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Mergers and acquisition (M&A) is a corporate strategy taken by organizations to expand their operations by acquiring or combining the facilities of other firms. Before a firm acquires the facilities of another firm, the profitability of the company is considered by evaluating the status of profits and loss accounts.
However, Selden, and Colvin (70) argue that about 75% of acquisition fail as a result of scanty scrutiny of the actual financial performance of the firms being acquired.
They claim that such problems can be avoided if the balance sheet is scrutinized properly. M& A should be seen as an effort to increase the value of shareholders through customers. Consequently, a firm ought to scrutinize the balance sheet because it tracks the capital, and at the same time profits of a firm.
The authors claim that business deals are about the profitability of customers. Some customers are money losers whereas others are profitable and thus an organization should be better placed to understand the profit position of customers during mergers and acquisition.
In this article, the authors acknowledge that the profitability of customers varies in a dramatic fashion. Consequently, they describe the measures of success.
Look At the Balance Sheet
Managers look at the profit, and loss account when evaluating their potential acquisitions. However, profits can change any time, depending on the market conditions, and therefore a firm may not be profitable in the long run. This means, one has to look at the balance sheet.
A balance sheet is a financial statement that shows the assets and liabilities of a firm at a particular time. It indicates the investment position of the firm. When evaluating potential acquisitions, wealth of shareholders will be destroyed if the balance sheet is ignored by the acquirers.
For instance, the profit, and loss account may indicate that the profits of the company are going up. However, scrutinizing the balance sheet may reveal that there is a big charge on capital invested.
If such a company is acquired, it may prove profitable before, but later become a disastrous loss thereby destroying the wealth of shareholders.
How to Measure the Profitability of Customers
A smart acquisition is pegged on profitability of customers. Customer profitability can be calculated using data collected in about two months based on several steps.
First, the profitability of product and service is measured taking into considerations all costs.
Second, an evaluation of customer preferences is done. The preference may be considered because some customers buy highly profitable baskets whereas others do not.
Third, the customer specifics, such as a how the customer behaves, are subtracted from the estimates of the profitability of the customer.
Lastly, all the expenditure not accounted for in the business should be divided and accounted for in the figures indicating profitability.
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It Is All About Customers
Selden and Colvin argue that M&A is primarily meant for customers. A company may merge or acquire a smaller firm to gain more customers or to serve existing customers better.
As a result, the management of the company acquiring another company should note that some customers are more profitable than others, and therefore their profitability should be factored during M&A.
Salvaging the Deal
Selden and Colvin claim that customers can be divided into four categories; the darlings, the dependables, the duds, and the disasters. This subdivision can only be done after analyzing their profitability on the company.
If the company understands its customers, then it will be possible for it to salvage any deal that has been rocked by customers grouped as disasters.
After acquiring a certain company, the management may discover that some customers grouped as disasters are rocking their deals thereby threatening shareholders’ value. In this case, the company may salvage their deal through several strategies.
For instance, the company may choose to shut down the disaster customers, and transfer the capital to profitable customers. This means the deal can be salvaged only if the company understands its customers.
From the analogy used in this article, authors have used the analogy of a bag of apples in the supermarket. In this case, most acquisitions are equated to picking a bag of apple without knowing its contents.
The acquirer in this case should not just be blind, but rather chose wisely. This can be made possible through proper analysis of the profitability of customers.
Conclusion: Is Merger And Acquisition The Answer?
Many companies engage in M&A for growth. They assume that by acquiring the assets of an existing company, they can expand their customer-base. However, M&A is not the only way for companies to grow.
Some of the top fortune 500 companies in the world have grown through organic process of creating value for the shareholders. However, the few that have grown through M&A have managed through proper analysis, and understanding of customers.
This means that although M&A is considered as an economic path for growth, it is not the only answer. At the same time, M&A has been misunderstood, and thus it is not a recommended way for growth.
Nevertheless, if the management content with the fact that M&A can only be successful if seen as a way of creating shareholders’ value through customers, the strategy will be lauded as the most effective.
This means M&A can only be the answer to growth if value creation through customer analysis is taken into consideration before and after M&A.
Selden, Larry and Geoffrey Colvin. “M&A needn’t be a loser’s game.” Harvard Business Review 81.6 (2003): 70-79. Print.