The leverage in cost reduction and growth opportunities.
I have talked before about using due diligence as an integration planning process. One of the key aspects you are looking for in that planning process when doing an acquisition are synergies. Finding these synergies is how you can make a purchase pay off in a big way. Let me explain.
Let’s start by doing some math.
In our example, I buy a company with $1 million in EBIDTA for six-times earnings, or $6 million. What will make this acquisition look even better is if I can find ways to increase the profits of the business. If I could double them, from $1 million to $2 million, for example, my purchase price becomes just three-times earnings–making $2 million on a $6 million investment–which is much more attractive and that is without any revenue growth.
So how do we find ways to increase profits like that? It all comes down to finding synergies during the due diligence process. And there are two primary areas to focus on: opportunities to cut costs and those to help drive growth.
When you acquire, you should look for opportunities to reduce operational costs either in the company you are acquiring, inside your existing business, or both. Here are some areas to potentially target:
In most businesses, the largest cost is often related to payroll and benefits–which makes it an obvious target of reduction. That’s especially true if the acquired company was paying its people at a higher percentile relative to the market than your existing company was. But beware: Cutting pay right after acquiring can be risky. You could suffer a hit to morale or even the loss of key personnel by cutting pay and benefits. My approach has been to leave benefits and payroll where they are to start and reduce the number of people, if that is appropriate. That way, people miss their friends, but they are employed with no changes now. Of course, you might come back and unify the payroll and benefits approach between the two firms later for another cost improvement.
2. Building and Rent
When you put two companies together, you can often get by with less office or factory space. That gives you the opportunity to cut costs by trimming some of your real estate by closing a location and moving everyone into a new single location. The onset of widespread remote work can also be an opportunity to save costs on real estate. Of course, you will have to navigate the existing leases for property if you don’t own the facilities. This can delay this cost reduction.
I worked for a business for a long time where we acquired target companies in manufacturing and consolidated them into my operation. I had extra capacity in my plant that allowed me to absorb the acquired company’s volume without adding space or people–all of which led to significant cost savings.
4. Supply Chain
Many times, when you acquire someone who operates in the same business segment, you use the same suppliers. But the supplier pricing isn’t always rational, as one company might pay more than the other for similar volumes. After an acquisition, you have the opportunity to approach the supplier and ask for lower prices–especially as a result of consolidating the purchasing volume of the two companies–but at a minimum, the lower of the two firm prices.
5. Location Arbitrage
Sometimes you can purchase a company and gain cost savings because of where that company operates. For example, if you operate a software company in Silicon Valley and you buy a company in India, you might be able to gain considerable cost savings by shifting some of the work from the U.S. to India. Perhaps less of a savings, but operationally easier, is a shift to a lower cost of operation within the United States, perhaps to the Midwest.
While I first look for cost savings in an acquisition because I can control them better, you also need to examine what growth opportunities might be possible in the new combined entity. While growth opportunities can be riskier, they are certainly exciting and worth considering. If cost savings are the game, growth opportunities are the bonus rounds.
If you are acquiring a company that sells into same industry, you might have opportunities to sell new products to existing customers. You might also be able to sell existing products to new customers. The classic move is to build a grid with products and customers on the different axes and then assess which customers buy which products. That should help identify opportunities where customers aren’t yet buying everything they could be. These then become the targets for your sales team to drive some high-value cross-selling.
It can make a great deal of sense to target acquiring companies that operate in different geographic areas than you currently operate in. That will give your sales team new access to these markets–and give the acquiring company access to your geographic markets. This is a classic approach to take a regional player into a national footprint.
3. Account Coverage
Many companies have sales teams dedicated to serving large customers. If you acquire a company where there is overlap with a customer, this becomes an opportunity to redeploy some of those sales people to different customers–which improves your coverage of the market because you don’t need that same density in those same large accounts.
4. Product Road Map
By combining two companies, you might create new opportunities to expand your joint product road map. That might enable you to bring new products to market faster and grow revenue and profits in ways neither company could do on its own. If both development teams were working on the same feature set, one can be shifted to newer revenue generating and customer desired features.
Anytime you make a strategic acquisition, you have an opportunity to learn more about the market you operate in from a different perspective. You can gain insights from the vantage point of that other company and hopefully gain valuable insights that enable you to raise prices and earn more profit. It takes a bit of humility to be open to the idea that the firm you just acquired has some better ideas than you might, but if you can tap into them, you really are getting at some of the best opportunities for the combined firms.
I’d be remiss if I didn’t hit the opportunities in repricing customers and the shift in customer power due to an acquisition. The same way you have cost-reduction opportunities with your supply based in a combination, you should evaluate the pricing of both firms. Many times, there are gems of increased price opportunities in that analysis. At a minimum, you become a bigger and more relevant supplier to a customer and that improves your relative position in any price negotiation. A word of warning: Customers will claim the combined volume means you should be dropping their prices, so be ready for that conversation, too.
The point is that whenever you look to make an acquisition, there are endless possibilities of how you might gain cost cutting and growth synergies that you can use to make that acquisition really pay off in the long run.