Creating value through acquisitions

Acquisitions can be a powerful tool to achieve growth, enter new markets and expand the range of a firm's capabilities. But with the highly competitive market for acquisitions and the correspondingly high acquisition prices, all too often transactions fail to create value for shareholders. Does this mean companies should avoid acquisitions and focus solely on organic growth? If acquisitions are to be part of a company's growth strategy, how can management identify which targets have the potential to more than justify the required investment and create value. In this article, the author shows how the discipline of strategic market position (SMP) can be used to test whether a proposed acquisition will really improve a company's overall competitive position and enhance its ability to deliver strong profitability for the future.

Using the example of Northrop Grumman, the author shows how to apply a four‐part “SMP test” to assess potential deals.

The example serves to illustrate how a merger to increase scale within a broad industry may contribute little to improved performance, but an acquisition of a company with distinctive, but complementary capabilities targetting a shared set of customer needs can deliver a very successful outcome. In particular, the author discusses the case of Northrop's acquisition of Ryan Aeronautical, a supplier of unmanned aircraft. The deal enabled Northrop to win new contracts worth many times the acquisition cost for Ryan.

The lesson is that if acquirers understand the true strategic value of an asset, measured in terms of stronger SMP and increased revenues, and/or higher profitability for the combined organization, then they can identify situations when the value opportunity will more than offset the premium required to complete the transaction.