Scale or scope?
The critical choice for business buyers

Most business acquisitions fall into one of two broad categories: scale or scope. While an M&A transaction can realize both of these goals, successful buyers typically decide which type of deal will best serve their long-term strategic objectives before they begin the acquisition process.

Choosing between scale and scope enables you to tune out the “noise” and focus on specific acquisition needs. You may end up, for example, passing on a company that’s appealing in many other ways but doesn’t work strategically. Or you may buy a company that on the surface shares little in common with your own, but offers specific long-term opportunities.

The case for scale

In a scale acquisition, the buyer seeks an enlarged presence in a particular market or sector and hopes to achieve greater overall economies of scale. For such acquisitions, buyers typically target a competitor or a company in a related sector or a new geographic market. Ideally, both companies should share similar costs.

While there are many potential economies of scale, some common ones include:

Reducing expenses. The purchase of a rival company may enable the consolidation of operations, thus reducing the new entity’s overall overhead and administrative costs. The combined organization is also likely to enjoy greater purchasing power as it negotiates prices with suppliers, which can lower variable costs, such as direct materials and labor, as well as fixed overhead expenses, such as rent and insurance premiums. Mergers of all types of companies, from oil pipelines (for example, Kinder Morgan and El Paso Corp.) to airlines (such as Southwest and AirTran), have been realized to get more “bang for the buck.”

Building a capital base. An acquisition can push your company to the next stage in its growth cycle. For example, a midsize manufacturer that buys a similar-size competitor could now generate enough revenue to invest in new equipment and technology upgrades that vastly expand its production output and improve quality. And lenders typically perceive larger borrowers as less risky, so a scale merger can improve your access to lower-cost financing.

Expanding research and development (R&D). A scale merger may enable you to cast a wider net and acquire new business intelligence. For example, in the pharmaceuticals industry, success depends on developing the next big drug. A company may buy a rival to consolidate R&D departments and apply R&D expenditures to a greater number of potential sales opportunities.

Support for scope

Scope deals aren’t as concerned with streamlining operations and cutting costs as scale deals. Typically, these transactions are made by companies that are already well established in their current market but want to move in a new direction. Mondel?z International has purchased several companies — including Kraft Foods and Cadbury — using this strategy.

Scope buyers often use their acquisition as a springboard into new and unfamiliar territory. The long-term goals of such a strategy are to:

  • Expand the company’s breadth and geographic range,
  • Open up new markets,
  • Sell products to new customers, and
  • Diversify the company.

This last objective is important because it makes the acquiring company less susceptible to market fluctuations and product cycle downturns.

On the other hand

It’s important to note that both scale and scope deals carry potential risks. Buyers in a scale deal risk devoting too much time and energy to cost-reduction initiatives when their primary focus should be on integrating the acquisition. Fixating on (often minor) cost synergies can sabotage future growth — not to mention employee morale.

Scope deals have the potential to be unrealistic if they aren’t backed up by solid due diligence and at least some core compatibilities between the two companies. If you acquire a company in an unfamiliar sector with a markedly different corporate culture, you should expect serious integration challenges.

Seller on board

Given the complexity of these needs, buyers and sellers need to be on the same page when it comes to the core strategic rationale of an acquisition. Knowing which type of deal you want and making sure that your seller supports your goals can help you make the right choice.