Acquisition is a Better Way to Grow
It's quite simple--the way to expand your business is through hard work. Keep your customers happy and market aggressively. In the end it comes down to old fashioned sales and marketing, and plenty of hard work. This is what most consultants, professors, and businessmen will insist. You'll hear a lot of slogans and truisms like "there are no shortcuts to success."
We're certainly not about to claim that hard work isn't a key ingredient of success in growing a business. But, in contrast to the traditional wisdom, there is a short cut to growth. Growth through acquisition, too often considered the exclusive domain of the largest of companies, is also quite appropriate for the small and midsize company looking to achieve rapid expansion.
Synergies through Acquisition
The key to growth by acquisition is taking advantage of synergies: making 2+2=5. Growth through acquisition is a quicker, cheaper, and far less risky proposition than the tried and true methods of expanded marketing and sales efforts. Further, acquisition offers a myriad of other advantages such as easier financing and instant economies of scale. The competitive advantages too are formidable, ranging from catching one's competition off guard, to instant market penetration even in areas where you may currently be weak, to the elimination of a competitor(s) through its acquisition.
Synergistic acquisition is not limited to buying direct competitors. We will also detail how small and mid-size companies can efficiently grow by buying related or complimentary companies. It is quite common for a company to buy another to take better advantage of each other's distribution channels. For example, a candy manufacturer with several retail outlets, might purchase a specialty food mail order company. The buying company could then use the mail order company's distribution channels to sell its candy. If it were a really good fit, it could also offer some of the mail order firm's products through its retail outlets.
Another fairly common type of acquisition involves the purchase of a company in the same industry but in a different geographic area. Internet Service Provider companies, for example often buy ISP's in other regions. Cost center elements like customer service and billing can be centralized to gain economies of scale through the dramatic increase in volume of business.
Few major companies have grown to where they are today without acquiring at least a few companies along the way. Many of the Fortune 500 group of companies achieved membership in that exclusive club by relying on external growth strategies. This is particularly true in rapidly changing industries such as telecommunications and high technology. Yet successful companies in less volatile industries like groceries, home construction products, and certainly banking often rely on a acquisition to achieve growth, market share, economies of scale, and marketing clout.
The benefits of growth through acquisition are hardly limited to marketing. It is typically easier to finance growth via acquisition than via more traditional routes of expansion. As we'll demonstrate, lenders and investors are more impressed by real financials than with projections based business plans, no matter how positive they may be. Further, a whole otherwise non-existent form of financing is available through the common practice of seller financing. That is, business buyers typically pay some of the sales price over a period of several years, at interest rates below those of bank lending rates.
The catalyst driving many business acquisitions involve synergies. When companies are merged together, the whole is often greater than the sum of its parts. Synergies involving marketing and economies of scale, as pointed out already, are clear benefits. Also, there are typically opportunities involving production, volume discounts in purchasing, and reduced overhead expenses (as a percentage of sales).Free Consultation
Conventional Wisdom & Acquisition Wisdom
Build Customer Loyalty, Sell Aggressively, Growth Will Follow
The conventional wisdom, which this book will challenge, is based on time honored principles. As with many time honored principles, they have been subject to less and less consideration over time, so eventually their wisdom stops being questioned and they are accepted without examination.
For example, it's almost an axiom that to grow, it is essential to gain trust and customer loyalty. This is done by consistently doing a superior job and gaining a top-notch reputation. Now a good job and a top-notch reputation are certainly admirable characteristics and business advantages. They are not always the most essential ingredients to growth though. Even companies with less than stellar reputations and fickle customers can and do grow through acquisition. We're not saying to discount a well-developed reputation. We are saying that this is only one route to growth, and while perhaps the most laudable, not necessarily the most efficient, by itself.
Another unchallenged principle is that business success and growth goes only to the most aggressive business people. Aggressiveness is a valuable trait but it is manifest in a number of ways. Usually when advisors coach business owners to be more aggressive they mean aggressiveness in terms of sales efforts. "Knock on more doors, don't take no for an answer, do what you must to get that sale; that's how you'll grow." Business is a broad enough field that success can come from a number of directions and can come to people with varying personalities. Being a "don't take no for an answer" sales person can be helpful but it is not necessarily the only or even the most efficient mode of growing a business. Acquisition is a more efficient means to growth than a super charged sales effort.
