Are you hoping to grow your company? Often, the best way to scale is through M&A. However, to be successful, you need to know which business acquisition strategies are successful and which strategies are not.
More than 55% of executives report that up to a quarter of their deals fall short of expectations. Why do many acquisitions succeed but just as many flops? Maybe they're just not applying the correct strategies.
Successful business acquisition strategies provide ways to grow your business without assuming too much risk. This is especially true if you already have intimate knowledge of your industry. Plus, inorganic growth supports opportunities to build economies of scale and leverage cost synergies.
Keep reading to learn about six critical business acquisition strategies. They will propel your company into success—no matter the size of the companies involved.
Below is everything we will cover. Feel free to skip ahead.
- The importance of a sound acquisition strategy
- Six proven business acquisition strategies
- More difficult merger and acquisition strategies
- Determining when to buy
The importance of a sound acquisition strategy
Sadly, there isn't a straightforward way to execute successful business acquisitions.
Like research and development, marketing, and other popular business practices, acquisitions aren't intrinsically all good or all bad. Each transaction requires exceptional strategic logic. While there isn't a magical formula to guarantee success, you can look for the signs of a more fruitful union.
The most prosperous acquirers go into each deal with unique and distinctly-articulated value creation approaches. The strategies for less-prosperous deals, including filling portfolio gaps, seeking international scale, or creating a three-fund portfolio, are hazier.
Empirical analysis and findings of particular methods provide poor insight. This is because there are so many types of business acquisition strategies and no accurate way to distinguish between each strategy.
Besides, the documented approach may not be the actual one used. Companies often tout a slew of strategic advantages from business mergers that are actually just ways to save money. Without empirical research, recommendations for value-creating strategies must be based on tangible experience acquiring businesses.
Six proven business acquisition strategies
When considering an investment in another company, there are specific strategies to create value.
When planning an acquisition, one of these models should be the foundation of your strategic rationale. Forget vague concepts like strategic or growth positioning. They are important, for sure, but need to be rendered more tangibly.
If your M&A process doesn't fit into one of these methods, you're taking a risk that it won't succeed.
Even if you choose to base your acquisition on one of these models, remember that it's impossible to build value if you pay too much.
The six types of business acquisition models we'll discuss are proven to add value and increase mergers and acquisitions' success rate.
1. Advancing the target company's performance
One popular value-creating acquisition approach is to improve the target company's performance. It's simple—you acquire a business and drastically cut costs to boost profit margins and cash flow.
You may also have to outline specific steps to expedite revenue growth in some cases.
The most auspicious private equity firms are those that pursue this strategic approach. Operating profit margins rose by 2.5% more than those at similar companies over the same period between successful private-equity acquisitions. This was with no additional investments along the way.
Consequently, several of the acquisitions resulted in even higher operating profit margins.
Remember that improving a business's performance with low returns on invested capital (ROIC) and low margins is more accessible than improving one with high ROIC and high margins. As an example, take a target company with a 5% operating profit margin. Reducing that company's costs from 95% to 90% of revenues grows the margin to 10%, leading to a potential 50% increase in its value.
By comparison, consider a company's operating profit margin is at 30%. Expanding the company's value by a total of 50% requires stretching the margin to 45%. For this to happen, costs must decrease from 70% of earnings to 55%—a 21% reduction. A situation like this isn't reasonable to suspect.
2. Accelerating products' access to the market
Smaller start-ups with innovative products often face challenges in reaching a more significant market. Smaller pharmaceutical companies, for example, don't have the vast sales networks needed. They can't develop relationships with the numerous doctors necessary to advertise their products.
Larger pharmaceutical companies often buy smaller ones and use their large-scale sales networks to sell their products faster. However, this method can be applied across industries.
In the technology industry, for example, IBM acquired 43 companies from 2010 to 2013. The average acquisition cost was around $350 million each.
They estimated that by pushing these companies' products through their worldwide sales force, they would significantly increase the target company's profits. And they did—sometimes as much as 40% in the first two years following the acquisition.
