Chapter 7: Merger and Acquisition Strategies 221to profitability following payment of the nonrecurring acquisition costs. Firms tend to
underestimate the sum of indirect costs when specifying the value of the synergy that
may be created by integrating the acquired firm’s assets with the acquiring firm’s assets.7-3e Too Much Diversification
As explained in Chapter 6, diversification strategies, when used effectively, can help a firm
earn above-average returns. In general, firms using related diversification strategies out-
perform those employing unrelated diversification strategies. However, conglomerates
formed by using an unrelated diversification strategy also can be successful.
At some point, however, firms can become overdiversified. The level at which this
happens varies across companies because each firm has different capabilities to manage
diversification. Recall from Chapter 6 that related diversification requires more infor-
mation processing than does unrelated diversification. Because of this need to process
additional amounts of information, related diversified firms become overdiversified
with a smaller number of business units than do firms using an unrelated diversification
strategy.^68 Regardless of the type of diversification strategy implemented, however, the
firm that becomes overdiversified will experience a decline in its performance and likely a
decision to divest some of its units.^69 Commonly, such divestments, which tend to reshape
a firm’s competitive scope, are part of a firm’s restructuring strategy. (Restructuring is
discussed in greater detail later in the chapter.)
Even when a firm is not overdiversified, a high level of diversification can have a
negative effect on its long-term performance. For example, the scope created by addi-
tional amounts of diversification often causes managers to rely on financial rather than
strategic controls to evaluate business units’ performance (financial and strategic controls
are discussed in Chapters 11 and 12). Top-level executives often rely on financial controls
to assess the performance of business units when they do not have a rich understand-
ing of business units’ objectives and strategies. Using financial controls, such as return
on investment (ROI), causes individual business-unit managers to focus on short-term
outcomes at the expense of long-term investments. Reducing long-term investments to
generate short-term profits can negatively affect a firm’s overall performance ability.^70
Another problem resulting from overdiversification is the tendency for acquisitions
to become substitutes for innovation. Typically, managers have no interest in acquisitions
substituting for internal R&D efforts; however, a reinforcing cycle evolves. Costs asso-
ciated with acquisitions may result in fewer allocations to activities, such as R&D, that
are linked to innovation. Without adequate support, a firm’s innovation skills begin to
atrophy. Without internal innovation skills, a key option available to a firm to gain access
to innovation is to complete additional acquisitions. Evidence suggests that a firm using
acquisitions as a substitute for internal innovations eventually encounters performance
problems.^71
7-3f Managers Overly Focused on Acquisitions
Typically, a considerable amount of managerial time and energy is required for acquisi-
tion strategies to be used successfully. Activities with which managers become involved
include:
■■searching for viable acquisition candidates
■■completing effective due-diligence processes
■■preparing for negotiations
■■managing the integration process after completing the acquisition
Top-level managers do not personally gather all of the information and data required
to make acquisitions. However, these executives do make critical decisions regarding the