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Approaching acquisition strategically How Indian FMCG players can scale-up successfully in a

concentrating market

Approaching acquisition strategically Kanvic .com

!Approaching acquisition strategically How Indian FMCG players can scale-up successfully in a concentrating market. !!In a concentrating FMCG market, tremendous pressure is put on outgrowing competitors. In this context, acquisitions are a major instrument of growth. To avoid costly mistakes, Indian FMCG leaders would benefit from putting strategy at the centre of their acquisition game plan. !by Deepak Sharma and Vlad Flamind

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Indian FMCG companies are racing for scale and market share to secure a sustainable position in an increasingly competitive marketplace. This has made ramping up growth the top priority of most CEOs. To achieve their objectives a number of FMCG companies have resorted to inorganic growth. However, this acceleration in M&A activity has had mixed results, producing a number of failures, characterised by the inability of the buyer to grow the acquired brands. !Because organic growth alone has limitations, Indian FMCG companies must keep on playing the acquisition game. However, to improve their chances of winning they should put strategy at the core of their acquisition game plan.

Scale is increasingly important in a concentrating FMCG market

In the last few years, the Indian FMCG industry has witnessed the rapid expansion of ambitious players such as Dabur, Godrej, Marico and Wipro. These companies have been on a fast growth trajectory, distancing themselves from smaller competitors and closing in on the top five players. The motivations behind such aggressive growth have been to increase market share, but also to gain scale benefits. These benefits come in the form of better utilisation of tangible and intangible assets, more efficient spreading of costs across business units, and an improvement in bargaining power.

Deepak Sharma (deepak@kanvic.com) is cofounder and partner at Kanvic where he leads the strategy practice. Vlad Flamind (vlad@kanvic.com) is an associate consultant working in Kanvic’s strategy practice between India and Europe.

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As fast-growing players became bigger, companies that failed to keep-up found themselves under increasing pressure. These players have seen their position erode as the more aggressive players ate into their customer base (Exhibit 01). Most impacted were smaller-scale players who have found it increasingly d i f f i cu l t t o compe te i n a more concentrated market.

Acquisitions are a key instrument of growth for many players

Many Indian players turned their attention towards acquisitions as a means to win the race for scale. These players started acquiring more often, going after bigger targets, and widening their scope to include new categories and even new countries that could deliver faster growth.

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For example, between 2005 and 2012, God re j a cqu i r ed mo re t han 10 companies, adding around 4 new brands per year to its existing portfolio and expanding its presence in more than 20 count r i e s . In the same per i od , c ompe t i t o r Dabu r pu r c ha s ed 4 companies, adding more than 20 brands to its portfolio and expanding to new categories and geographies as well (Exhibit 02).

Players like Wipro Consumer Care and Jyothy Laboratories have also stepped-up their game in recent years by engaging in large-scale acquisitions.

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Acquisitions can be value destroying if they are carried out on impulse and without clear direction

The problem with playing the acquisition game with such zeal is that strategy often comes after opportunity. The acquisition game as it is currently being played is leading managers to put excessive stress on rapid, intuition-based decision-making and thus to neglect careful strategic analysis.

As a result, many of the acquired brands fail to deliver the results expected by their buyer. In the last few years, the Indian FMCG market has seen a number of unfortunate acquirers pay a premium for brands they could not grow any better than their previous owner (Exhibit 03).

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The most frequent reasons for failure in these cases were a lack of commitment to the category relative to established competitors, and/or a lack of capabilities to grow the acquired brands. !For example, an Indian player ventured into a sub segment of the hair care category by buying a rising brand. Instead of growing further after this acquisition, the brand has consistently been on a downward trend. During a period of seven years, faster growing competitors have managed to strip this brand of almost one third of its market share. Another good illustration is a leading personal care player that launched an aggressive expansion into food categories, only to grasp - several months after the acquisition - the full complexity of distributing perishables and fresh products. !In contrast, certain companies have had impressive success in growing acquired b rands much f a s t e r t han t he i r predecessors.