Acquisition is Lower Risk
Another truism we challenge is that small business owners must take big risks, if they intend to grow. The conventional wisdom says, "The more rapidly you want to grow, the bigger the risks you must take." Now risk is a part of business, and every entrepreneur understands that. However, that doesn't mean huge risks are necessary on a regular basis and it doesn't mean there is anything wrong with minimizing risk to the extent possible. A lot of growth can indeed come from taking risks in the hope of a sizable return. A lot of growth can also come from the lower risk route of acquisition.
We can't argue that acquisition is without risk. We can argue that the risks are not only smaller but are also far easier to anticipate and quantify than are the more traditional risks associated with growth. For one thing the expenses of an acquisition can be projected with reasonable accuracy. The expenses associated with more traditional growth strategies are far less predictable when measured against a clear objective. For example suppose you're running a $10 million company and want to grow by 50%. Suppose also there is a $5 million company for sale for $2 million. Well, your 50% growth will cost $2 million. Under this scenario, your likelihood of achieving your 50% growth goal is very near 100%
Suppose you instead decided on a more traditional method of achieving 50% growth such as increased promotion or increased sales effort. How much would it cost? How long would it take? How likely is it that the projected number of dollars spent would achieve the stated growth goal?
Our point: an acquisition strategy may well be cheaper, is probably quicker, and is certainly less risky in terms of meeting the stated objective at the anticipated cost.Get a Free Copy of Our Book
Ease of Integration
Rapid growth comes with some dangers. Some otherwise successful companies, have actually gone under due to rapid growth. While growth is enviable, it by nature is problematic. Spur of the moment management decisions must be made regularly, without benefit of adequate supporting information. Money and resources must be expended in advance of projected increased revenues, or one runs the risk of not being equipped to adequately deal with the new business efficiently, thereby alienating customers.
For example, in a modest growth environment, existing employees can generally accommodate the modest increases in responsibilities and volume of work. When they become stretched, orderly hiring can begin. Likewise, when facilities become cramped, you can start seeking new space to rent or buy. However, when growth is taking place at say, 45% a year, making the decisions of when to hire, when to buy new capital equipment, and when to expand facilities become infinitely more complex. Expending a lot of money and other resources too early can be very wasteful. But making the expenditures too late can be disastrous in that all sorts of problems will occur in trying to please the new customers that your marketing efforts (and dollars) worked so hard to secure.
Contrast the seat-of-the-pants decision and plan making of this kind of expansion with an acquisition. First, you know within a small margin of error what your expanded volume will be-you're buying a defined customer base with a history by which to make inferences based upon hard data.
Second, systems and procedures will be in place to handle the increases. The selling company has the facilities, procedures, and even the employees in place to deal with the new business smoothly and without the need for quick decisions and interventions. After all, though it's new business to you, it's business they've been dealing with for some time. You may elect to make changes in procedures, but you won't need to do so immediately, and you probably won't want to do so until you have watched and analyzed the systems that you acquired with the company you purchased
An expansion of any type comes with challenges, sometimes wrenching challenges as a business enters uncharted territory. An acquisition may have a few surprises and challenges, but they are likely to be controllable; far more controllable than the uncharted territory of traditional rapid expansion. Spur of the moment decisions without adequate information will be the exception, not the rule. The conventional wisdom is that growth should be kept in the 5% to 25% per year range in most industries. Much more than that and the danger increases exponentially. "Control your growth, take the time necessary to digest the new business (and new challenges) that's coming from your growth efforts. Consider the fact that new customers you've gained, particularly if you've stolen them from a competitor are fickle customers and need to receive special attention and TLC to retain their loyalty. The longer a customer has been a customer of yours, the less likely he is to be wooed away by a competitor." This is the kind of advice a small business owner is likely to hear.
Financing is Easier to Secure for Acquisition
Even if a confident entrepreneur insists that organic growth is better, he's likely to hit a brick wall in financing his ambitious expansion. Bankers, not known for challenging convention, will take a dim view of business plans projecting quick growth of say 60% to80% or more. They too will scold you about being unrealistic and not understanding the dangers of too-rapid growth. Now you may not care about the banker's scolding but getting the banker to agree to finance growth that he has determined to be too ambitious and too risky, we'll that will make the rest of your growth challenge seem like child's play.