In other cases, the target may also assist the acquirer in accelerating revenue growth. In the consumer packaged goods (CPG) industry, Proctor & Gamble acquired Gillette. The merged company benefited because P&G had more substantial sales in some up-and-coming markets. Gillette had more robust sales than others. They worked together to bring their goods into new markets quickly.
3. Exploiting a business's industry-specific ability to grow
Experts frequently mention economies of scale as a critical source of value creation in mergers and acquisitions.
While they can be justified, you must be very cautious when using economies of scale to justify a significant acquisition because large corporations are often already running at scale.
If two large corporations already operate in this manner, merging them is unlikely to lower unit costs.
Consider the United Parcel Service and FedEx as an example. They already have some of the world's biggest airline fleets and run them effectively. It's unlikely that combining their flight operations will result in significant cost savings.
However, when the incremental capacity unit is high or when a larger company buys a smaller company, economies of scale may be significant sources of value in acquisitions. For example, auto manufacturers try to reduce the numbers of platforms they need because the cost to develop a new car is substantial.
The merger of Audi, Porsche, and Volkswagen allows these three companies to share platforms. The Audi Q7, Porsche Cayenne, and Volkswagen Toureg are built on the same foundation.
4. Consolidating to eliminate excess industry capacity
Typically, as industries mature, they create excess capacity. An excellent example of this is in the chemicals industry. Chemical companies like Exxon are constantly searching for ways to get more production out of their plans, even as new entrants continue to enter the market. As a result, companies are continually scanning for ways to increase production.
The mixture of increased production and capacity from new entrants creates more supply and less demand. Therefore, it can be easier for companies to close factories across a newly merged entity that is a result of M&A than close their least profitable plants pre-acquisition. Without M&A, closing a less-productive plant reduces the size of the company.
You can also reduce excess industry capacity in less tangible ways. Consider the pharmaceutical industry—consolidation has significantly diminished the capability of the sales network. This is as product portfolios change due to mergers, and they reconsider their approach to communication with doctors.
Pharmaceutical organizations have also reduced their research and development capacity. This is achieved by reducing their development projects' portfolios and finding more efficient ways to administer research.
While eliminating capacity can add significant value, most of it goes to the seller's shareholders rather than the buyer's. This is typical with most M&A transactions. Also, other competitors may act as free-riders. They stand to benefit from the reduction in capacity without taking any action.
5. Acquiring technologies and skills faster or cheaper than it takes to develop them
Many tech corporations purchase others that have the technology to improve their products.
This allows them to obtain technology faster than they can develop it in-house. They can avoid paying royalties on patented inventions while preventing rivals from accessing them.
Let's use Apple as an example: Apple bought Siri to improve its popular iPhone. Then, Apple acquired Novauris Technologies, a speech recognition technology firm. Purchasing this company allowed them to improve Siri's capabilities.
The same year, Apple bought Beats Electronics. Beats had just released a music-streaming platform. Through this acquisition, Apple was able to provide a music-streaming service to its customers more quickly. They did this as the demand shifted from Apple's iTunes model of users buying music to streaming instead.
During the frenzied internet growth era, Cisco Systems purchased other companies to create a comprehensive IT product catalog. Cisco purchased 71 companies at around $350 million each. Their revenues jumped from $650 million to a whopping $22 billion in eight years. Acquisitions accounted for nearly 40% of the company's revenue in 2001. Cisco produced over $36 billion in earnings with a market capitalization of around $150 billion by 2009.
6. Choose winners early to help them scale their business
The last business acquisition strategy is making acquisitions in newer industries before others begin to catch on.
This business acquisition strategy requires a supremely-disciplined approach. To succeed here, you must be willing to make purchases early—long before your competitors see the industry's potential. It would help if you also recognize that some of the bets you make will fail. Lastly, nurturing acquired businesses takes patience and skill.
An excellent example of a company utilizing this strategy is Johnson & Johnson purchasing DePuy, an orthopedic-device manufacturer. In 1998, the company produced $900 million in revenue. The company's revenue grew to $5.6 billion by 2010. That's an impressive annual growth rate of 17%.
