According to McKinsey’s survey, executives anticipate new products and businesses to generate 30% of revenue by 2027.
Most of the time, it’s much easier, faster, and cheaper to grow through M&A than to develop a business organically. However, choosing an M&A direction is no easy task. This article explains why, when, and whom to acquire. You will get answers to the following questions:
- Which of the four M&A strategies aligns with your strategic goals?
- Which acquisition deal size and frequency delivers the best long-term results?
- What is the best M&A strategy in 2024?
- Which practices to follow to develop a successful M&A strategy?
What are M&A strategies?
Senior leadership teams, including C-suite and board directors, are responsible for strategic M&A development and long-term business growth. Successful companies use M&A strategies to engage in successful deals.
|An M&A strategy defines the direction and type of M&A deal a company engages in based on its goals and capabilities.
Business leaders differentiate four acquisition strategies: vertical, horizontal, concentric, and conglomerate.
The 4 most common M&A strategies for business development
According to a Deloitte survey on 1,000 executives, accurate target firm selection (and valuation) and post-merger integration ensure 55% of deal success.
These factors originate from the company’s ability to align its M&A and strategic goals. It is when M&A strategic planning comes into place. Below, we describe the four most common M&A strategies with pros and cons and explain when and where they apply:
|In horizontal M&A, an acquiring firm buys similar companies operating in the same industry. These target companies may be an acquirer’s direct competitors, producing the same products and services.
With horizontal M&A, companies pursue the following goals:
- Eliminate competition and drive growth. An acquirer aims to increase its market share, gain pricing power, and build influence in the industry.
- Achieve economies of scale. Companies combine production and spread costs over larger product volumes, achieving cost synergies.
- Access new customers. Acquirers access audiences of target companies, increasing their sales and creating cross-selling opportunities.
- Access different markets. A market-extension merger gives access to geographic segments of the same market and ensures competitive advantage in different geographies.
|Benefits of horizontal M&A
|Disadvantages of horizontal M&A
|More efficient production due to shared R&D, facilities, marketing, and technology.
Greater revenue due to combined products and services.
Greater market influence due to new partnerships, supply vendors, and customers.
|Regulatory scrutiny. There is an antitrust risk when two companies operating in the same industry merge.
Management challenges. Big companies require more managerial resources and are less adaptive to market changes.
Post-merger integration issues. Big mergers may fail synergies due to leadership, cultural, and operational inconsistencies.
Horizontal M&A example: Disney + 21st Century Fox
Disney closed a $71 billion deal with 21st Century Fox on March 20, 2019. Both companies are media giants producing multi-billion movie franchises.
|Disney aimed to strengthen its position in the media industry by reducing competition and acquiring new audiences and intellectual property.
|Content expansion. The company acquired the rights to Fantastic Four and X-men, an addition to the Marvel Cinematic Universe. It also got the rights to the Avatar franchise.
Product expansion. Disney launched a streaming service, Disney+, in November 2019, prepared to feature Fox’s content on its streaming platform. As a result, Disney+ proposed a comprehensive content choice for its subscribers at the time of launch.
Greater cross-selling opportunities. Access to Fox’s intellectual property opened new opportunities for merchandise selling and theme park extension.
Strong position in the streaming industry
New markets and audiences
Stock price boost
|In vertical M&A, an acquirer buys companies in the same industry but at different production stages. A target company may be a distributor or a supplier.
Companies achieve the following goals with vertical M&A:
- Optimize supply chains. The acquirer consolidates supply chains by pursuing deals with supply vendors.
- Reduce operating costs. Control over supply chains leads to cost reductions and operational improvements.
- Improve quality control. Finer control over raw materials and production allows the acquirer to improve end-product quality.
- Get cross-selling opportunities. Vertical integration allows businesses to sell complementary services, like software, hardware, raw materials, etc.
|Benefits of vertical M&A
|Disadvantages of vertical M&A
|Revenue growth due to operational efficiencies.
Cost reduction due to control of supplies and distribution.
High market power and price influence due to control of supplies.
|Antitrust concerns. Vertical acquisitions often suppress competitors that rely on associated supply materials.
Management issues. An acquirer may be unfamiliar with supply management specifics or have an incompatible organizational structure for efficient supply management.
No economies of scale. Vertical mergers don’t scale products and services as they occur at different production stages.
Vertical M&A example: Ikea bought Romanian forest land
Ikea is one of the world’s biggest furniture retailers, with over 230,000 employees and 468 stores in 63 markets worldwide. Geopolitical instability caused by the Russian-Ukrainian conflict made Ikea buy forest land on a large scale. In 2015, Ikea bought 33,600 acres of forest from Greengold, a Swedish private company in Romania, for $62 million.
|Ikea aimed to get control over wood supplies and secure its production costs from the anticipated increase in lumber prices. In 2015-2018, lumber prices surged over 170%, according to Trading Economics.
|Supply control. The forest land acquisition reduced Ikea’s dependence on external suppliers and high commodity market volatility.