A large Indian player managed to double the market share of a toothpaste brand less than 5 years after acquiring it. This company recognised how the scale of its manufacturing units, distr ibution network and advertising budget could help a stagnating brand skyrocket. !Approaching acquisitions strategically is the key to value creating deals

Instead of immediately jumping at emerging acquisition opportunities, managers should first assess them through a strategic lens. A strategic view will help acquirers generate more value more consistently by focusing their hunt in the right territory, by enabling them to track value adding targets closely, and by getting them into position to pull the trigger at the right moment. In the business terminology, this means that buyers should improve in three areas: matching targets with existing strategy, assessing value creation opportunities thoroughly, and staying ready for opportunity (Exhibit 04).

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Clarifying corporate and growth strategies is the first step to successful target hunting

Aligning targets with strategy is the first and most crucial step towards value-adding acquisitions. From a purely financial perspective, there are two ways to get value from acquisitions. First, a buyer is rewarded when it raises the present value of the acquired business above the price paid for acquisition. Second, a buyer wins when the sum of present values, for acquired and existing businesses combined, add up to more than the present value of these businesses considered separately.

From the strategic perspective, this means that successful acquisition should be aligned with corporate and growth strategies for a buyer to capture value. Corporate strategy, in a nutshell, is the set of decisions and actions taken to ensure that business units perform better together than as standalone organisations. Centralised head-office functions, mobility of human resources and redistribution of cash are examples of initiatives that can create such advantage. The focus of growth strategy is to ensure that each business unit is positioned in the right market space and has the necessary capabilities to win the competitive battle (Exhibit 05).

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From the point of view of acquisitions, this means that on the one hand, acquired businesses should help the buyer establish strong positions in market spaces where it can outperform the competition. When this is not the case, acquired brands progressively collapse under competitive pressure. The resources invested by the new owner, in the acquisition and in further attempts to grow the brand often offer poor returns. On the other hand, it means that targets should also have the potential to benefit from the buyer’s unique capabilities, to ensure that it can justify the premium paid to the former owners.

Af ter the corporate and growth strategies have been outlined, managers should determine what market position or capability they should develop through acquisition and what can be achieved through organic growth. In general, acquisitions are a faster and more cost effective way of acquiring market share, technology or knowledge compared to organic growth. However, they also require more cash, involve greater risks and result in less control over the organisation and its culture. In determining the balance between organic and inorganic growth these elements need to be taken into consideration.

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Clarity about corporate and growth strategy enables focused and efficient target screening

Once leaders have formed a clear picture of how acquisitions could bring their company closer to their goals, they can start to outline what an appropriate target company could look like. The key criteria for a desirable target company should be defined including: the size of the target; its financial performance; its ownership structure; the positioning of its brands; its corporate culture; and its capabilities.

Having such clear selection criteria is essential to ensure that the companies that are considered as potential targets have high prospects to become valuable additions to the buyer’s portfolio. !With this picture in mind, buyers can start looking at the market to identify potential targets. From an initial pool of companies operating in desired market spaces or geographies, the buyer can obtain a shortlist of top targets by going through a process of screening and ranking (Exhibit 6).

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Potential targets must be identified first based on their expected fit with the buyer’s corporate and growth strategy. These companies can in turn be ranked to obtain a shortlist by using further filtering criteria. These criteria can include: an evaluation of the target’s readiness to sell; an assessment of the existing relationships between the leadership of the buyer and target company; or simply the degree of u rgency to acqu i re the des i red capabilities or market position. !Thoroughness in assessing synergies is key to value creation

Once buyers are clear about what type of targets are the most attractive, they should begin to assess the opportunities for value creation on a case-to-case basis. While going through the shortlist of qualified targets, managers should clarify both how they intend to promote synergies in the short term, and how they will grow the acquired brands in the longer term. !There are two principal errors managers make in assessing potential synergies. The first is arriving at an incorrect understanding of potential synergies. This often comes from leaving potential cannibalisation out of the equation, as we l l as foresee ing non-ex is tent opportunities for cross selling, or headcount and overheads reductions.

