When markets are ripe for consolidation, and acquisition expedites organic growth. When a company spots a disruptor in the market, an acquisition facilitates disruptive development. Either way, acquisitions tempt because market growth can take years to establish and mature.
Companies rely on acquisitions to speed time-to-market and capture new clients, resources, and product lines. They also facilitate vertical and geographic market expansion, which results in increased revenue, accelerated market entry, and recent customer acquisition.
Related: Difference Between Horizontal and Vertical Acquisition.
There are three types of acquisition: upstream, downstream, and lateral.
In an upstream acquisition, a smaller company ensures market consolidation by merging with a larger company from the same industry. This type of merger aims to provide investment, secure the employees, and consolidate market share. In downstream acquisition, one firm (usually bigger) acquires another firm (smaller) to expand its business. Management and control pass to the acquiring company through purchasing the entire company or buying a majority share. The bigger company decides the market, brand name, employees, and the existence of the acquired company. In lateral acquisition, the common aim of both companies is to pool their resources for mutual profit.
The acquisition has always been an excellent tool for companies to strengthen their existing position and enter a new market/industry. General Electric and CISCO Systems are Illustrating this: “Over the past ten years, Cisco Systems has acquired 81 companies. Their stock price is up a remarkable 1300%. GE outperformed the S&P 500 index over the same period by 300%.” With each acquisition, these companies have snowballed shareholder’s value to new highs.
GE’s Growth Strategy
In 2020, General Electric ranked as the 33rd largest firm by gross revenue among Fortune 500 companies. Forbes reports that, under the leadership of former CEO Jack Welsh (1981-2001), the company grew its market value from $14 billion to $410 billion.
GE usually bought companies with either the largest or second-largest market share. They operate through multiple market segments: aviation, healthcare, power, digital industry, renewable energy, manufacturing, venture capital, and finance.
Acquisition as a Growth Tactic
The acquisition is one of the best strategies for diversifying new markets and more robust positioning in a highly competitive scenario. Companies secure greater market share (in the same industry), new resources, and more revenue. Propelled by a stronger market position, the acquiring company consolidates its hold and asserts its dominance in the market.
Other growth methods work but offer their challenges.
Establishing a new company and relying on its organic growth is not a sure-shot bet. Many companies see entry into a new market as a critical strategy for growth; however, entry into a new industry is challenging. You need to have a defined growth objective and revenue and timeline targets since entry and establishment into a new market take time and have risk. Sales cycles lengthen without the experience to develop new products or the market credibility to acquire new customers. It may take longer than expected to reach the revenue target. So, there is a big question on the future sustainability of the business.
New businesses can take years to mature and grow. Every company goes through a 4-stage lifecycle: start-up, growth, maturity, and renewal/decline. Each stage imposes unique challenges the business must overcome to be successful. Taking your business to the next level requires time, industry knowledge, efficient processes, and a system that promotes growth. While many companies want to expand to new territories, they do not want the additional hassle of starting from scratch.
Acquisitions can boost sales quickly. The revenue base for many companies comes from a single segment of customers. This significantly increases enterprise risk, as the business may go bankrupt if it loses the customer base. Acquisitions facilitate diversification of products and service offerings, which helps to acquire new customers and increase revenue.
The market has already identified the emerging company as successful. Many companies do not have the right internal resources to expand their customer base or gain a stronger foothold in the market. To capture new market share in local areas, they may opt to acquire smaller business rivals that lack the capital to grow but have strong client bases and market reputations compared to more prominent companies. This pattern of growth through acquisition is called the “spoke pattern of growth.” Similarly, suppose a company from one country wants to expand its business operations in another country. In that case, it can buy stakes of a bigger company there and operate in the new country through that brand name. This pattern for growth is called the “hub pattern of growth.”
In both spoke and hub patterns, the emerging company avoids the interim struggle of establishing itself in the new market. Instead, it rides on the success of the acquired company.
Let’s take a look at a few cases in which acquisitions boosted return on investment.
Bank of America: Consolidation of Overshot Market
Business consolidation integrates several business units or different companies under the umbrella of one large corporation. The reasons for doing this vary from enhancing operational efficiency to eliminating competition to gaining entry into new markets. The concentration of the market also results in a bigger customer base for the acquiring company.
When Bank of America merged with the Nations Bank in 1998, its assets were worth $570 billion with a network of 4,800 branches across the country. From 2004 to 2007, Bank of America acquired FleetBoston Financial for $47 billion, credit card giant MBNA for $35 billion, and US Trust and LaSalle Bank for $3.3 billion and $21 billion each. The groundbreaking deal with FleetBoston strengthened and consolidated Bank of America’s position as the nation’s second-largest bank after Citigroup.
IBM & Lotus: Plan Ahead and Buy Time
Planning is beneficial, as companies need to start creating new businesses before they need them. Once a company establishes its needs to grow, they want results–fast. The downside of their impatience sometimes results in building new businesses larger than their capability to manage, which reduces their chances of success.
In early 1995, IBM acquired Lotus Development Corporation for $3.4 billion; the primary aim of this acquisition was to acquire Lotus Notes and initiate their presence in the growing client-server segment where IBM’s OfficeVision found the competition too tough to beat. IBM recognized its need to transition to a service-oriented business to grow revenues. The deal served Lotus well: it jumpstarted the sales of Notes without compromising the company’s mission and culture. But more than anything else, the merger saved Lotus in a marketplace predominantly influenced by Microsoft Corporation.
Best Buy: Spot Potential Value the Market Doesn’t See
To grow by acquisition, the question remains how to spot a potential acquisition target that increases the chances of creating a value-enhancing business. For this, one needs a clear sense of strategic rationale to understand what type of business you are looking for before you start looking to buy.
Established in 1966 and earlier known as The Sound of Music, Best Buy officially appeared in 1983 after the board renamed the company. A leading consumer electronics retailer, it had around 1,000 stores by 2008. Their success was attributed mainly to being a one-stop shop for entertainment, equipment, and technology.
In 2002, Best Buy acquired Geek Squad, a small, 50-person company providing IT services, 2002 for $3 million. The company now employees 10,000-plus people with $1 billion in revenues and $280 million in operational profits. In 2005, Best Buy acquired AV AudioVisions for $7 million and Howell & Associates for $1 million. With these small acquisitions, Best Buy created several disruptive offerings to sell world-class products and services.
Understanding customer behavior and needs were crucial for Best Buy’s successfully strategic decision to expand into new markets and add new products and services.
Cisco: Acquire Technology that Fuels a Disruptive Movement
Many companies strive to acquire enabling technologies to revamp their operations, services, or products, disrupt the market, and dominate it.
Cisco acquired Scientific Atlanta for $6.9 billion to add a fourth critical component–video–to their product line. Cisco already had products that delivered data, voice, and mobility. They integrated Scientific Atlanta’s set-top boxes with its router products to make a “unique, converged offering” with reduced complexity. Cisco’s backing also better positioned Scientific Atlanta to seek new opportunities in the ever-changing marketplace.
Under the right circumstances–when market conditions are favorable for consolidation when a company spots a market disruptor or needs time to enhance its organic growth efforts–acquisitions are a valuable tool for growth.