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One plus One can equal Three

Posted by David Humphrey on 17 August 2017 | Comments

Buying a competitor is a significant step, but can also be lucrative. Consider this simple example: Frank has a distribution business which, based on his profitability, would normally be worth $10,000,000. However he is only receiving offers in the $8,000,000 range due to customer concentration. One customer accounts for 30 percent of revenues making buyers nervous. His competitor, who is of similar size and profitability, also has a significant customer. One way to both lessen the customer concentration, and create value, is for Frank to buy the competitor for $8,000,000. A year later, Frank goes to sell his company once again. Now, since his revenues are twice as high, his largest customer is only 15 percent of revenues. The competitor’s largest customer, now part of Frank’s business, is only 15 percent as well. If the buyer perceives these customers as less risky since they are a “smaller” part of the business, Frank has immediately increased the value of his original business by $2,000,000 (25 percent) and the competitor’s business by $2,000,000 (another 25 percent) by reducing both customer concentration risks. The $8,000,000 purchase of the competitor increased Frank’s net worth by an additional $4,000,000, a 50 percent ROI (Return on Investment) with the acquisition.

This ROI increase is even before economies of scale are achieved by combining the two businesses, which should further increase value.

Acquisitions are a significant amount of work to locate, negotiate and integrate into an operation. Obviously, the example above is very simple and business integration is infinitely more complicated. However, acquisition of a competitor is a time-tested approach to value creation having been used successfully by some of the most famous and wealthiest industrialists for hundreds of years.