability of the customers of the acquisition (Bjorkman et al., 2007, p. 659). Technological It is important to evaluate as to whether the acquired firm embraces current technologies in order to increase the performance of the acquisition. In addition, the company should focus on the ability of the new company in terms of its potential to acquire new innovations and whether it has any patents in existence and of what value are these technologies in the current economic conditions (Ahuja and Katila, 2001, p. 200; Lehto and Lehtoranta, 2006, p. 5). Conclusion The acquisition of firms is the process in which one company buys another company in order to increase its value and market power in the industry. Most of the acquisitions that have taken place have been faced with a number of challenges making them unsuccessful in their business activities. This is because the acquisition process is very complicated and requires a lot of issues to be addressed in order to create value of the acquisition. The acquisition needs to develop and implement different ways and sources that will enable them to create value for their acquisition in order to avoid financial losses. Company managers are tasked with the responsibilities of creating value to the acquisitions. This means that creation of value in the acquisition can result from different sources such as economies of scale, economies of scope, diversification, and revenue enhancements. However, there is also a need for managers to carry out a SWOT and PESTE analysis in order to evaluate the potential of the acquisition to create value in the acquisition. References Ahuja, G. and Katila, R 2001. Technological acquisitions and the innovation performance of acquiring firms: a longitudinal study, Strategic Management Journal, vol. 22, no. 2, pp.197-220 Badinger, H 2007. Market size, trade, competition and productivity: evidence from OECD manufacturing industries, Applied Economics, vol.39, no. 3, pp.2143–57 Bjorkman, I., Stahl, G. K., &Vaara, E 2007. 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How acquisitions can revitalize companies.MIT Sloan Management Review, vol.46, no.4, pp.45–51. Read More