The merger, acquisition, and joint venture strategic fit assessment is based on gaps that the company needs to close in its own strategy. The criteria for a good strategic fit should not be so tightly defined that very few candidates meet the requirement, nor so loosely that too many passes. Also, the criteria should be flexible and change over time as the business environment or priorities warrant.
There are many different ways to determine if a candidate is an appropriate strategic fit:
Industry Served. If both companies serve the same industry, there might be ways in which a combined business operation may result in greater revenue opportunities or ways to lower unit operating costs and thereby increased profitability.
Operating Synergy. This is the motivation for most business transactions that are done today. Synergy strengthens existing business operations by either filling strategy gaps or replacing current strategy with those of a more efficient operator in the same business. The synergy evaluation often takes one or more of the following form:
Marketing synergy in which a company with strong marketing skills and reputation combines with another company with an excellent product line but limited marketing expertise.
Infrastructure synergy in which investment in plant and other assets may be avoided by combining assets and improving their utilization. The capital saved plus the higher operating performance of the assets (i.e., asset turnover) leads to improved profitability and cash flow.
Distribution synergy in which a company with considerable distribution channels uses that strength to promote other company’s products without having to make investments in product development, plant and machinery, and general and administrative overhead.
Operating synergy in which the combined businesses through greater economy of scale, elimination of duplicate operations, or by other means have the propensity to achieve lower levels of fixed and variable costs per unit of labor or product.
Financial Advantages. Cash flow, profitability, or access to capital tend to be the key drivers behind business combinations based on financial strategic fits. They frequently take the following form:
Access to capital in which a cash-rich company will join with another company whose growth is limited by a shortage of funds. This is the reason most entrepreneurs go to venture capital firms. However, more and more small businesses are going to large companies to seek funds because they will also receive help and guidance from the company in the form of loaned executives or board of directors representation. For example, UUNET, the Virgina-based Internet Service Provider, secured some of its funding from Microsoft and 3DO, a multimedia software development firm, received funding from AT&T.
Growth in which the corporation acquires a company that is achieving high revenue growth rate. This particular high growth company may not necessarily suffer from a lack of access to capital.
Profitability in the form of higher returns on investment, asset, equity or capital if the company engages in a transaction with the target. Companies sometimes execute this strategy by divesting non-performing assets and use the funds to acquire high performing businesses.
Financial leverage in which the company uses its favorable credit rating to lower the cost of capital for a desired candidate or use the candidate’s tax loss carry-forwards to reduce its overall tax payments to the government once the transaction is completed.
Geographical Synergy. A company that aims to be global may want to combine or ally with another company that operates in either the same or a similar business, in a geographical territory where it has no existing operations. For example, British Telecom (BT) and MCI Communications executed a transaction where BT took an equity stake in MCI and now both companies jointly market and sell each other’s products and services in Europe and the United States.
At the end of the day, the strategic fit assessment criteria should be such that it helps key business development personnel to appropriately screen transaction candidates that have a reasonable chance of executing a term sheet or letter of intent with the company. This will save the organization from countless, frustrating hours of “spinning its wheels.” Also, a good strategic fit assessment will make the job of other key stakeholders in the process (such as senior management, investment bankers, attorneys, board members, etc.) much easier.