Cost reduction. Removing third-party intermediaries allowed Ikea to reduce local production costs and improve revenue. This investment translated into high local profit. In 2020-2022, Ikea’s Romanian stores increased net profit from $10 million to $39 million. Ikea also reported a 10.6% sales increase in Romania in 2018-2019.
Sustainable production. Greater control of wood supplies allows Ikea to use raw materials sustainably. It places strict harvesting controls, and its products consist of 75% recycled wood.
ESG benefits. Forest used by Ikea doesn’t contribute to deforestation, according to the World Business Council for Sustainable Development. It gives the company favorable positions in the regulatory landscape.
|Greater supplies control
Greater market influence
|In concentric M&A, an acquirer buys a company that offers products and services in the related industry. This acquisitions strategy also often applies to target companies that offer different products and services in the acquirer’s industry.
Businesses pursue the following goals with concentric M&A:
- Diversify products and service offerings. Businesses acquire new products and services beneficial for their primary industry.
- Acquire customers. Acquirers access the target company’s customers, diversifying its customer segments and increasing its market reach.
- Establish cross-selling income. A merged company can sell complementary products and services to both audiences, significantly boosting its revenue.
- Acquire new technologies and talent. Complementary technology and talent allow acquirers to improve their innovation capabilities and production efficiencies.
|Benefits of concentric M&A
|Disadvantages of concentric M&A
|Operational synergies due to combined technology, talent, products, and services.
Competitive edge due to higher market share.
Diversification due to product and service extensions.
|Strategic misalignment. An acquired entity may not deliver anticipated synergies if it contradicts an acquirer’s goals.
Integration challenges. It may be challenging to eliminate operational redundancies and ensure business continuity simultaneously.
Concentric M&A example: Coca-Cola + Costa Limited
In 2019, Coca-Cola acquired Costa Coffee, a British coffeehouse chain with over 2600 units across the UK, for $4.9 billion. Costa Coffee operates in over 30 countries, which gives Coca-Cola high exposure to the coffee industry.
|Coca-Cola aimed to extend its market reach in the coffee industry and capitalize on the anticipated 8% market growth.
|Customer access. Coca-Cola accessed Costa’s 20-million consumer base, planning a revenue boost from cross-selling opportunities.
Extend product lines. Following the Costa Coffee acquisition, Coca-Cola planned to launch Coca-Cola Coffee in 25 markets. Also, Coca-Cola accessed Costa Express, a line of self-service coffee machines.
Cross-selling opportunities. Coca-Cola’s access to Costa Coffee restaurants allowed it to sell its non-alcoholic beverages, including Fuse Tea.
Risk diversification. Costa Coffee considerably added to Coca-Cola’s coffee business portfolio, enhancing its adaptability to shifting consumer trends.
|Operational and marketing synergies
Higher market share
Higher cross-selling income
|In conglomerate M&A, an acquiring company buys a target in an unrelated industry. The two businesses don’t share similarities and often operate in different geographical markets in pure conglomerate mergers.
With conglomerate M&A, companies have the following goals:
- Diversify business portfolio. By acquiring companies in unrelated industries, conglomerates diversify risks and protect themselves from market changes and economic downturns. If one business underperforms, others will keep profit margins positive.
- Access new revenue streams. Promising companies from diverse industries generate compound revenue. Buyers get new R&D opportunities and access previously unavailable distribution channels, creating cross-selling revenue.
- Increase market share. A conglomerate merger expands its power to various industries, reducing competition in unrelated markets.
|Benefits of conglomerate M&A
|Disadvantages of conglomerate M&A
|Stable cash flows due to a diversified business portfolio.
Strategic flexibility due to investments in unrelated industries.
High market power due to multi-industry presence.
|Increasing business complexity. It’s challenging to oversee dozens of companies in different industries.
Underperformance. Buying underperforming companies may result in long-term financial losses.
Conglomerate M&A example: Berkshire Hathaway + Dairy Queen
Berkshire Hathaway, one of the largest conglomerates in the financial sector, owns dozens of companies in the insurance, energy, utilities, transportation, retail, and other industries. In October 1997, Berkshire acquired Dairy Queen, a multinational fast-food chain, for $585 million. For Berkshire, this acquisition represented a solid entry into the restaurant industry.
|Berkshire aimed to diversify its portfolio with strong, financially profitable companies like Dairy Queen.
|Diversified business. Dairy Queen operates in an industry unrelated to Berkshire’s. This acquisition allowed Berkshire to capitalize on the hospitality industry and strengthen its global reach.
