Organizations operate in a competitive and highly dynamic market. Therefore, they are required to develop mechanisms and strategies that will allow them to stay ahead of their competitors. One of the ways through which an enterprise can enhance its competitiveness and expand its market share is by acquisition (Bogetoft, P., & Wang, 2005; Epstein, 2005). The process entails buying another company that was operating in the same or different market. The company may remain operational under the original name but controlled by the new buyers. Enterprises engage in acquisitions for a wide range of reasons such as to get into a new market, create a monopoly, and strengthen their position in the market. In other instances, the acquisitions are used as the basis for expanding the company’s market share in a given region. Measuring the value creation that occurs as a result of a merger or acquisition has been a major area of concern for organizations and researchers. Available research evidence shows that the value is usually seen in terms of the short-term and long-term impact on the organization (Färe, Grosskop, & Margaritis, 2011). The trend can be determined by looking at the revenue streams, stock returns, and market efficiency. Before acquisitions, the organization must also examine the value of the enterprise to be bought to get an idea of how it will affect long term operations. This paper aims to review and compared two articles dealing with cost estimation in acquisitions.
Cost Estimation Models
The first article is an Estimation of potential gains from bank mergers: A novel two-stage cost efficiency DEA model by Shi et al. (2017). The paper aimed to develop a new two-stage cost estimation model that can be used to determine the value of an organization before a merger or acquisition. The authors defined a hypothetical DMU as a combination of two or more organizations that can pass the traditional production possibility set. Furthermore, the estimation process entailed constructing a merger production possibility set. In the framework that the authors created, the focus was on determining the total cost of the hypothetical DMU while analyzing and evaluating the output of the enterprises at the current level. The second stage of the cost estimation process entails determining the acquisition efficiency by evaluating both the minimal total cost and the actual cost. According to Shi et al. (2017), the model that they created provides an effective method for assessing the scale efficiency, technical efficiency, and the harmony efficiency in the acquisition and mergers. To show the applicability and usefulness of the two-stage model, the authors used a real dataset from the top 20 most competitive banks in China. Through the framework, the researchers were able to show that there are considerable gains that can be made through mergers and acquisitions in the Chinese commercial banks. Second, the data samples that the researchers used show that the acquisitions can help in enhancing technical efficiency and harmony efficiency in the banking sectors. Finally, the model was used to show that scale effect usually works against acquisition in some cases, an indication that they are not favorable for full-scale acquisitions and mergers.
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The second article that was evaluated in this paper was the effect of reference point prices on mergers and acquisitions by Baker et al. (2009). The authors stated that the price that a bidding firm usually offers to a target firm is normally the result of a negotiation with the target enterprise’s board. In most instances, the focus is normally on the synergies that can be achieved through the merger or acquisition. The price offer estimation starts with the determination of the increased value that can be achieved through the new entity once it comes under the new corporate structure. The process entails determining the cost reductions that will be witnessed in capital or labor equipment, improved management, supply chain reliability, debt tax shields, market power, expertise, human capital, internal finance, and customer base. Once the value gain has been calculated, the next phase is to divide it between the shareholders of the two entities based on their relative bargaining power. From a theoretical perspective, the calculations will result in the determination of specific and objective price for the target organization’s share (Baker et al., 2009). The authors also stated that there is a wide range of assumptions that are usually made when using the above framework work to calculate the cost of the acquisition. First, it is assumed that the two boards will have relatively objective bargaining powers. Besides, the two boards are not expected to shift the negotiations when engaging in the valuation process. The third assumption is that there are no additional bidders that will emerge once the negotiation processes have been started. When the above assumptions are in place, then the model can help in getting a precise price for the new acquisition.
The two articles offer vital insights that can be used as the basis for determining the cost of acquisition. A review of the articles shows that the authors have taken different approaches when it comes to determining the cost of an acquisition or merger. In the first article by Shi et al. (2017), the focus is on using a two-stage model that is based on the variable returns to scales when evaluating the efficiency of the acquisition or merger from a cost perspective. The model entails construction merger production possibility tests and using it as the basis for estimating the technical efficiencies, scale efficiency, and harmony efficiency. Besides, the two-stage model entails assessing the technical improvements and the scale effects that will be experienced through the acquisition. The second article, on the other hand, revolves around calculating the price value of the two organizations. In this case, the researchers highlighted the need for the boards to calculate the gains that will be made in terms of capital, human resources, customer base, management, stock prices, and efficiency on the organizations. The calculated value is then divided between the enterprises based on their overall bargaining power. In this case, the resulting figure should provide an idea of the stock price that should be paid for a given target organization in the market.
Certain similarities also exist in the two frameworks that are highlighted in the selected articles. The first similarity is that even though the researchers created unique models, their focus was on determining the objective cost of mergers and acquisitions based on the short term and long term impacts that they will have in both cases. The second similarity is that the costing method is based on both the historical and future data on the performance of the two enterprises. The primary goal is to ensure that the buying organization pays the right price for the acquisitions so that it can enhance its competitiveness in the local and global markets. Another similarity that can be noted in the two articles is that the cost estimation process should be done in a systematic way irrespective of the model that is used. In the first case, the authors proposed the use of a two-phase model to determine the cost of the acquisitions based on information related to technical efficiency and harmony efficiency. In the second article, the researchers proposed a systematic process in which the focus is one of the gains that will be made in the short term and the long term. The information that is obtained through the systematic cost determination processes will help the management in determining whether it is prudent and cost-effective to buy the target enterprise. Besides, the organization will be able to determine whether it will gain a competitive edge in the market through the proposed acquisitions and mergers.
Conclusion
The local and global markets have opportunities that business enterprises can exploit as they work to achieve their short term and long term business goals. Furthermore, the organizations are required to focus on creating strategies that will enable them to compete effectively with their rivals in the market. Failure to have such strategies in place can result in the loss of market share. Moreover, it can make it difficult for the organization to achieve the desired performance levels. One of the methods that modern businesses rely on as they strive to expand their market share and achieve their goals is acquisitions. The process entails identifying and buying a target organization to reach out to more or new customers. The new organizations are expected to give the buying enterprise an avenue through which it can gain a competitive edge in the market. Before engaging in acquisitions operations, organizations need to determine the overall cost that will be incurred. The methods used may differ from one organization to the other. The two articles that were reviewed in this article highlights examples of two models that modern organizations can use to objectively determine the actual cost of acquisition. The information obtained through the models may be used as the basis for making decisions regarding the need for an acquisition and the way it will affect the success of the buying enterprise.
References
Baker, M., Pan, B., & Wurgler, J. (2009). The effect of reference point prices on mergers and acquisitions. Journal of Financial Economics, 106 , 49-71.
Bogetoft, P., & Wang, D. (2005). Estimating the potential gains from mergers. Journal of Productivity Analysis , 23 (2), 145–171.
Epstein, M.J. (2005). The determinants and evaluation of merger success. Business Horizons , 48 (1), 37–46.
Färe, R., Grosskopf, S., & Margaritis, D. (2011). Coalition formation and data envelopment analysis. The Business and Economics Research Journal, 4 (2), 216–223.
Shi, X., Li, Y., Emrouznejad, A., Xie, J., & Liang, L. (2017). Estimation of potential gains from bank mergers: A novel two-stage cost efficiency DEA model. Journal of the Operational Research Society, 9, 1-10.
