I want to introduce you to the acquisition analysis. And this is a tool in your toolkit that can be especially valuable when you’re considering a potential acquisition. Now remember acquisitions are a very common growth strategy for firms. They're often attempted, but they often turn out to be problematic. Most acquisitions fail. But, of course, some acquisitions work out terrific. They can be fantastic for the acquiring firm. And they can allow you to create more value and achieve some strategic growth. So the important job of the strategist is to try to determine in advance if a particular acquisition is one that has high potential for growth and value creation. Or if it's an acquisition that is more likely to turn out to be problematic. Now, at its heart the acquisition analysis Is essentially a cost-benefit analysis. We're trying to understand if the potential strategic benefits outweigh the potential costs associated with making that acquisition. And it might be useful to think about an acquisition analysis essentially like a math equation. If we think about it and lay it out like an equation, this might be a way for us conceptually to think about these different concepts. So first of all, we can focus on the strategic benefit. What is the strategic benefit of making this acquisition? Well that benefit derives from both the independent value of that target firm and also the value that acquiring that firm would add to the combined organization. In other words, at the very least, the strategic benefit ought to at the least be the independent value of the discounted cash flows of that business that we're thinking of acquiring independent of whether it's acquired or not. Is it a valuable business? Is it profitable? What do we think is working in that organization? And that's something we can assess independently, but that's not enough. We need to make sure that there's some additive value, some integrative value by acquiring that organization. And that there's some synergy or some complementarity or that there's some benefit that acquiring them will bring to the combined organization. In other other words the whole needs to add up to more than just the sum of the parts. So we need to think first of all about that strategic benefit, then we need to think about the cost. What's the biggest cost associated with an acquisition? Usually it's the purchase price. So we need to make sure and be very careful that we get that purchase price exactly right. And this is a stumbling block for many acquisitions. Oftentimes, acquisitions fail primarily because the purchase price is too high, and the acquiring firm overpays for the target. And they're just simply never able to recover all of those costs and get the associated value out of them. So we have to be really careful about that purchase price, make sure that it's not too high, make sure we're not over leveraged, make sure that it fits into sort of our larger strategy. And one of the important things we need to do as we do that is we need to consider all of the costs of the acquisition, not just the purchase price, but the potential future additional costs as well. What are the costs of integration? What are the costs of merging the cultures and putting these things together? And we need to be willing to not only incur those costs in the future, but we need to also be able to incur the negotiated purchase price that we've arrived at. If we're willing to incur all of those costs and we think we can achieve that value added benefit from the acquisition, then it's worth considering proceeding. But even that is not enough, the strategic benefit minus the purchase price needs to add up to more than the opportunity cost. In other words this is a key idea in business strategy, that we need to make sure the strategy that we're pursuing is the best strategy we can pursue. If it's obvious that there are some alternative strategies we could pursue that have lower costs, lower risks, then we might want to think twice, in this case about making the acquisition. We might want to think about that opportunity cost more narrowly. We might think about it in terms of the specific, strategic goal we have in mind. Is there another way to achieve that goal? Let's say we're trying to diversify. We can do it by acquisition, but maybe we could do it by scaling our existing operations or expanding our business in some other way to enter that new market. We could also think about this opportunity cost more broadly. Are there other completely different strategic goals that we ought to be considering? Maybe diversification isn't the most important things we ought to be doing at this point in time. Maybe there's something else that would be potentially more valuable, has a better cost-benefit analysis associated with it. So as we zoom out and conduct an acquisition analysis, we might think about it sort of like an equation where the strategic benefit derived from both the independent value of the target as well as the sort of additive value of acquiring that target. That less the cost associated with the acquisition needs to outweigh the other strategic opportunities that we might pursue instead.
