Mergers and acquisitions: strategic frameworks and analysis

Revenue enhancement can be a compelling motivator for merger and acquisition activity. Revenue enhancement implies either the development of revenue streams that did not previously exist or the strengthening of existing revenue streams as a result of M&a activity. Firms may acquire companies in complementary geographical or product markets, for example. An example of this would be found in the Renault-Nissan tie-up, where the two countries had strength in different geographic markets, allowing the combined entity the ability to have a broader revenue base without cannibalizing existing business. Another way that revenue enhancement could be used to spur M&a activity is in a situation where one firm has a competency in a key business task, and that competency is applied to the other firm's business. In the banking industry, for example, it has been identified that acquiring banks can improve the performance of their loan portfolio by purchasing smaller banks that outperform in loan portfolio measures (Tehranian, 2006).

Cost reduction is another common impetus for merger and acquisition activity. This can also be worked in a number of different ways. For example, firms in declining industries facing overcapacity often enter into mergers so that capacity reduction can be used to increase economies of scale, lowering production costs. The recent wave of consolidation in the global brewing industry is an example of merger for cost reduction purposes. Mergers are often used as an excuse to "trim the fat" - to engage in a cost-reduction strategy by reshaping the mission of the organization and cutting non-essential businesses and programs.

Risk management is an often underrated aspect of merger and acquisition activity. Firms can reduce their risk through M&a activity in a number of different ways. Diversification of businesses can offset the exposure of a company to factors in its existing environment. Risk management can not only be the impetus for M&a activity, it can also be one of the key success factors. When two firms come together, there is significant risk involved -- cultural clash, lack of synergy and different accounting policies can all complicate a transaction and result in the companies failing to realize the desired outcomes. Risk management can help to set control processes and strategic objectives during the M&a process and can play a valuable role in identifying potential pitfalls as well (Dounis, 2008).

Tax shields can impact on merger and acquisition decision as well. Some forms of corporate restructuring are treated as tax-free reorganizations. In some cases, these reorgs can earn the company considerable synergies in other areas at no cost. The tax implications of a proposed corporate restructuring, therefore, will often shape the precise nature of that reorganization. There are times when the tax situation for two firms is such that it is favorable to merge because it creates enhanced tax shields over and above what the two firms would enjoy individually (Gaughan, 2007).

Synergies are often cited as a main driver of M&a activity. A synergy occurs when the combined entity can do something more competitively than either of the constituent companies (Croson, Gomes, McGinn & Noth, 2004). Whether synergies are realized, they are often an important part of the decision-making criteria for a transaction. When FedEx bought Kinko's, for example, it hoped that there would be marketing synergies wherein the two companies could drive business to one another. As it turned out, those synergies largely failed to materialize and, along with corporate culture clash, this resulted in the failure of that acquisition. Renault-Nissan, however, succeeded because each car company was able to gain access to strong established distribution networks around the world in each other's key markets. This allowed each company to increase sales and to build economies of scale in production as well.

The weighted average cost of capital reflects a firm's total cost of doing business and is related to the firm's risk level. M&a activity can be conducted in order to lower a firm's cost of capital. This can be done either by lowering the firm's total risk through diversification, by absorbing a company in a lower-risk business than the new parent company, or by using the M&a activity as an opportunity for arbitrage, taking advantage of disequilibrium between currencies and interest rates in two different nations.

Corporate organization and ownership issues can stimulate merger & acquisition activity as well. In some cases, the activity is a reorganization within the company, conducted for strategic reasons and often tied to tax consequences. In other cases, firms may combine assets in a manner that allows for one or both of the firms to improve its strategic position in specific products or markets. Organization and ownership can have a negative impact on the success of a merger or acquisition, however. Issues regarding control, culture or mission conflict can arise post-merger that can reduce the ability of the firm to gain synergies or otherwise meet the objectives of the merger activity.

Litigation risk can have an impact on M&a activity as well. Firms can initiate a merger in part to offset litigation risk that they face -- Anheuser Busch for decades sought to settle its long-running trademark dispute with the Czech government by purchasing the Budweiser Budvar brewery with whom it was battling from the government. Mergers and acquisitions also create new opportunities for litigation, ranging from antitrust suits to disputes surrounding cost-cutting measures post-merger. These litigation costs could ultimately result in a dramatic increase in the cost of the merger. Firms engaging in M&a activity need to consider the potential litigation risks created by the merger prior to engaging in such activity.