Archetypes for Value-Creating Acquisitions  593 Perhaps it is just as important to identify the characteristics that don’t mat- ter. There is no evidence that the following acquisition dimensions indicate either value creation or value destruction: • Whether the transaction increases or dilutes earnings per share • The price-to-earnings ratio (P/E) of the acquirer relative to the target’s P/E • The degree to which the acquirer and the target are related, based on Standard Industrial Classification (SIC) codes • Whether deals are made when the economy is strong or weak16 This empirical evidence is important because it shows that there is no magic formula to make an acquisition successful. Like any other business strategy, acquisitions are not inherently good or bad, just as marketing or research and development (R&D) are not inherently good or bad. Each deal must have its own strategic logic, and the company must have the relevant skills to execute deals or deal programs. In our experience, acquirers in the most successful deals have well-articulated, specific value creation ideas going into each deal. The strategic rationales for less successful deals tend to be vague, such as to pursue international scale, fill in portfolio gaps, or build a third leg of the portfolio. Archetypes for Value-Creating Acquisitions The empirical analysis is limited in its ability to identify specific acquisition strategies that create value. This is because acquisitions come in a wide vari- ety of shapes and sizes and also because there is no objective way to classify acquisitions by strategy. Furthermore, the stated strategy may not be the real strategy. Companies typically talk up all kinds of strategic benefits from ac- quisitions that are really all about cutting costs. In the absence of empirical research, our suggestions for strategies that cre- ate value are based on our acquisitions work with companies. In our experi- ence, the strategic rationale for an acquisition that creates value for acquirers typically fits one of the following six archetypes: 1. Improve the performance of the target company. 2. Consolidate to remove excess capacity from an industry. 3. Create market access for the target’s (or, in some cases, the buyer’s) products. 16 Fich et al., “Large Wealth Creation in Mergers and Acquisitions.” 594  Mergers and Acquisitions 4. Acquire skills or technologies more quickly or at lower cost than they could be built in-house. 5. Exploit a business’s industry-specific scalability. 6. Pick winners early and help them develop their businesses. If an acquisition does not fit one or more of these archetypes, it’s unlikely to create value. The strategic rationale for an acquisition should be a specific articulation of one of these archetypes, not a vague concept like growth or strategic position- ing. While growth and strategic positioning may be important, they need to be translated into something tangible. Furthermore, even if your acquisition conforms to one of these archetypes, it still won’t create value if you overpay. Improve Target Company’s Performance One of the most common value-creating acquisition strategies is improving the performance of the target company. Put simply, you buy a company and radically reduce costs to improve margins and cash flows. In some cases, the acquirer may also take steps to accelerate revenue growth. Pursuing this strategy is what the best private-equity firms do. Acharya, Hahn, and Kehoe studied successful private-equity acquisitions where the tar- get company was bought, improved, and sold with no additional acquisitions along the way.17 They found that the operating profit margins of the acquired businesses increased by an average of about 2.5 percentage points more than at peer companies during the private-equity firm’s ownership. That means many of the transactions increased operating profit margins even more. Keep in mind that it is easier to improve the performance of a company with low margins and low return on invested capital (ROIC) than that of a high- margin, high-ROIC company. Consider the case of buying a company with a 6 percent operating profit margin. Reducing costs by three percentage points from 94 percent of revenues to 91 percent of revenues increases the margin to 9 percent and could lead to a 50 percent increase in the value of the company. In contrast, if the company’s operating profit margin is 30 percent, increasing the company’s value by 50 percent requires increasing the margin to 45 percent. Costs would need to decline from 70 percent of revenues to 55 percent, a 21 percent reduction in the cost base. That expectation might be unreasonable. Consolidate to Remove Excess Capacity As industries mature, they typically develop excess capacity. For example, in chemicals, companies are constantly looking for ways to get more production 17 V. V. Acharya, M. Hahn, and C. Kehoe, “Corporate Governance and Value Creation: Evidence from Private Equity” (working paper, Social Science Research Network, February 17, 2010).