Mergers and acquisitions are often considered as being a remedy for any company in order to improve its business performance and increase profits. However, statistics of failures and successes of the companies undertaking such actions proves the opposite. Interestingly enough, the majority of large companies, which were not successful in mergers or acquisitions, were consulted to do so by experienced professionals and planned it very carefully. Thus, it is necessary to understand what makes an acquisition successful and how a company can benefit from applying this approach in its business practice.
Choosing the Right Perspective
Traditionally, companies are analyzed from a point of view of their products, services, functions and territories portfolio. However, the authors mention that a new perspective is based on understanding the value of the company as an aggregated value of its customers. Thus, searching for the way of increasing the value of the company should be based on analyzing the portfolio of the customers that distinguish the company’s profitability. According to the authors, having a clear understanding of the customers’ profitability allows making right decisions and differentiating the deals that would be useful for the company from the ones that would cause a failure.
Evaluating Potential Mergers and Acquisitions
The first step a company should make when planning an acquisition is to evaluate the balance sheet. The company should concentrate on tracking the capital instead of focusing on the profits that are expected as the result of the acquisition. An increase in sales and profits immediately after the acquisition does not assure profitability of the company in the future. The main measure of the business performance is the economic profit that takes into account the expenses the company had.
Projected profits might seem to be absolutely satisfactory. However, by ignoring the charge for invested capital, the managers can have a wrong picture of the company’s real profitability that would lead to a great failure of the investor’s business. Thus, the deal might look attractive judging by operating profits, although taking into account acquisition costs might demonstrate that return on the invested capital and economic profit will drop after acquisition. If the investor acquires a company and does not change anything in its operations, financial indexes will remain the same. Hence, return on investment will be much lower than expected; thus, destroying the value for shareholders.
Chief executive officers quite often ignore the evaluation of the balance sheet in order to project the results of acquisition because of the pressure they suffer. They try to increase reported earnings dramatically, reinvest cash, and use an opportunity of acquisition before their competitors do so. Even in the event, when they know that return on invested capital might drop, they believe that it is possible to pay off the deal either by raising revenue or by cost savings.
Although reducing costs and increasing revenues are possible thanks to the integration of two companies’ operations, the reality can be very different for a couple of reasons. First of all, it is usually overestimated by managers who project unreal figures they want to reach by joining two companies. Secondly, a merger between two companies creates large additional costs that are usually not foreseen on the planning stage. The time factor leads to the managers making quick decisions about the spheres where they cut costs which often harms some vital spheres.
Measuring the Profitability of the Customers
The authors argue that managers need to understand the profitability of their customers and the customers of a company they are planning to acquire. Evaluating the customer profitability will help a company choose which companies to acquire in order to have positive outcomes for the business. The evaluation can be completed in few steps. First, managers should measure the profitability of all products and services considering all costs. It will help to identify and eliminate the products that are unprofitable. Second, the company should study which categories of customers buy the products that were found to be unprofitable and which customers buy profitable baskets.
The third step requires subtracting all costs connected to customers from the preliminary calculations of customers’ profitability. It involves considering the amount of salespeople’s time that certain customers take, the frequency of cases of retuning items, the manner if they pay in time or delay bills, etc. The final step is based on accounting all the costs, which are not directly related to the customers but have not been assigned in any other category while evaluating customers’ profitability. All costs equally split between the customers should be included in order for the company to maintain its profitability even if it loses some customers.
The Reasons for Acquisitions
There are many reasons why some companies choose to go through the process of acquisition such as getting brands, patents, technologies, employees, real estate and other facilities of another company. However, the main reason of any acquisition is to acquire customers. Moreover, other reasons mentioned above are also connected to the customers since they create additional possibilities to develop the customer service and, thus, increase the loyalty of existing customers and attract new ones.
The concept of identifying the groups of customers that bring more profit than the others is often new to businesses. Companies normally pay attention to the spheres or regions that bring more money than others, but they do not analyze the breakdown of profits received from certain groups of customers. Managers quite often do not think they have any unprofitable customers and have no idea which of them are more profitable than the rest.
The research made by the authors of the article demonstrates impressing figures regarding the customers’ profitability. Hence, it is quite a common situation when a company’s most profitable one fifth of the customers generates more than 100% or even 200% of its profits. Meanwhile, 60% of middle customers will not generate any profit and the least profitable 20% of the customers might generate 100% or 200% of company’s loses.
Realizing this statistic makes managers evaluate acquisitions from a different point of view allowing them to divide its customers in four equal groups. The most profitable group, which brings 200% of the company’s profit, is called the Darlings. This group is followed by the Dependables and the Duds. Finally, the last group of customers that generate a negative economic profit and makes the whole deal unsuccessful is called the Disasters. By means of presenting the calculations made to research these groups, the authors express their idea that companies need to use the customers’ evaluation results in order to stop dealing with the worst customers and focus on the ones that generate the most profit. Shutting down the Disasters would result in the company improving its return on the invested capital.
Thus, the findings of the authors demonstrate that a company should carry out a customer profitability analysis before acquisition to be sure that it is worth doing. Sometimes it is more beneficial for a company to acquire profitable customers one by one by investing in new stores and marketing, rather than buying customers in bulk through acquisitions that mean getting the customers of all four groups.
Mergers and acquisitions can bring astonishing results in some situations, although they are not perfect solutions for every business and can be even harmful in the majority of situations. Negative statistics of acquisitions outcomes proves that quite often other ways of growing the business are more likely to work than mergers and acquisitions. Nevertheless, managers should precisely evaluate the possible results of acquisition based on estimating the customers’ profitability as the main factor to realize if it is the right solution for their company in a certain situation.