7 Reasons Organizations Merge with or Acquire Other Firms

Companies merge with or acquire other firms for one overarching reason: growth. This growth manifests in different ways, such as market share, geographic expansion, knowledge transfer, and product diversification.

When we say that a transaction is accretive or adds value, it means that the company has grown due to the deal. The opposite can be said of transactions that are dilutive or value-destructive.

At DealRoom, we work with hundreds of companies and intermediaries on an ongoing basis as they attempt to maximize value from mergers and acquisitions. Most, if not all, of these companies have already established the “why” for their transaction before they turn to our platform for their due diligence requirements. In this post, we’ll go through some of the most frequent “whys” we see among our clients as they pursue an M&A deal.

Reasons for mergers and acquisitions

The most common reasons for mergers & acquisitions that we see at DealRoom are:

To grow the business
To generate revenue synergies
To achieve economies of scale
To diversify
To vertically integrate the business
To receive tax benefits
To transfer knowledge

Let’s discuss each one in more detail.

1. To grow the business

This is the most commonly cited motive for undertaking a deal, and it’s hardly surprising. If you’re not at least passively looking at M&A as a strategic option for your company, you’d better be confident in your company’s prospects for significant organic growth.

A 2020 survey of 300 companies involved in M&A found that 34% of respondents cited growth as their top priority. The rest of the respondents (66%) said that although growth hadn’t been their priority, it should have been.

Although growth is a catch-all answer, it’s first on this list because it’s the most important. Companies exist for value creation and the best way to achieve this is through growth. Virtually all of the world’s largest value creators have undertaken M&A at some stage to drive growth, even when they could achieve double-digit organic growth at the same time.

2. To generate revenue synergies

“Synergy” is another way to describe the “1+1>2” effect. A well-thought-out M&A transaction can lead to multiple types of synergies, including revenue synergies (say, through cross-selling products: Starbucks’ purchase of Teavana being a case in point), cost synergies (cost savings 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 independently).

3. To achieve economies of scale

Economies of scale are closely related to synergies as a motive for M&A. Generally, the higher the production volume, the lower the unit cost. This explains why auto companies, for example, have merged in such numbers over the past half-century. Using the same rationale, scale also allows companies to take advantage of bulk purchases with their partners and suppliers, again leading to lower costs.

4. To diversify

M&A is a proven way for companies to successfully diversify their product line, geographic footprint, or target market. Mars, for example, started as a humble chocolate bar. But a series of acquisitions, a lot of product innovation, and a merger with chewing gum manufacturer Wrigley turned it into a global conglomerate. In fact, every conglomerate today got to where it is through the M&A process.

Not all companies are looking to become conglomerates, however. Geographic diversification is a common motive for deals, particularly international ones. In theory, and very often in practice, it’s easier to gain a foothold in a different geography to your own by acquiring (or merging) with another company rather than starting from scratch. In 2019 alone, cross-border deals reached nearly $500 billion.

5. To vertically integrate the business

If diversification is horizontal integration, then acquiring other companies along your own supply chain is vertical integration.

Examples include Coca-Cola buying bottling and distribution companies, Kellogg’s buying wheat producers, Apple buying a screen manufacturer, and ExxonMobil buying oil distributors.

Essentially, any time a company can generate further value by bringing a target company under their supply chain umbrella, acquisitions or vertical mergers become attractive strategies.

6. To receive tax benefits

Companies are less likely to talk about tax purposes as the impetus for a deal for at least two reasons:

It’s more glamorous to say that you’re buying for growth.
Nobody wants to attract the ire of the IRS.

Purchasing a loss-making company in a given year can also allow the acquiring company to enjoy some of the benefits discussed above, like greater cash flows, new customer bases, and increased profitability, while simultaneously reducing their own tax liability. Trust us—they’re far more likely to mention the former motive than the latter.

7. To transfer knowledge

The acquisition of knowledge—often in the form of intellectual property—is a common motive for M&A, particularly among technology companies looking for a competitive advantage.

If, say, Google wanted to acquire expertise in artificial intelligence, it would be easier for them to acquire a pre-existing artificial intelligence company (and its patents) than to start 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.

Why do companies merge instead of acquire?

A merger is distinct from an acquisition in that the target firm does not get subsumed by the acquirer. The two end up on more-or-less equal footing in the deal. In contrast, an acquisition brings the target company completely under the acquirer’s umbrella.

Brand recognition and valuation play a large role in driving the merger vs. acquisition decision. If the target firm is already well-known by the new markets and customers the acquirer is going for, getting rid of that completely would harm rather than help the new company. With a strong brand comes market power, and the M&A transaction could potentially come with market expansion as well.

Company size is also important. Mergers are more common between large enterprise organizations of around the same size, while an acquiring company is often (but not always) larger than its target. Plus, a merger of two major players in a particular industry can cut down or even eliminate competition.

Why do companies acquire rather than merge?

In addition to the reasons discussed above, an acquisition can drive significant synergies for the acquiring company—ones that they hope to take full advantage of. By completely absorbing the target company, the acquirer can achieve greater market penetration, gain new talent to drive innovation, and deliver greater value—all under their own brand.

Remember your “why”

At DealRoom, our clients have all manner of motives behind their M&A activity. Put another way, they nearly all possess a good “why” for their strategy.

If you’re considering a transaction, whether it be a merger or an acquisition, make sure you’ve taken the time to clearly define exactly what you want to get out of it. And as soon as that has been established, talk to us about how we can simplify the process for you.