Disney and Pixar
Four Tests for Successful Acquisitions
lot of academic research shows that the odds of making an acquisition work are not high. Should companies just forget about M&A, and focus exclusively on innovation and organic growth?
Maybe not, at least in some cases.
Careful thinking about what it means for an acquisition to succeed, coupled with an analysis of why deals fail, can lead to some practical advice for managers, thus helping them to develop a more refined view. More specifically, in order for acquisitions to pay off, they ought to pass four tests. I describe the tests below, showing how each offers a way to head off common sources of merger malfunction.
The Industry Attractiveness Test
If the industry in which the acquired company participates has the potential to remain profitable, then the target passes the industry attractiveness test. One reason that mergers fail is that the inherent profit potential of the target company’s industry is low. That is, the average player in the industry does not earn very high returns and the factors that drive those investment returns are likely to keep them low in the future. Such was certainly the case, for example, with JDS Uniphase, which paid way too much for SDL because a huge drop in demand in the wake of the dot-com crash, was turning its optical components industry into a huge money loser.
The “Better Off” Test
If the acquirer and the target boost their market share and growth potential in the industry as a result of their combined capabilities, then the deal passes the better off test. A second reason for merger failures is that when the acquirer and the target combine, they end up being weaker as a combined company than they would have been separately. As a result, the combined companies end up as hobbled competitors in that new market. Consider here a merger between two tech firms in Silicon Valley, both of whom had IBM as a leading customer. When the merger was announced, they both lost IBM’s
lot of academic research shows that the odds of making an acquisition work are not high. Should companies just forget about M&A, and focus exclusively on innovation and organic growth?
Maybe not, at least in some cases.
Careful thinking about what it means for an acquisition to succeed, coupled with an analysis of why deals fail, can lead to some practical advice for managers, thus helping them to develop a more refined view. More specifically, in order for acquisitions to pay off, they ought to pass four tests. I describe the tests below, showing how each offers a way to head off common sources of merger malfunction.
The Industry Attractiveness Test
If the industry in which the acquired company participates has the potential to remain profitable, then the target passes the industry attractiveness test. One reason that mergers fail is that the inherent profit potential of the target company’s industry is low. That is, the average player in the industry does not earn very high returns and the factors that drive those investment returns are likely to keep them low in the future. Such was certainly the case, for example, with JDS Uniphase, which paid way too much for SDL because a huge drop in demand in the wake of the dot-com crash, was turning its optical components industry into a huge money loser.
The “Better Off” Test
If the acquirer and the target boost their market share and growth potential in the industry as a result of their combined capabilities, then the deal passes the better off test. A second reason for merger failures is that when the acquirer and the target combine, they end up being weaker as a combined company than they would have been separately. As a result, the combined companies end up as hobbled competitors in that new market. Consider here a merger between two tech firms in Silicon Valley, both of whom had IBM as a leading customer. When the merger was announced, they both lost IBM’s