The second error is having unrealistic expectations - that is overestimating potential gains or the management’s capacity for execution. To avoid such mistakes, it is important to form the right team to conduct the synergy assessment. Ideally, the team should have a balance between financially focused peop le , s t ra teg is ts and operations experts. More importantly, to become elite acquirers, managers should ensure that emotional attachment and individual financial incentives do not come in the way of unbiased decision making. !As far as growing the acquired business is concerned, managers should be equally thorough in detailing their plans. They should identify the specific leverage points they will rely on to grow the acquired business in the mid to long term, and understand how they will allocate resources in order to reach their growth objectives. Critical areas to investigate at this stage include: the potential to accelerate innovation cycles, extend brand and product lines, and even reposition the brand. Managers are generally thorough in answering these questions when acquiring a business they plan to turnaround. However, when acquiring a healthy business, they often assume a linear progression of its current growth, despite the impact of the leadership and organisational changes it will undergo.

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Having a team dedicated to chasing acquisition opportunities is a major advantage

With a list of high potential targets and a clear plan to generate value, managers are now hunting for the right targets in the right territory. However, to become elite acquirers, they still need to track their targets, and be in the prime position when the time comes to pull the trigger. To ensure they are ready to secure deals before competing bidders, acquirers should have a team in place dedicated to pursuing acquisition opportunities on a continual basis. !The role of this team is to monitor the market for value adding targets, track the results and future plans of each target, and build relationships with their key decision makers. It is often a d v i s a b l e t o i n c l u d e o u t s i d e professionals in the team to complement the internal team’s skill set. Further it can be useful to engage a third party to facilitate contact between the buyer and the target when discretion is required. !After forming the acquisition team, it is crucial that the leadership clearly informs the team of the firm’s corporate and growth strategies to ensure targets are aligned with the their objectives.

To prioritise the team’s activities it is often useful to assess the readiness to sell of the target’s decision makers. To make this assessment, research on ownership structure is always useful, but other areas must be investigated as well. Financial difficulties, poorly performing brands, or market turbulence may all be powerful indicators that the time is right for a target to consider selling. !In addition to assessing the readiness to sell, teams should create a sale thesis for each target. This document should outline the major reasons why the target shareholders would benefit from selling assets, brands, business units or even the entire organisation to the buyer. The sale thesis is a crucial tool for aspiring acquirers to approach their targets with compelling arguments. It should be built with the same analytical rigour that would be applied to the writing of its counterpart, the investment thesis. !In complement to their research initiatives, team members should be proactive in developing relationships with top targets. The objective is to create enough trust and familiarity to promote open discuss ions about acquisition and divestiture opportunities.

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They should then apply a stringent process of elimination to identify targets with the highest potential for value creation. Once targets are listed, managers should proactively study these targets and build relationships with them. By fo l lowing these steps, managers can avoid the pitfalls of opportunistic acquisitions and become strategic acquirers. Among the firms hunting for acquisition opportunities, only the best will bag the most promising deals. The winners might not be those who are the fastest to fire, but rather those that are most thoughtful about the targets they select. In this way, strategic acquirers are more likely to avoid value destructive deals, and grow where they can sustain long term leadership.

The sale thesis prepared by the team should be introduced, discussed and refined during recurring interactions with the target’s management. At the same time, the aspiring buyer should be attentive to the fears and concerns of the target’s owners and managers. It is often important for the buyer to show its willingness and capacity to keep a business with a long history and strong sentimental value on the right track. In the same way, it is important to send the right signals to other stakeholders about the prospects of working under the new ownersh ip , t o p reven t resistance and build allies before a deal is announced, or even decided. By tracking their targets closely, aspiring buyers can be in prime position with a suitably attractive offer when it’s time to pull the trigger. !In conclusion, managers will need to excel at acquisitions to succeed in a rapidly concentrating Indian market. To make better acquisitions, they can start by screening opportunities to match them with their chosen corporate and growth strategies.

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About Kanvic !Kanvic is a management consulting firm helping businesses develop winning

strategies, drive profitable growth and achieve operational excellence to

reap long lasting rewards in the fast growing Indian economy. We work with C-

level executives to develop innovative solutions for the business challenges of

21st century India by bringing in leading edge management thinking informed

by in-depth research and sound analysis.

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