Why do Companies Merge with or Acquire Other Companies?
Kison Patel
CEO and Founder of DealRoom
Kison Patel
Kison Patel is the Founder and CEO of DealRoom, a Chicago-based diligence management software that uses Agile principles to innovate and modernize the finance industry. As a former M&A advisor with over a decade of experience, Kison developed DealRoom after seeing first hand a number of deep-seated, industry-wide structural issues and inefficiencies.
CEO and Founder of DealRoom
Companies merge with or acquire other companies for growth. This growth manifests itself in different ways, such as market share, geographic expansion, knowledge transfer and product diversification. Growth is what underpins all of these motives.
However, when we say that a transaction is accretive or adds value, it means that the company has grown as a result of the deal. The opposite can be said of transactions which are dilutive or destroy value.
Most, if not all, of these companies have already established the âwhyâ for their transaction before they turn to our platform for their due diligence requirements.
The following are just some of the reasons why they, and others, decide to merge with or acquire other companies with examples.
Reasons for Mergers and Acquisitions
To grow the business
To achieve revenue synergies
To achieve economies of scale
To diversify
To vertically integrate the business
To avail of tax benefits
For knowledge transfer
1. To Grow Your Business
This is the most commonly cited motive for undertaking a deal, and itâs hardly surprising: If youâre not at least passively looking at M&A as a strategic option for your company, youâd better be confident in your companyâs prospects for significant organic growth.
A 2020 survey of 300 companies involved in M&A in 2019 said that 34% of respondents said, before the deal, growth was their priority. Everyone else, that is 66% of respondents, said that although growth hadnât been their priority, it should have been.
Although growth is a catch-all answer, itâs first on this list because, as the survey respondentsâ answers show, itâs the most important. Companies exist for value creation and that the best way to achieve this is through growth.
Virtually all of the worldâs largest value creators have undertaken M&A at some stage to achieve growth, even when they could achieve double digit organic growth at the same time.
2. To Achieve Revenue Synergies
The â1+1>2â effect.
In a well thought-through deal, synergies can be found in several places.
These include revenue synergies (say, through cross-selling products: Starbucksâ purchase of Teavana being a case in point), cost synergies (cost savings that come from scale, such as supply chain efficiencies, etc), and even operational synergies (whereby the performance of the merged company is stronger than the combined performance of the two companies unmerged).
Closely related to synergies as a motive for M&A are economies of scale.
As a general rule, the higher the production volume, the lower the unit cost. This explains why auto companies, to take one example, have merged in such numbers over the past half century.
Using the same rationale, scale also also allows companies to take advantage of bulk purchases with their partners and suppliers, again helping to bring down their unit costs.
4. To Diversify
Be it geographic or otherwise, M&A is a proven way for companies to successfully diversify.
Mars started as a humble bar of chocolate but a series of acquisitions (and, it must be said, a lot of product innovation) including several in pet food, and a merger with Wrigley (a manufacturer of chewing gum) made it a global conglomerate.
In fact, there isnât a conglomerate that exists that didnât do so without partaking in mergers and acquisitions to at least some degree.
Not all companies are looking to become conglomerates. Geographic diversification is a common motive for deals, particularly those cross-border deals. In theory, and very often in practice, itâs easier to gain a foothold in a different geography to your own by acquiring (or merging) with another company rather than starting from scratch.
This is true in any industry and explains why cross-border deals alone reached nearly $500 billion in 2019.
That means Coca-Cola buying bottling and distribution companies, Kelloggâs buying wheat producers, Apple buying a screen manufacturer, and Exxon Mobil buying oil distributors. Essentially, anywhere that a company can generate further value by bringing someone on their supply chain under their umbrella, an acquisition will be considered.
6. To Avail of Tax Benefits
Companies are less likely to talk about tax purposes as a âwhyâ for a deal for at least two reasons:
first, itâs more glamorous to say that youâre buying for growth.
second, nobody wants to attract the ire of the IRS.
Acquiring a loss-making company in a given year can also allow a buyer to enjoy some of the above benefits, while simultaneously reducing their own tax liability. Trust us, theyâre far more likely to mention the former motive ahead of the latter.
The acquisition of knowledge - often in the form of intellectual property - is a common motive for M&A, particularly among technology companies.
If, say, Google, wanted to acquire expertise in artificial intelligence, it should be easier for them to do so by acquiring a pre-existing artificial intelligence company (and their patents) than starting from scratch.
For good examples of this, look no further than the acquisitions that big tech companies have made in self-driving car technology over the past decade.
Conclusion
At DealRoom, our clients have all manner of motives for their mergers and acquisitions. Put another way, they nearly all possess a good âwhyâ for their transactions.