Now here's where acquisition just plain wins hands down. Companies regularly acquire their way to 50%, 100% and even higher growth rates overnight through acquisitions. The warnings of too-rapid growth just don't apply because the systems to handle the growth are in place in the form of the business you just bought. Sure they may need some tweaking and changing to fit in with your own procedures, but chances are they are serviceable for a period of time, and that the adjustment will be relatively easy to achieve, at least relative to rapid growth by more traditional methods.
As for financing, the argument gets even more compelling. Not only do bankers accept growth through acquisition, they prefer it to even modest traditional growth. Bankers are taught to make projections based on past financial performance as demonstrated through financial statements. They pay lip service to business plans but they want to see tangibles, in terms of assets that they can take away from you if necessary, and in terms of past performance from which they can draw inferences regarding cash flow. When you buy a company you can show them what they want to see in their own language-the financial statements of the selling company.
Consider this financing scenario...
Banker: "Well Mr. Owner just what are you basing your ambitious projections of a $1,000,000 sales increase upon?"
You: "Well Mr. Banker, I'm basing it on the sales of the company we are buying which are about $1,000,000. Here's their financial statements for the past three years. And, notice the annual cash flow of $200,000 which will come in very handy for repaying the loan, Mr. Banker."
If this isn't advantage enough, consider that you may not even need the banker because sellers often will provide some of the cash needed to buy their company through owner financing. That's right, owners will often lend you much of the money to buy their business and they'll accept lower interest rates and may accept the assets of the business you’re buying as sloe security! Finally, consider the argument about new customers being fickle customers. When you buy a company, largely what you're buying is an established customer base. In many industries, a higher price is paid for customers that have been customers of that business for a longer time. Your new customers are not new customers. Sure they're new to you, but they'll keep doing business with the same company that they've been doing business with for years. The only difference: you'll now own that company.Free Consultation
Myth: Acquisition is Only for Large Companies
It's no secret that larger, publicly traded companies buy other companies regularly. Though it tends to be called "merger and acquisition" it's the same thing with a fancier name.
At least several times a month, the business pages carry a headline like Citibank is Acquiring XYZ Bank, or that Google is Buying Another High Tech Company.
Somehow, owners of smaller businesses assume that merger and acquisitions is a Wall Street game that is not appropriate for small businesses to play. Some of the mechanics are different (there can be no hostile takeovers of privately held companies, for example), and your acquisition probably won't be reported by CNBC. But the rationale is just as compelling and the benefits are just as real for a small privately held company as for a large publicly held firm.
More on Synergies and Economies of Scale through Acquisition
The benefits realized in a strategic acquisition are largely a result of synergies and economies of scale. Concept of Synergies (Can 2 + 2 = 5?)
In a well-executed acquisition, the acquiring company can take advantage of synergies. That is, the two companies together will be stronger and more profitable than either company was previously.
Synergy is roughly defined as two or more things together being better or more effective than the sum of their parts. As it's used here, it means two or more companies merging such that the combined resources of the merged unit have more than the sum of the value they had individually.
For example, suppose XYZ Engineering Company has very skilled sales and marketing people. Through their marketing abilities they have a number of contracts for sophisticated engineering projects. However, their engineering staff leaves something to be desired. The engineers are inexperienced and are not well equipped to handle the contracts that XYZ sales personnel are able to secure.
ABC Engineering Company has opposite strengths and weaknesses. This firm is made up of top flight engineers. However ABC does not have strong marketing abilities, so it holds few contracts despite its engineering superiority to XYZ. The obvious solution-- merge ABC and XYZ into one company. XYZ's marketing staff could secure contracts, while ABC's engineers could complete the jobs.
While this example is simple, it demonstrates a powerful business concept that is being exercised all the time by companies of all sizes. Some of this nation's most successful firms owe their success largely to external growth strategies that capitalize on the synergistic logic.
As we've discussed, conventional wisdom maintains that growth comes through delivering quality products and services, and effectively marketing those products and services. While this is one effective means to growth, it is not the only one. Another way to add customers, leads, production capabilities, and other intangible assets is to buy them.
Economies of Scale
Production economies of scale are obvious in an acquisition. Undeniable benefits of scale will be realized when a production facility is suddenly operating at say 85% of capacity rather than 50%. However, the economies of scale don't end with production. They also come into play in areas of marketing, administration, professional expertise and in other areas.
Most successful acquisitions are based largely on the concept of synergies and of economies of scale. Marketing synergies and production synergies drive many acquisitions. However, synergistic advantages can also result from strategically combining expertise, complimentary products, and several types of economies of scale. Add the advantages that acquisition is easier to finance and decidedly quicker and less risky to implement than more traditional growth strategies and you have a powerful alternative route to rapid expansion This lower risk shortcut to growth is every bit as appropriate to smaller businesses as to larger ones.
