Mergers and Acquisitions
In a concentrating FMCG market, tremendous pressure is put on outgrowing competitors. In this context, acquisitions are a major instrument of growth. To avoid costly mistakes, Indian FMCG leaders would benefit from putting strategy at the centre of their acquisition game plan.
- Article |
- 01 May, 2015
- In a rapidly concentrating Indian market, inorganic growth can be extremely effective, if approached strategically.
- An acquirer should perform a thorough assessment of financial performance, structure, culture, brand positioning and capabilities, as well as the company's readiness for acquisition.
- Through this screening of opportunities based on the targets' current and future capabilities, the acquirer can achieve their objectives
Indian FMCG companies are racing for scale and market share to secure a sustainable position in an increasingly competitive marketplace. This has made ramping up growth the top priority of most CEOs. To achieve their objectives a number of FMCG companies have resorted to inorganic growth. However, this acceleration in M&A activity has had mixed results, producing a number of failures, characterised by the inability of the buyer to grow the acquired brands.
Because organic growth alone has limitations, Indian FMCG companies must keep on playing the acquisition game. However, to improve their chances of winning they should put strategy at the core of their acquisition game plan.
Scale is increasingly important in a concentrating FMCG market
In the last few years, the Indian FMCG industry has witnessed the rapid expansion of ambitious players such as Dabur, Godrej, Marico and Wipro. These companies have been on a fast growth trajectory, distancing themselves from smaller competitors and closing in on the top five players. The motivations behind such aggressive growth have been to increase market share, but also to gain scale benefits. These benefits come in the form of better utilisation of tangible and intangible assets, more efficient spreading of costs across business units, and an improvement in bargaining power.
As fast-growing players became bigger, companies that failed to keep-up found themselves under increasing pressure. These players have seen their position erode as the more aggressive players ate into their customer base. Most impacted were smaller-scale players who have found it increasingly difficult to compete in a more concentrated market.
Acquisitions are a key instrument of growth for many players
Many Indian players turned their attention towards acquisitions as a means to win the race for scale. These players started acquiring bigger targets, more frequently and widening their scope to include new categories and even new countries that could deliver faster growth.
For example, between 2005 and 2012, Godrej acquired more than 10 companies, adding around 4 new brands per year to its existing portfolio and expanding its presence in more than 20 countries. In the same period, competitor Dabur purchased 4 companies, adding more than 20 brands to its portfolio and expanding to new categories and geographies as well. Players like Wipro Consumer Care and Jyothy Laboratories have also stepped up their game in recent years by engaging in large-scale acquisitions.
Acquisitions can be value destroying if they are carried out on impulse and without clear direction
The problem with playing the acquisition game with such zeal is that strategy often comes after opportunity. The acquisition game as it is currently being played is leading managers to put excessive stress on rapid, intuition-based decision-making and thus to neglect careful strategic analysis. As a result, many of the acquired brands fail to deliver the results expected by their buyer. In the last few years, the Indian FMCG market has seen a number of unfortunate acquirers pay a premium for brands they could not grow any better than their previous owner.
The most frequent reasons for failure in these cases were a lack of commitment to the category relative to established competitors, and/or a lack of capabilities to grow the acquired brands.
For example, an Indian player ventured into a sub-segment of the hair care category by buying a rising brand. Instead of growing further after this acquisition, the brand has consistently been on a downward trend. During a period of seven years, faster-growing competitors have managed to strip this brand of almost one-third of its market share. Another good illustration is a leading personal care player that launched an aggressive expansion into food categories, only to grasp - several months after the acquisition - the full complexity of distributing perishables and fresh products.
In contrast, certain companies have had impressive success in growing acquired brands much faster than their predecessors. A large Indian player managed to double the market share of a toothpaste brand less than 5 years after acquiring it. This company recognised its competitive advantage in its manufacturing units, distribution network and advertising budget to help a stagnating brand skyrocket.
Approaching acquisitions strategically is the key to value-creating deals
Instead of immediately jumping at emerging acquisition opportunities, managers should first assess them through a strategic lens. A strategic view will help acquirers generate more value more consistently by focusing their hunt in the right territory, by enabling them to track value-adding targets closely, and by getting them into position to pull the trigger at the right moment. In the business terminology, this means that buyers should improve in three areas: matching targets with their existing strategy, assessing value creation opportunities thoroughly, and staying ready for an opportunity.
After the corporate and growth strategies have been outlined, managers should determine what market position or capability they should develop through acquisition and what can be achieved through organic growth. In general, acquisitions are a faster and more cost-effective way of acquiring market share, technology or knowledge compared to organic growth. However, they also require more cash, involve greater risks and result in less control over the organisation and its culture. In determining the balance between organic and inorganic growth these elements need to be taken into consideration.
