Growth through Mergers and Acquisitions

Companies seek growth through mergers and acquisitions to satisfy one or more of the following – adding a related product or service; expanding geographic reach; purchasing assets, i.e. real estate, patent, brand; and/or, acquiring clients.  There is also the promise of cost reductions through consolidation of back-office and front-office services.  The justification for two companies coming together to either expand or further strengthen a competitive position is logical and easy to support from a financial perspective.  More than likely if an increase in shareholder value can be demonstrated, based on a proforma, the entities will proceed.

Very soon after a decision to merge or acquire is made, a press release is issued which identifies the combination benefits.  “We look forward to working with Cerberus to maintain and grow GMAC’s traditional strong performance and contribution to the GM family,” said GM Chairman and Chief Executive Officer Rick Wagoner.  “This agreement is another important milestone in the turnaround of General Motors. It creates a stronger GMAC while preserving the mutually beneficial relationship between GM and GMAC. At the same time, it provides significant liquidity to support our North American turnaround plan, finance future GM growth initiatives, strengthen our balance sheet and fund other corporate priorities.” (Ally Financial Inc.  Press Release: 2006)

But regardless of how good the merger or acquisition looks on paper, there is a large body of research that shows that mergers and acquisitions add no value, for a majority of the transactions.  In my career I have been exposed to seven entity combinations.  In two instances, the entity I was associated with was acquired; in three situations we were the acquirer; in one situation my entity assumed a majority interest in another entity; and finally one situation where a majority interest was taken in the entity where I was associated (quote above).

The successful execution of this type of growth initiative rests on the details of how the process is managed.  If you choose to acquire or agree to be acquired, consider the following three topics –

Business Integration

Systems – Integration of systems must be addressed upfront to ensure clients of each heritage entity can communicate with the new entity, in a seamless fashion, securely.  This initiative is extremely important during this period where cybercrime and hacking are ubiquitous.  Allowing systems from legacy companies to communicate via workarounds is not a secure approach.

Policy & Procedures – While these guidelines may have common features from company to company, they are custom to each organization.  More than likely your P&P does not match the P&P of the entity that you are acquiring.  You will find that one set is more restrictive than the other.  The question you will have to deal with – “Which policies should be the policies of the new organization?”

Costs – A primary reason to merge or acquire is the perception that cost efficiency can be obtained either from economies of scale, usage of excess capacity, co-location, supplier discounts…

The integration topic has a direct link to time, i.e. how fast you can integrate to secure systems, ensure consistent policies and procedures and cut costs.  Moving too quickly can cause needless disruption to the business; while moving too slowly just delays the benefit of the acquisition.

Employees

Attrition – The combination of two entities immediately creates redundancy.  Employee loss will be high. Some of this loss will be welcomed, but other will not.  You may find that you prefer Manager #1 over Manager #2, but Manager #1 resigns.  Regardless of the amount of analysis and preparation, management has the least control over the individual preferences and decisions of employees.  This point is apparent when you consider the following citation – “Yahoo has naturally lost some of its acquired talent. At least 16, or roughly one-fifth, of the more than 70 startup founders and startup CEOs who joined Yahoo through an acquisition during Ms. Mayer’s tenure have left the company.”  “Yahoo’s Other Challenge: Retaining Acquired Talent.”  Wall Street Journal Online.  Wall Street Journal, 1 May 2015.

Reporting – In my first merger experience, my company was acquired by a company of equal size but stronger economically. A colleague at the time explained to me that when two companies come together, the acquiring company assumes the management responsibility of all roles.  In essence, I would fall under that manager and be performing the role of the person that reported to me.  Every individual in the company that was acquired must be ready to do the job of their direct report.  This explanation was true for all combinations.  At times I had the higher role, as I was with the acquiring entity; while in other situations the reverse was true.

Clients

Attrition – Client loss will be high, more commonly from those clients that were associated with the brand that no longer exists.  This set of clients, do not feel they have any relationship with the new entity.  Consider short-term pricing discounts to persuade clients to consider keeping their business with the new entity.

Sales Management – If you sell a product or service in a geography and you acquire an entity in the same market, you will need to wrestle with the question of who owns the customer, i.e. territory management.  This situation occurs commonly when clients represent national accounts.

Sales Compensation – Similar to Policies and Procedures – While these compensation structures may have common features from company to company, they are custom to each organization.  More than likely your compensation plan does not match the compensation plan of the entity that you are acquiring.  You will find that one set is richer than the other.  The question you will have to deal with – “Which compensation structure should be the structure of the new organization?”

In summary, when an entity wishes to add a product or service or expand geographic reach or purchase assets or purchase clients, the acquisitions approach is considered preferable by many, as it is faster.   Just remember that the economics of the new entity will not be the economics of the addition of each heritage company.  A merger or acquisition takes careful planning to be effective.  There will be upfront costs required for integration and client incentives.  It will require flawless execution to come anywhere close to the proforma goals established at the outset.  There are too many unknowns, internally and externally, to be positive of the outcome.