The Marketing Logic of Growth by Acquisition
The marketing advantages alone can more than justify a lot of acquisitions. Some of the advantages detailed below dwarf the incremental improvements that more familiar marketing methods will bring. What's more, a growth through acquisition strategy will probably be cheaper and almost certainly less risky than the typical uphill marketing campaign will be.
Acquiring Saves Marketing Dollars and Avoids Risk
Some novice entrepreneurs, and all too many new MBAs, think that they can develop marketing campaigns that are so good that sales will increase by huge percentages, and take profits on a similar journey up the growth chart. While such campaigns are possible, so is winning a lottery. Those of us who have been around marketing for awhile know that more typically, promotion results in incremental increases in sales and profits. Expecting a single ad or single ad campaign to quickly double sales is not realistic, at least not at an affordable cost. A more reasonable standard for most promotion is the return it garners beyond its cost. If I buy a thousand dollars’ worth of advertising and it brings in six hundred dollars in bottom line profit after paying for itself, I'm delighted with those results.
Most of us who have been around marketing for a while also understand its inherent risks, particularly when varying from the tried and true methods. For example, let's say ABC Digital is a computer repair service that has been in business for six years. For promotion, ABC relies solely on direct mail campaigns that routinely yields a 2% response with a 50% conversion to sales rate. Perhaps the ultimate cost of this marketing is $120 per new client recruited. Let's suppose this company wants to expand more quickly than its single method marketing will allow. There are, of course, a myriad of promotional possibilities-newspaper advertising, radio, TV, internet, direct sales, etc. However, as none of those have been used or even tested, they all involve significant risk. They may succeed in that that they may bring in clients at a cost of say $90 per customer-- $30 less per customer than the tried and true method. They may also bring disappointing result in that the cost will end up being $150 per customer or even may result in a net loss if the new revenues can't cover advertising expenses.
Let's look at another possibility for expansion for this mythical computer repair business. Let' say the owner has built the business to about $1,000,000 in revenues but he's decided he's gone as far as he can go with direct mail as his primary growth vehicle. His goals are ambitious-a 25% increase over the next year. He understands that to achieve his objectives he'll have to increase his advertising expense significantly on a total expenditure basis and probably on a per client gained basis as well. He's talked to all the advertising salesman he wants to talk to and heard each sales pitch about how advertising is an investment and how it takes many repetitions before an ad really pays for itself. They all stop short of anything approaching a promise and all look at him like he has two heads when he tries to negotiate a deal involving payment based on sales, or even upon responses, from the ad.
While he's pondering his decision he learns that a small competitor of his may be interested in selling his business. We'll steer clear of cleverness in business naming here and call the competitor XYZ Technologies. ABC and XYZ compete for the same types of customers-small businesses with two to ten computers at a single facility. He learns that he can buy this business for $250,000. XYZ claims a customer base of about 2200 customers, and gross sales of $350,000 which translates to sales of about $160 per customer per year. At this price, the acquisition would cost about $114 per customer. This rate is competitive with his direct mail response rate, far less risky than any of the untried promotional possibilities, and he would gain those new customers right away; there would be no ramp-up time.
He learns that while the price of $250,000 can't be negotiated any further, the terms may be flexible. Perhaps the owner would accept some of the payment over time or on a contingency basis (a partial credit for customer attrition) reducing the risk and initial cash outlay even further. We'll get into financing possibilities and advantages in a later chapter. For now though, let's focus on the marketing advantages of this simplified but far from unreasonable scenario:
|Increase Promotion||Acquire Business|
|promo costs with uncertain results 25% growth projected time frame: about a year costs paid as incurred (mostly advertising)||customers already exist, only risk is some attrition of customer base 35% increase (minus attrition estimated at 5% to 7%) time frame: literally overnight some costs paid on delivery of actual customer base, some deferred based on negotiations with seller|
Acquiring a Distribution Channel
A common marketing goal of acquisition is the merging and sharing of distribution channels. A distribution channel, or more to the point a customer base, typically takes years of hard work to develop. However, acquisition can be a very effective shortcut. For example:
A distributor of outdoor furniture, which we'll call Yard and Patio Furniture Co. had been selling its products to garden and patio retailers for over 15 years. The company's owner wanted to expand. He was familiar with the tried and true methods of growing a business; he had been using them for 15 years. In the past he had grown by hiring sales people to knock on doors, advertising by direct mail, and advertising by telemarketing. All of the methods worked to some degree, and all involved risking time and money.
