In the third article in his series on international business, Tony Grundy explains how to make effective acquisitions
First published in the September 2014 UK edition of Accounting and Business magazine.
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This article looks at the different types of acquisition, their objectives, their value, the acquisition process and acquisition skills. We then finish with a classic case study - BMW's acquisition of Rover Group.
Acquisitions can be broken down into three main types:
- 'Step-out' acquisitions involve diversification and take you into a new business domain.
- 'In-fill' acquisitions add another business unit to existing domains.
- 'Absorption' acquisitions involve integrating new operations within the existing business.
Step-out acquisitions are generally the riskiest as there is often not just an information gap about what you are buying but also an understanding gap - what does that data say about the strategic and financial health of what you are buying? There is also typically a competency gap in that you may not know how to run a business that is different in subtle as well as more obvious ways.
In-fill acquisitions are generally lower risk as you are dealing with the relatively familiar.
Absorption acquisitions are virtually always low risk as they entail fully integrating operations. Exceptions are when a new customer base is being put through the acquirer's own operations, with the attendant risk of alienating customers.
Acquisitions can be made for quite different reasons:
- to achieve cost savings
- to acquire competences
- to grow market share
- to just grow generally
- to grow internationally
- to gain a position in future high-growth markets
- to defend the business or protect industry structure
- to add shareholder value
- to generate exciting new career opportunities
- to send a message to shareholders that the company is a dynamic one.
Potentially poor objectives here are: to just grow generally, to protect the business, to generate exciting career opportunities, and to send a message to shareholders that the company is dynamic. Each of these is associated with shareholder value destruction. A classic case was the RBS takeover of ABN Amro Bank just before the credit crunch to expand its presence in the sub-prime market.
Better objectives might be acquiring competences, cost cutting, and generating shareholder value.
Absorption acquisitions tend to be made to reduce costs, to increase market share etc.
In-fill acquisitions are typically to defend position, to grow generally and to increase market share - provided that the acquisition actually serves whatever market that is.
Step-out acquisitions are usually more about positioning for future high-growth markets, acquiring competences and growing internationally.
Acquisitions are not only of different types and have different objectives but also add value in different ways - what's known as 'value segmentation'. Put simply, 'value' comes in different pots and ought not to be collapsed to a single number (eg a net present value). In the most general terms we can distinguish between value added at different stages of the process as:
- V1: the value inherent in the existing strategy
- V2: the value added (or destroyed) by the deal
- V3: the value added (or destroyed) through integration (and further strategy development).
The idea here is that each one of V1, V2, and V3 is positive - although, all too often, one, two or even three of these value segments are actually negative.
In addition to these aspects, value can be added in different ways, such as cost savings and gaining market share ('sweat value'), or positioning in markets expected to be high growth in the future ('opportunity/speculative value').
Being very, very clear not only about the objectives but also the targeted value of an acquisition means going a lot deeper than just doing a set of numbers for future sales, margins and costs.
Value segmentation can be made very specific indeed. For instance, Rolls-Royce many years ago acquired Allison Engine in the US. The value segments identified here were 'core value' (the value of existing products), 'spares value' (the value of the spares stream) and 'capability value' (the value that could be generated through its skills as applied either in the Allison business, or to the Rolls-Royce business).
So the business case was based on three, and not one, present values.
Commonly the acquisition process is thought of as:
- searching for targets
- evaluating the targets
- doing the deal.
And, perhaps, if you are lucky, you get an integration stage too.
This model is, however, very limited as it fails to nest the acquisition within the strategic context - and also in the latter stages of implementation and learning. A better model might be:
- Goals: define corporate goals, position and do gap analysis (linked to V1)
- Role and criteria: define the possible role of acquisitions and set criteria (linked to V1) in relation to others eg organic development and alliances
- Options: identify and evaluate options (linked to V1)
- Doing the deal (V2 stage)
- Integration and learning (the V3 stage).
This model does a number of things over and above a mere search process.
It anchors the process to corporate strategies and the wider opportunity stream (acquisitions are not a strategy in their own right but a means towards a corporate strategy).
It sets clear acquisition criteria - which can be set up as a series of strategic dos, don'ts and might-dos.
And learning is crucial - for any further acquisitions and to steer the integration.
A wide range of skills are needed to manage the acquisition process. First, there are the strategic, organisational and financial analytical skills for pinpointing your current strategic position and needs. There are also the investigative skills on top of these for identifying and evaluating targets.
In addition there are the imaginative, creative and visionary skills sometimes needed to come up with an unusual but cunning idea and the insight that a particular company may really fit in well (or not) to your business portfolio.
This may need the support of culture diagnosis skills as well as astute judgment of leadership capability.
Negotiation requires another skill set and also more technical skills associated with due diligence such as legal, tax and financial.
Integration entails change management and communications skills as well as excellent project management, speed and tenacity. To combine this with the learning process demands considerable objectivity.
Last but not least is the need for outstanding leadership capability.
It's a tall order that cries out for adequate training, the right team, sufficient resources, a detailed and thorough plan, and the right people - who need to have almost psychic sensors for where the risks and uncertainties lie.
BMW and Rover
In 1994 BMW decided to buy Rover to expand its model range (smaller cars and four-wheel drives in particular) and to build its mass for competing globally.
Unfortunately, its strategy (V1) was flawed. With the exception of its four-wheel drive, Rover had an ailing product range in very competitive markets. Much more investment was needed to turn it around than the £3bn actually spent.
BMW never really understood what it was getting. It overlooked Rover's reliance on Unipart for parts and did not appreciate the enormous engineering input required to replace Rover's Honda technology. Even Rover's four-wheel-drive model wasn't in as good a strategic shape as BMW assumed, while the Mini needed redesigning from scratch. And finally, BMW's hands-off approach following the first two years of acquisition was a poor integration strategy.
Huge currency losses helped take Rover's total losses in 1999 to £0.9bn, threatening BMW's independence. In 2000 BMW sold the four-wheel-drive business to Ford for £1.7bn and got rid of the rest to a consortium led by John Towers, Rover ex-CEO, recouping the £0.7bn original purchase price it had paid for Rover. By then BMW had invested £3bn - and had to develop its own four-wheel drive. £3bn is a lot to pay for the Mini.
Did BMW follow the acquisition process well? No. Did it have the requisite skills? Probably another no. Did Towers? No - Rover burnt up its £1bn dowry and finally went bust in 2005.
Dr Tony Grundy is an independent consultant and trainer, and lectures at Henley Business School