Clarity about corporate and growth strategy enables focused and efficient target screening
Once leaders have formed a clear picture of how acquisitions could bring their company closer to their goals, they can start to outline what an appropriate target company could look like. The key criteria for a desirable target company should be defined including; the size of the target; its financial performance; its ownership structure; the positioning of its brands; its corporate culture; and its capabilities.
Having such clear selection criteria is essential to ensure that the companies that are considered as potential targets have high prospects to become valuable additions to the buyer’s portfolio.
With this picture in mind, buyers can start looking at the market to identify potential targets. From an initial pool of companies operating in desired market spaces or geographies, the buyer can obtain a shortlist of top targets by going through a process of screening and ranking.
Potential targets must be identified first based on their expected fit with the buyer’s corporate and growth strategy. These companies can, in turn, be ranked to obtain a shortlist by using further filtering criteria. These criteria can include; an evaluation of the target’s readiness to sell; an assessment of the existing relationships between the leadership of the buyer and target company; or simply the degree of urgency to acquire the desired capabilities or market position.
Thoroughness in assessing synergies is key to value creation. Once buyers are clear about what type of targets are the most attractive, they should begin to assess the opportunities for value creation on a case-to-case basis. While going through the shortlist of qualified targets, managers should clarify how they intend to promote synergies in the short term, and how they will grow the acquired brands in the longer term.
There are two principal errors managers make in assessing potential synergies. The first is arriving at an incorrect understanding of potential synergies. This often comes from leaving potential cannibalisation out of the equation, as well as foreseeing non-existent opportunities for cross-selling, or headcount and overheads reductions. The second error is having unrealistic expectations - that is overestimating potential gains or the management’s capacity for execution. To avoid such mistakes, it is important to form the right team to conduct the synergy assessment. Ideally, the team should have a balance between financially focused people, strategists and operations experts. More importantly, to become elite acquirers, managers should ensure that emotional attachment and individual financial incentives do not come in the way of unbiased decision making.
As far as growing the acquired business is concerned, managers should be equally thorough in detailing their plans. They should identify the specific leverage points they will rely on to grow the acquired business in the mid to long-term, and understand how they will allocate resources in order to reach their growth objectives. Critical areas to investigate at this stage include; the potential to accelerate innovation cycles, extend brand and product lines and even reposition the brand. Managers are generally thorough in answering these questions when acquiring a business they plan to turn around. However, when acquiring a healthy business, they often assume a linear progression of its current growth, despite the impact of the leadership and organisational changes it will undergo.
Having a team dedicated to chasing acquisition opportunities is a major advantage
With a list of high potential targets and a clear plan to generate value, managers are now hunting for the right targets in the right territory. However, to become elite acquirers, they still need to track their targets and be in the prime position when the time comes to pull the trigger. To ensure they are ready to secure deals before competing bidders, acquirers should have a team in place dedicated to pursuing acquisition opportunities on a continual basis.
The role of this team is to monitor the market for value-adding targets, track the results and future plans of each target, and build relationships with their key decision makers. It is often advisable to include outside professionals in the team to complement the internal team’s skill set. Further, it can be useful to engage a third party to facilitate contact between the buyer and the target when discretion is required.
After forming the acquisition team, it is crucial that the leadership clearly informs the team of the firm’s corporate and growth strategies to ensure targets are aligned with their objectives. To prioritise the team’s activities it is often useful to assess the readiness to sell of the target’s decision makers. To make this assessment, research on ownership structure is always useful, but other areas must be investigated as well. Financial difficulties, poorly performing brands, or market turbulence may all be powerful indicators that the time is right for a target to consider selling.
In addition to assessing the readiness to sell, teams should create a sale thesis for each target. This document should outline the major reasons why the target shareholders would benefit from selling assets, brands, business units or even the entire organisation to the buyer. The sale thesis is a crucial tool for aspiring acquirers to approach their targets with compelling arguments. It should be built with the same analytical rigour that would be applied to the writing of its counterpart, the investment thesis.
In complement to their research initiatives, team members should be proactive in developing relationships with top targets. The objective is to create enough trust and familiarity to promote open discussions about acquisition and divestiture opportunities.
The sale thesis prepared by the team should be introduced, discussed and refined during recurring interactions with the target’s management. At the same time, the aspiring buyer should be attentive to the fears and concerns of the target’s owners and managers. It is often important for the buyer to show its willingness and capacity to keep a business with a long history and strong sentimental value on the right track. In the same way, it is important to send the right signals to other stakeholders about the prospects of working under the new ownership, top events resistance and build allies before a deal is announced, or even decided. By tracking their targets closely, aspiring buyers can be in prime position with a suitably attractive offer when it’s time to pull the trigger.
In conclusion, managers will need to excel at acquisitions to succeed in a rapidly concentrating Indian market. To make better acquisitions, they can start by screening opportunities to match them with their chosen corporate and growth strategies.