With our help, the owner looked at the alternative possibility of growth through acquisition. Together we set the following acquisition goals for the company:
- Add a new synergistically appropriate product line(s) that could be sold to Yard and Patio's current customer base.
- Add a new customer base for Yard and Patio's line of outdoor furniture.
- Increase Yard and Patio's sales and profits, while limiting the corresponding increase in overhead.
After a period of six months of looking, this firm found and bought a company that imports specialized planters and wholesales them to garden and patio shops. Now, Yard and Patio can sell its furniture to the acquired company's customers, and sell the acquired company's planters to its own furniture customers. The two companies were geographically far enough apart that there was very little overlap in customers.
In another example, a large company owned a regional (West Coast) manufacturing firm that made plumbing fixtures for mobile homes. It purchased a Midwestern manufacturer of mobile home heating devices. Of course, both companies sold to the same industry, mobile home manufacturers, but in different geographic regions. The goals here were to instantly gain a Midwestern distribution channel for the West Coast company, and a West Coast channel for the Midwest firm. Now this firm is selling plumbing and heating devices in both the West and Midwest by exploiting its pre-existing and its acquired distribution channels. The company is now trying to find and purchase similar firms in other regions to expand further, using the same synergistic strategy.
In both of these instances, developing new customers by relying on the traditional bag of tricks of sales and marketing would have been a far more cumbersome, expensive, and time consuming undertaking than was the path chosen. In fact in the case of the mobile home component example, the acquired company nearly doubled its volume overnight through the acquisition. The buying company has gone from a 300 million dollar firm ten years ago to a 1.2 billion dollar firm today, primarily through its synergistic external growth strategy.
This type of acquisition of a channel is another potential advantage of buying a company. The advantages here are too obvious to dwell upon. Gaining resellers is clearly one of the major challenges facing wholesalers. Once retailers are secured as customers, they tend to remain as customers. It is far easier for a wholesaler already supplying a resellers to introduce new items than it is for a new wholesaler to break in with a reseller no matter how good his products, service, or prices may be. Many large and even some small bookstores, for example, have a policy of refusing to consider books from wholesalers (or publishers) who aren't already selling to them (i.e., they must be on an approved vendor list for the title to even be considered). However, when an existing publisher comes out with a new title, as they do on a regular basis, it is an easy sell to get that title on the bookstore shelf, at least on a test basis.
Using the bookstore example, consider a small publisher with great new books but no secured resellers. If he tries to get bookstores to even test his great titles, he is likely to be disappointed. However, if he acquires a company already on the vendor list of a number of stores, his selling job is far easier.Get a Free Copy of the Book
Add Value to Existing Channel
Currently, we are working with an electronic connector manufacturer that sells to companies that assemble electronic devices. This company is seeking to acquire a company that manufactures a related product such as electronic cables or power devices. The logic here is that the same customers who are already regularly purchasing connectors also purchase electronic cables, power supplies, etc., just as regularly. If this company is successful in finding a manufacturer of complimentary products, it then can add those products to its own connector offerings that are sold to its customer base. Needless to point out, it will sell its connectors through the acquired company's reseller channels as well.
It is fair to say that many businesses that have gone through the effort of setting up a stable of resellers (a channel of distribution) are under-utilizing that channel. A company selling only its current products through those channels and letting others reap the benefits of complimentary product sales is selling itself short. An acquisition is a viable remedy to this shortfall.
Promotion Synergies & Economies
There aren't too many services that better demonstrate the concept of economies of scale then the printing industry. Print 1000 brochures and it may cost $200 or 20 cents each piece. Print 2000 and it may cost $250 or 8 cents each piece, 60% less on a per piece basis. The more you print the cheaper it is on a unit cost basis. Even in the high tech 21st century, printing is still an integral component of marketing campaigns so saving on printing costs alone can contribute to bottom line profitability. The same kinds of saving though perhaps less dramatic than the printing example can also be realized in space advertising, media advertising, or any other service where eager salesmen will offer better prices for higher volume purchases.