Whenever youâre considering a transaction, whether it be a merger or an acquisition, make sure thereâs a good âwhyâ for the transaction.
As soon as it has been established, talk to us about how we can simplify the process for you.
Companies merge with or acquire other companies for growth. This growth manifests itself in different ways, such as market share, geographic expansion, knowledge transfer and product diversification. Growth is what underpins all of these motives.
However, when we say that a transaction is accretive or adds value, it means that the company has grown as a result of the deal. The opposite can be said of transactions which are dilutive or destroy value.
Most, if not all, of these companies have already established the âwhyâ for their transaction before they turn to our platform for their due diligence requirements.
The following are just some of the reasons why they, and others, decide to merge with or acquire other companies with examples.
Reasons for Mergers and Acquisitions
To grow the business
To achieve revenue synergies
To achieve economies of scale
To diversify
To vertically integrate the business
To avail of tax benefits
For knowledge transfer
1. To Grow Your Business
This is the most commonly cited motive for undertaking a deal, and itâs hardly surprising: If youâre not at least passively looking at M&A as a strategic option for your company, youâd better be confident in your companyâs prospects for significant organic growth.
A 2020 survey of 300 companies involved in M&A in 2019 said that 34% of respondents said, before the deal, growth was their priority. Everyone else, that is 66% of respondents, said that although growth hadnât been their priority, it should have been.
Although growth is a catch-all answer, itâs first on this list because, as the survey respondentsâ answers show, itâs the most important. Companies exist for value creation and that the best way to achieve this is through growth.
Virtually all of the worldâs largest value creators have undertaken M&A at some stage to achieve growth, even when they could achieve double digit organic growth at the same time.
2. To Achieve Revenue Synergies
The â1+1>2â effect.
In a well thought-through deal, synergies can be found in several places.
These include revenue synergies (say, through cross-selling products: Starbucksâ purchase of Teavana being a case in point), cost synergies (cost savings that come from scale, such as supply chain efficiencies, etc), and even operational synergies (whereby the performance of the merged company is stronger than the combined performance of the two companies unmerged).
Closely related to synergies as a motive for M&A are economies of scale.
As a general rule, the higher the production volume, the lower the unit cost. This explains why auto companies, to take one example, have merged in such numbers over the past half century.
Using the same rationale, scale also also allows companies to take advantage of bulk purchases with their partners and suppliers, again helping to bring down their unit costs.
4. To Diversify
Be it geographic or otherwise, M&A is a proven way for companies to successfully diversify.
Mars started as a humble bar of chocolate but a series of acquisitions (and, it must be said, a lot of product innovation) including several in pet food, and a merger with Wrigley (a manufacturer of chewing gum) made it a global conglomerate.
In fact, there isnât a conglomerate that exists that didnât do so without partaking in mergers and acquisitions to at least some degree.
Not all companies are looking to become conglomerates. Geographic diversification is a common motive for deals, particularly those cross-border deals. In theory, and very often in practice, itâs easier to gain a foothold in a different geography to your own by acquiring (or merging) with another company rather than starting from scratch.
This is true in any industry and explains why cross-border deals alone reached nearly $500 billion in 2019.
That means Coca-Cola buying bottling and distribution companies, Kelloggâs buying wheat producers, Apple buying a screen manufacturer, and Exxon Mobil buying oil distributors. Essentially, anywhere that a company can generate further value by bringing someone on their supply chain under their umbrella, an acquisition will be considered.
6. To Avail of Tax Benefits
Companies are less likely to talk about tax purposes as a âwhyâ for a deal for at least two reasons:
first, itâs more glamorous to say that youâre buying for growth.
second, nobody wants to attract the ire of the IRS.
Acquiring a loss-making company in a given year can also allow a buyer to enjoy some of the above benefits, while simultaneously reducing their own tax liability. Trust us, theyâre far more likely to mention the former motive ahead of the latter.
The acquisition of knowledge - often in the form of intellectual property - is a common motive for M&A, particularly among technology companies.
If, say, Google, wanted to acquire expertise in artificial intelligence, it should be easier for them to do so by acquiring a pre-existing artificial intelligence company (and their patents) than starting from scratch.
For good examples of this, look no further than the acquisitions that big tech companies have made in self-driving car technology over the past decade.
Conclusion
At DealRoom, our clients have all manner of motives for their mergers and acquisitions. Put another way, they nearly all possess a good âwhyâ for their transactions.
Whenever youâre considering a transaction, whether it be a merger or an acquisition, make sure thereâs a good âwhyâ for the transaction.
As soon as it has been established, talk to us about how we can simplify the process for you.
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