In the article M&A Needn’t Be A Loser’s Game authors Larry Selden and Geoffrey Colvin argue most M&A are failures but they do not have to be. If companies properly do their homework, they can avoid acquisitions that destroy shareholder value or in some cases, even turn bad acquisitions into good ones (Selden & Colvin, 2003).
One of the most important concepts I have learnt in this article is that management should not look at the income statement but the balance sheet when deciding whether to acquire a company or not. The management often focuses on revenues and profitability because Wall Street expects it to grow which often results in acquisitions that end up destroying shareholder value. It is important to look at the balance sheet so that the management has a better idea of economic profit. After the true cost of capital is taken into account, depending upon the acquisition price, the acquisition may end up destroying shareholder value rather than creating it. The acquirers may argue they will achieve cost savings through synergies but the authors state such claims are often exaggerated and costs may even increase as a result of integrating the operations and cultures of two companies.
Another important concept I have learnt in this article is that the most important reason to acquire a company is customers. When targeting a company, the management should try to understand the profitability of its customers as much as possible. While it is not always an easy task, there are ways to get a reliable estimate if there is a will. Understanding the value of customers may enable the management to avoid bad deals and it may even allow the management to turn bad deals into good deals.
The third important concept I have learnt in this article is that not all customers are created equal. Some are more profitable and some are less. There are even customers that actually cost the company. It was a shock for me to learn sometimes just a small proportion of the customers can be responsible for the entire profitability of the company and their contribution to profitability may even reach percentages as high as 200 percent. Such profitable customers are so valuable that the authors even suggest paying high price to acquire them if the entire target company cannot be acquired at a good price.
Customer profitability is a concept with wide applications. One of my summers jobs few years ago was at Best Buy. The concept of customer profitability as suggested by the author argues only a certain proportion of customers are responsible for a significant proportion of profitability. The management of Best Buy could employ this concept to better serve most profitable customer segments. Collecting customer data is not a major challenge since I witnessed most customers paying by debit and credit cards. The management should identify which customers make more frequent purchases, make large purchases, and rarely return and could offer them value-added services. The management may also offer them more convenient payment options to encourage them to buy more. In the meanwhile, the management could close stores which are more frequented by less profitable customers. Cost-cutting is important because Best Buy customers are increasingly being stolen by online companies, thus, the management should identify most loyal clients and provide them with service levels that are superior and more personal as compared to online retailers.
One of the insights that surprised me most in the article is poor understanding of customers by a significant proportion of business leaders and managers. Many companies have poor understanding of the customers of target companies and many companies don’t even properly understand the profitability of their own customers. It was surprising how companies often identify even unprofitable customers as profitable and how they keep poor record of cost centers. Competition has been growing and customers have more choices than ever. This only increases the importance of better understanding customers and providing the best service to the most loyal and profitable customers. If the companies cannot differentiate between most profitable and least profitable customers, they will seriously endanger their long term competitiveness.
While I agree with the authors it is important to focus on the value of customers when engaging in M&A activities, I do feel the authors arguably overestimate the importance of customers and underestimate the importance of some other factors that drive M&A activities. One factor that is quite important in my opinion is human resources. Skilled and creative talent is rare and we have seen technology companies often acquiring small companies not for the customers but for the talent that comes with it. Skilled and creative talent is also difficult to imitate and, thus, offers a valuable source of competitive advantage in the long term.
Selden and Colvin argue most M&A are failures because the management of the acquiring company focuses on the wrong measures. Instead of focusing on income statement, they should pay more attention to the balance sheet to ensure they create and not destroy shareholder value. The authors also argue customers should be the most important factor in an acquisition decision. In addition, companies should also develop better understanding of the profitability of different customer groups they serve so that they can allocate more resources to serving the most profitable and loyal customer groups and can take measures to discourage the least profitable customer groups.