The economies don't end with quantity discounts though. Consider the cost of creating a product catalog or a web site with online catalog ordering. In either case doubling the number of products offered will not come close to doubling your costs. It may increase costs by say 20%. Just like in the printing example this drastically lowers the per catalog item cost. Also, it arguably makes for a stronger catalog or web site in that more products offered will lead to a synergistic effect in purchasing as your catalog becomes more of a one-stop-shopping vehicle.
Increase Market Share
Years ago a local businessman approached us because he wanted to buy a business for his daughter. I told him about a package and mailing storefront business for sale. He thought about it and said, "Well, if you can find two or three more for sale in the same area, I might be interested, but I don't want to buy just this one". His logic: a small storefront location would have a very hard time competing with the heavyweight competition from franchises like Wrap & Pack or Mailboxes Etc. However, with a few locations in the same area where brand identification could be established and economies of scale could be achieved, his daughter would have a chance to compete on closer to equal footing. She also would be able to concentrate her competitive efforts on the franchises and not have to worry about the independents in the area (because Dad already bought them for her).
Market share equals market clout. By acquiring a company in your own industry you can gain that market share immediately and the market influence that comes with it. A company with a formidable market share can more confidently make pricing and other business decisions rather than merely respond to what others are doing. A large long distance carrier can risk increasing its prices without losing too many customers, even if the increase would mean other smaller companies might provide long distance services cheaper in some localities.
In all likelihood if AT&T or Verizon raised prices, smaller carriers would soon follow their lead and raise prices as well. Paradoxically though, the smaller companies don’t enjoy the economies of scale of a large provider like Verizon. They would probably need the increase more than Verizon does to earn a profit given the less favorable cost structures. However, a small phone company would be taking a huge risk if it raised its prices before AT&T and Verizon and the other major players (read, those with a large market share) raised theirs.
The same logic can work in local or niche marketplaces as with the long distance company example. Supermarket pricing of vegetables will have influence on how local farm stands set their prices though the supermarket will probably not be too influenced by the farm stand prices. Finally, in the case of an expanding market, the larger your market share, the more your sales are carried along with the increases. As the entire market for say GPS devices grows, Garmin with its large market share will be a large beneficiary. As the market for greeting cards increase, Hallmark will benefit more than smaller greeting card companies will.
Eliminate a Competitor through Acquisition
If some of the above discussion of market share seems too theoretical for a smaller business, here's a clear and practical benefit of buying a competitor. Quite simply: after the purchase, you have one less competitor. Now in a market with lots of competition, one less may not be that big of a deal. But consider this real situation. Years ago, I was approached by a typing and copying service in the heart of an urban college campus area. They wanted to sell their company which was marginally profitable. I didn't have to do a lot of research to find a buyer. The company's only neighborhood competitor was a block away. I approached the competing company arguing that if he bought his only competitor he would be able to increase prices with impunity, and would not have to jump through as many hoops to please his demanding clientele. After all, the threat of going down the street to his competitor would no longer mean much if he owned that competitor. He bought the argument and the company. The students may not be happy, but the owner of the only typing and copying service in this area is very happy.
Shrink Your Overhead Percentage
Economies of scale typically involve one form or another of quantity buying in order to get a per unit cost advantage. For example it may cost $500 to print 1000 brochures but $800 to print 3000 brochures. Another element of the economies of scale advantage to acquisition involves gaining cost efficiencies in meeting general business overhead (often called meeting your nut). Just about every business has some expenses that it must meet each month whether the month is a sales record breaker or a sales disaster. Most businesses (not all) have more producing capacity than they fill without increasing their fixed overhead. Most drug stores can fill at least a few more prescriptions without buying new pharmacy equipment or hiring more pharmacists. Most delivery services can deliver more packages without hiring new drivers and buying new trucks, etc. The necessity of efficiently meeting overhead was brought home to me early in my small business career. Just out of business school, I started a video production business. Somehow I was able to persuade a bank into lending my fledgling corporation money to buy the cameras, editing equipment, and the other expensive equipment that a video production company needs in order to operate.
As my partner and I were celebrating and admiring our state of the art setup, two frightening thoughts occurred to me. Both thoughts had been in the back of my mind for a while, but now they moved rapidly and forcefully to center stage. First, the bank would soon be expecting payment number one of a long string of monthly payments of principle and interest, whether or not our new equipment was in use and earning money. Second, that equipment was depreciating in value, again whether or not it was making us money. When I shared my logic and panic with my partner it kind of dumped cold water on our little celebration and technological admiration session. Instead, we sat down to try to figure out how we could get some customers to pay us money so we could in turn pay the bank, and hopefully have a few dollars left over for ourselves; all this before our equipment became antiquated and worthless.