One approach to make this acquisition strategy work is to invest capital into budding startups. It's less risky than acquiring, and as an investor, your company can help nurture the business model. Then, once the model is proven, you have the option to pursue M&A.
An excellent FinTech example of this approach is Visa's attempt to acquire Plaid for $5.3 billion in 2020. While the DOJ eventually rejected the acquisition in 2021, the approach was sound. Visa was an early investor in Plaid and finally decided to acquire it.
More difficult merger and acquisition strategies
The six business acquisition strategies we just discussed are not the only ones you can use. However, they're the methods most likely to create value.
There are a handful of others that have been proven to be valuable, albeit rarely.
Consolidate to improve return on invested capital
In very competitive industries, many executives believe that competitors will focus less on price opposition following consolidation. The goal of this strategy is to improve ROIC.
However, evidence shows that unless mergers can prevent new entrants, the industry's pricing behavior will not change. If anything, smaller and newer businesses have an incentive to offer lower prices. In an industry with several companies, many acquisitions must take place before the competitive landscape changes.
Many executives' desire to transform one or both corporations leads to a merger. Transformational mergers are rare and difficult. To see success, your management team must be able to precisely and efficiently execute this strategy.
To explain this strategy, we'll use another example. Novartis, a leading pharmaceutical company in Switzerland, was created through a $30 billion merger of Sandoz and Ciba-Geigy. Underneath the surface, however, this was more than simply combining businesses.
The two companies combined to form a new company. The new CEO used the merger to redefine its mission, portfolio, strategy, and organization. They also overhauled vital business processes, from sales to research.
The leadership teams did not follow a specific formula to ignite this change. They had to determine the best way to do things systematically.
The new company spun-off of the original businesses and switched focus. Notable changes included structuring worldwide research and development by therapeutic area. In the past, this was done by geographical location. This simple change enabled the company to build a world-class oncology franchise.
Through this transformational merger, Novartis built a robust, performance-oriented culture. They did this by shifting to a performance-based salary system for leadership. In the past, compensation was based on seniority.
More recently, an example of a transformational merger is Lending Club's acquisition of Radius Bank for $185 million in 2020. Lending Club is a peer-to-peer lending marketplace, and Radius Bank is a fully-fledged bank with a bank charter. The acquisition is unusual, as typically, Banks look to acquire FinTech companies and not the opposite.
However, Radius Bank has several valuable relationships as it offers a banking-as-a-service to several institutions. Nonetheless, this is a genuinely transformational merger, and only time will tell whether this specific deal is valuable.
Roll-up acquisition strategies occur in markets in which competing companies are too small to realize economies of scale. This method works best when companies can realize substantial cost savings as a group. Together, they can produce higher revenues than individual corporations can.
For example, from the 1960s to 2008, Service Corporation International transformed from a sole funeral home to over 1,400 cemeteries and funeral homes.
For a roll-up acquisition to be successful, you must determine your exact goals. Are you rolling up geographies to expand your footprint? Are you growing your one-product company to one that carries several?
Perhaps you're rolling up markets to sell into—adding retail, automotive, and insurance to your original consumer-products business.
If executed correctly, a roll-up acquisition can accomplish whatever your business needs. One tip is not to try to integrate the businesses on day one completely. There are too many skill sets, company cultures, and personalities involved.
Think of a roll-up of businesses in three phases:
- Roll-up the business financials into one entity and keep the businesses running mainly the same as before the acquisitions.
- Integrate all back-office functions (i.e., Human Resources, Finance, Supply Chain) across all businesses.
- Integrate all front-office functions (i.e., Sales, Marketing, Customer Success).
Doing it all at once most likely won't work out and may result in revenues falling short of plan. Failing to phase a roll-up over a couple of years can lead to disgruntled employees and endangered debt services. All too often, acquisitions lead to bleeding talent if employees no longer enjoy working there.
Another challenging acquisition strategy is to buy companies at a lower price than a company's intrinsic value. Finding an opportunity like this is rare and unlikely to produce substantial results.
