Collins The Trend Tracker
by Mike Collins
May 31st, 2016

The Sources of Value in Acquisitions

There are common misconceptions about how purchasers of building-product businesses and other companies profit by making acquisitions. Many believe that the buyer comes in with the “new broom” and makes major headcount reductions in the wake of an acquisition. In reality, this is very seldom the case.

Suppose that we replicated your door or window manufacturing operation, down to the machinery, subcomponents and every physical aspect of the business. Would we have the same company as you currently have? Certainly not. We would not have some of the most critical aspects of your operation – its people, their deep experience and knowledge of customers, markets, products, distribution requirements and many other aspects of the ongoing operation. For this reason, buyers typically want all the key executives, experienced production workers and productive sales professionals to continue contributing to the success of the company after a transaction closes.

Another common view is that buyers can only profit in an acquisition if they slash costs once they’ve taken over. This was more common in the past, when lenders would knowingly extend more debt to a buyer than the combined companies could possibly service post-closing. It was necessary in such a case to quickly improve the ability to pay the debt by selling assets or divisions or by cutting costs. The shortsightedness of this approach resulted in some famous blowups, so it has fallen by the wayside.

So just how do buyers who are successful in their M&A endeavors profit from deals?

A study by the Boston Consulting Group (BCG) has shown that almost 60 percent of the value created in an acquisition over a five-year period comes from plain, old-fashioned revenue growth. Cutting costs and reducing headcount only contribute 20 percent to the overall value created in an acquisition. Nothing is more critical to the success of a newly acquired business (or, for that matter, a newly launched subsidiary or product area in an existing business) than the growth plan for the first 100 days. That plan must focus on the variables that drive revenue growth, not be overly focused on cost control or reduction. Otherwise, the BCG study showed, managers do not realize that they will fall short of their long-term growth and profitability goals until several years after the transaction.

By then, the temptation will be great to put suboptimal plans into place, such as those driven by growth at the cost of margins. Far better to start out with a sharp focus on growth and the drivers of revenues, in order to ensure that the venture will achieve the highest possible level of profitability.

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