The same issue faces just about any business that relies heavily on expensive equipment and/or expensive facilities. A factory must pay the fixed expenses on its production equipment whether or not it's in use, a hotel must pay the fixed expenses on a each room whether occupied or not, and an internet service provider must pay for its equipment and facilities whether their servers are at 40%, 50% or 80% of capacity.
The challenge of getting the maximum out of every expense dollar isn't only for business that rely on high priced equipment and facilities. Generally, labor costs are the same whether employees are working or waiting for work as are associated costs such as worker's comp insurance, health insurance, payroll preparation expenses, etc. Other expenses like telephone and other utilities, some taxes, professional dues, and a host of others remain relatively constant whether you're operating near or nowhere near capacity.
Just like I had to hustle to keep my young video company as near capacity as possible many if not most other businesses have to hustle to get paying customers to first meet overhead expenses and then earn a profit.. Hustling (as it's used here meaning to sell like crazy) is the most time-honored way to achieve this essential objective. Certainly the first and most common reaction for the business person frightened like I was at the prospect of piling up expenses as I was is to "get out there and sell".
Sales efforts are important to keeping a business going; there's hardly a prudent argument to the contrary. However, it would also be prudent to concurrently look at filing excess capacity by gaining customers via the acquisition route. As shown previously in this book, companies routinely acquire companies in their own industry and dramatically increase their business overnight while cutting way down on their excess capacities and their overhead as a percentage of their revenues. For a company with significant excess capacity whether it be unused video production equipment, unused office space, or under-worked employees, this kind of acquisition makes a great deal of sense. Let's look at a few examples:
Recently, we brokered the sale of a company engaged in the prepress business. Prepress is an essential step in the color printing process, and as the name implies, a step that is completed before printing is started. The selling company, which had sales in the $2 million range was bought by a much larger competitor with a facility less than 25 miles from the selling firm's offices. Within three months of the acquisition, the buyer sold off most of the selling company's equipment and incorporated the entire operation into their existing facility. From the buyer's perspective what they essentially did was buy the seller's customers in order to eliminate some of their own excess capacity. The savings in office rental, labor, and equipment together with the revenues from selling off the seller's equipment more than paid for the acquisition. The elimination of a major local competitor and the economies of scale resulting from a bigger operation (by $2,000,000) didn't hurt bottom, line either.
Another example: Companies of all sizes retain payroll service companies to handle the processing of payroll for their employees. The sensitive nature of the work these service companies provide, makes it particularly unappealing for their clients to change to another service, so it's difficult for one company to steal customers from a competitor. Also, overhead is more or less fixed up to certain capacity levels. For example, a company may calculate that they can handle say 100 more client companies without adding computers, employees, office space, etc. To achieve and enhance profitability, payroll services need to decrease overhead on a percentage of gross sales basis. For these reasons payroll companies love to acquire their competitors
A payroll company may be struggling to get by with gross fee receipts of about $200,000 and expenses of $175,000. However, to a larger company that acquires this company, the $200,000 in revenues may stay the same or may decrease by about 5% (due to a few lost clients in the transfer) to$190,000. However, the acquired expenses of $175,000 would decrease dramatically to perhaps $90,000 (or less). So a company earning about $25,000 for its previous owner ($200,000-$175,000) will immediately be earning $100,000 for the buying company ($190,000-90,000).
Cost efficiencies in meeting overhead in and of themselves can often more than justify an acquisition. But there is no need to stop with that efficiency; the economies of scale that come with quantity purchasing will also accrue to the acquiring company More often than not, additional benefits will accrue to an acquiring company. Any business with a sizable overhead to pay can likely benefit from a well-executed acquisition of a company in the same industry. By all means continue your aggressive sales and marketing efforts. However, acquisition can be a nice shortcut to filling excessive capacities if you can find the right match.
Acquisition can be a faster, cheaper, and generally more efficient shortcut to growth for companies of any size. The risk is smaller, and the financing is easier. Finding the right company to acquire takes some effort. We can help you with finding the right acquisition and with the entire growth through acquisition process. Please contact us for further information.
For complete information on finding and buying a company, check out our book: Strategic Acquisition: A Smarter Way to Grow a Company.Free Consultation