Market values and intrinsic company values are typically aligned. However, sometimes this isn't the case. For example, sometimes markets overreact to negative news. Suppose a CEO is under criminal investigation or a single product within a more extensive portfolio fails to produce results.
Moments like these are more likely to occur in cyclical industries. At the bottom of a cycle, assets may be undervalued. In this situation, corporations can nearly double their shareholder returns. They can do so by obtaining holdings at the bottom of the cycle and then selling at the top.
To gain control in this situation, companies must pay shareholders over the current market value. Market values can wildly deviate from intrinsic ones. So, you must be aware of the possibility that a potential acquisition is overvalued.
For example, during the dot-com bubble of the 1990s, companies that merged with telecommunications businesses saw plummeting share values when the market returned to normal.
When the market is inflated, it's imperative to consider the possibility that you may pay too much. Merger and acquisition activity seems to grow following periods of strong market performance.
Substantial improvements are necessary to justify an acquisition when prices are artificially high. This is true even when the target company can be purchased at market value.
Determining when to buy
When you're thinking about expanding your business, how do you decide whether to build or buy? It would be best if you questioned which strategy will be cheaper. Do you grow to an area where a competitor dominates the market or try to purchase them instead?
In every industry, there are examples of companies faced with this decision. Consider Facebook's acquisition of Instagram. Facebook's leadership had to ask themselves whether it was cheaper to build a competing platform or make a deal. At the time, industry experts questioned Facebook's $1 billion purchase. Five years later, however, $1 billion seems cheap.
Whenever you're faced with this dilemma, here's what to consider.
Know what you're purchasing
In some examples, you can look at acquisitions as a method to purchasing your ideal customer.
You're indeed purchasing a company, but when it comes down to it, you're buying their book of business. You may not need their CEO because you already have one. Or you don't need their offices because you have new offices in those same areas. You're not only purchasing infrastructure. You're building your customer base, which you can fold into your well-oiled machine.
If you're competing for an area's market share, you can also look at acquisition as a way to own that area. If you move into a competitor-dominated area, you may spend millions on marketing without denting their business. In this case, it's probably better to strike a deal.
Young entrepreneurs can benefit from lower salaries to keep cash on hand to reinvest in their businesses.
Develop a way to measure success
To experience a successful M&A, you must realize that it isn't about integrating businesses but accelerating your vision.
Many mergers and acquisitions are followed by a honeymoon period. While this feeling is wonderful, it can be short-lived if you don't quantify success.
Whenever you make a deal, there must be synergies. Each time you purchase a company, 1+1 must equal 3, not 2.
What does this mean? Buy more than something that works in isolation. You grow a business by having separate arms that leverage each other, not do things independently. This is the only way to see a return on your investment.
Avoid bidding wars
Our final piece of advice is to avoid acquisition bidding wars at all costs. They're likely to turn into ego wars that inflate the price beyond what the company is worth. You can lose sight of what you were purchasing in the first place.
Instead, walk into every deal knowing what a company is worth to you. It would help if you also determined what your pain threshold is. This way, if another party begins driving up the cost, you know when to walk away.
Acquisitions aren't about having more just for the sake of it. It's about looking at your business as a whole. If you take a step back, can you spend money to buy an asset for cheaper than you can build it yourself? What enables you to make it back more effectively down the road?
If your deal becomes about anything other than that, you're making a mistake. The math must add up.
Put these business acquisition strategies to the test
Business acquisition strategies are a sound way to scale your business. However, you must perform them successfully. Whether you're new at M&A or not, these archetypes can be your key to a robust growth strategy.
By embracing one of these six business acquisition strategies, you can avoid pitfalls. You won't fall victim to acquisitions that look great on paper but fail in the long run. While acquisitions will never be straightforward or easy, you can create promising unions if you go about them in the correct ways.
A critical aspect of integrating companies is mastering the process in an organized way. Start your new team off on the right foot with a platform to effectively manage your M&A projects online. TrueNexus was built to help teams do this. You can automate status reports, collaborate with stakeholders, and ensure accountability and transparency.
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