High cash flows. Dairy Queen uses a franchise business model, which is safe and reliable. Instead of building restaurants from scratch, Dairy Queen collects a 10% fee from each of nearly 7,000 restaurants under its brand.
Long-term success. Berkshire’s successful business strategy has boosted the company stock by over 200,000% since 1980.
|High market share
Stable cash flows
Long-term investment success
Different approaches to M&A strategies: which one to choose?
M&A approaches play a crucial role in post-deal outcomes. If executed incorrectly, they may neutralize the positive effects of a correct M&A strategy. McKinsey’s empirical research identifies several types of M&A approaches and investigates business outcomes by deal type.
|Average excess total returns to shareholders (TRS) in 2010-2019
|An acquirer makes several small-value tactical deals to add strategic capabilities and accumulate market capitalization.
|3-15 deals a year
|An acquirer makes “opportunistic” deals with a cumulative value over 2% of its market cap. These deals aim at specific strategic goals.
|≤ 2 deals a year
|An acquirer makes a deal worth 30%+ of its market cap. It’s a highly complex transformative event with high strategic significance.
|Organic growth (no M&A)
|A company relies on organic expansion instead of mergers and acquisitions.
|✅ Main insights from the study: Programmatic M&A is the single best approach to business growth and benefit to the company’s shareholders. It is 200% more effective than organic growth. Programmatic M&A generates positive median TRS across all sectors. It’s most effective in advanced industries (5.9%), energy & materials (2.2%), and transport & logistics (2%).
Large deals generate positive median TRS only in technology, media, and telecommunications (1.7%) and financial services (0.6%).
Selective M&A generates positive (0.3%) median TRS only in energy & materials companies.
Organic growth generates positive median TRS only in consumer packaged goods (0.3%) and pharmaceuticals (0.9%).
What is the best M&A strategy in 2024?
The 2023 M&A activity was the lowest in both M&A volume and total deal value in five years.
Source: S&P Global
However, the market will likely see an activity boost in 2024 as global economic conditions stabilize. Financial buyers, including private equity firms, have accumulated considerable dry powder, ready to increase the deal volume as interest rates tend to settle. That said, antitrust regulations and election-induced political uncertainty may become the biggest M&A challenges. Thus, the U.S. government released new draft merger guidelines affecting horizontal and vertical mergers. Among other changes, companies will disclose more info in HSR filings.
|Competitive harm threshold
|When a new entity holds 30% of the market share
|When a merged entity limits competitors’ access to 50% of the market
As a result, a programmatic approach within concentric and conglomerate mergers may face fewer struggles than horizontal and vertical strategies in 2024. Acquiring firms should carefully explore competitive implications if they plan horizontal and vertical mergers.
Preconditions for successful M&A strategy
Check the two most important preconditions for successful M&A strategies below.
Emphasize preliminary assessment
McKinsey’s M&A blueprint provides helpful recommendations for facilitating an actionable programmatic M&A strategy:
- Understand corporate strategy gaps. Understand which M&A direction to choose based on your strategic goals and gaps in your business capabilities. Thus, concentric M&A fills product gaps, while vertical M&A strengthens the supply chain.
- Define competition opportunities. Check how your value drivers fit in the competitive landscape and ensure your acquisition strategy helps you outperform the competitors.
- Understand financial capabilities. Unveil and review any financial limitations on the deal value, quantity, and post-merger performance expectations. For instance, the limit is three acquisition deals a year at $100 million each.
- Develop an M&A business case. Establish several business improvement directions and identify potential targets opportunities within. Thus, one company fills the gaps in the same supply chain, while another target is the best for product extension and address changing customer needs.
- Consider post-merger integration. Determine operational interventions and resources required to integrate acquisition targets. For instance, a few new facilities are required to absorb target A, while a new business department is needed for target B.
Leverage M&A software
Use dedicated M&A software solutions, like virtual data rooms (VDRs), to collaborate smoothly and seamlessly. VDRs provide the following benefits to the deal process:
- Ironclad security. Leverage zero-trust security to protect yourself from data compliance concerns, unsolicited file sharing, agreement violations, and data breaches.
- Fast due diligence. Establish M&A workflows to manage high data flows between the companies involved in due diligence.
- Convenient governance. Use role-based content rights to facilitate collaboration between senior management and execution teams.
- Horizontal, vertical, concentric, and conglomerate are the most common M&A strategies.
- Horizontal M&A ensures economies of scale, while vertical deals improve the production process.
- Concentric M&A is the best for product extension, while conglomerate deals diversify business risks in uncertain times.
- A series of small deals aiming at particular strategic gaps (programmatic M&A) is the best approach for long-term success.
- Robust self-assessments and post-merger integration plans ensure a successful M&A growth strategy.
- Virtual data room software enhances collaboration, security, and compliance in the acquisition process.