Author: Regis Quirin
Visit Regis's Website - Email Regis
Regis Quirin is a financial executive with 23 years of corporate experience, i.e. New York Stock Exchange, JP Morgan Chase, and GMAC ResCap; and 15 years working with small and medium-sized entities, i.e. joint ventures, start-up entities, established businesses. In 2014, Regis published "Redesign to Turnaround Underperforming Small and Medium-Sized Businesses" available via Amazon.

Pricing Strategy – Tips and Caveats for Discount Pricing

Discounts have their place, but more often than not, they are used incorrectly. Prior to offering a discount, controllers involved with establishing pricing strategy need to take the following steps:

Understand your business economics. If you have a 15 percent profit margin and for a period of time you are willing to give up a third of the margin to offer a discount, that may be a correct business decision. However, if you have a 15 percent margin, and for a period of time you give up an amount equal to 150 percent of the margin to offer a discount, that approach will hurt your business.

Establish the discount duration. Discounts should have a finite life. If they continue into perpetuity, you are just resetting price with the word “discount.” A discount is simply a marketing tool—a program that is planned, fielded, and completed. At a certain point, once the program ends, it is important to calculate the return on marketing investment received to understand whether the expense was worthwhile.

Understand the client’s needs. Some clients are driven by the word “discount.” In this situation, you should find the price that allows you to achieve your required returns, and increase the price of the product/service by the discount you will be giving. Billing and applying the discount will result in the attainment of your profit requirements. This approach is quite common in all businesses.

Different Types of Discounts

There are three types of discounts that work, as they benefit each party in the transaction. These are:

Discount to try your product or service. For a service, this includes discount pricing while the service provider gains the required knowledge to provide the client with the maximum service possible. During the early days of a relationship, a client should not be asked to pay full price, while you learn their business. For products, a discount provides an incentive for consumers to try your product vs. staying with their usual selection.

Discounts provided to clients based on their purchase volume, i.e., relationship pricing. The philosophy behind this type of discount is as follows: “If I can count on you to purchase 10 units of my product or service, I will charge you full price. But as you purchase more, I can take advantage of economies of scales, which I can pass down to you.”

Discounts provided for early payments. To incentivize early payment, it is common to offer a benefit (discount) to consumers.  Receipt of your money sooner rather than later is worth the customary 2 to 3% in discount.  But if your profit margins are already razor thin simply raise the price by the discount amount.  Billing and applying the discount will result in the attainment of your profit requirements.

Whichever type of discount is used, the greatest responsibility of the manufacturer/service provider is to communicate the discount terms and when they will expire. In fact, over-communicate these items. If you implement a discount to benefit the client but the discount goes away prior to when the customer was expecting it to go away, the relationship will be disrupted.  The discount expense will be a waste.

Avoid Three Common Discounting Errors

Controllers also need to be aware of the following three common errors when offering discount pricing:

Offering a discount to customers to entice them to pay their late bills. The message you relay here is, “Do not pay on time and I will reduce your price.”

Offering a discount to match the competitor’s price. This approach assumes your economics are the same as those of your competitor. That assumption is often very wrong. For example the competitor may be giving up a piece of their margin, while you may be giving up your entire margin.

Offering a discount on one product or set and losing money, expecting to make it up in other products/services. In some situations, one product is heavily discounted while other products are premium priced. The goal is to lose money on a few items in order to entice the client to also buy others, while making a higher margin on those other products/services. However, this approach will always backfire when you work with clients who understand the market price. They will understand where to focus their purchasing, i.e. only on the lower priced products.

The Bottom Line

A business will not thrive when it competes on price. Ensure that your value proposition is strong. Customers should seek out your company because the value you provide exceeds the cost of doing business with you.

When considering discounts as part of pricing strategy, controllers would be wise to take the following steps:

– Always calculate the projected cost of the discount to the company, prior to implementing.

– Consider a key performance indicator that measures discount usage and report on it.

– Ensure that discounted sales are booked separately from non-discounted sales, so discount usage is clearly quantifiable.

I wrote this post for the Institute of Finance Management “Controller’s Report Member Briefing.”  It was published in the May 2015 edition.

Author: Regis Quirin
Visit Regis's Website - Email Regis
Regis Quirin is a financial executive with 23 years of corporate experience, i.e. New York Stock Exchange, JP Morgan Chase, and GMAC ResCap; and 15 years working with small and medium-sized entities, i.e. joint ventures, start-up entities, established businesses. In 2014, Regis published "Redesign to Turnaround Underperforming Small and Medium-Sized Businesses" available via Amazon.