Chapter Ten
Failsafe Steps for Extraordinary M&A Growth
When companies merge or acquire, stakeholders usually expect that the whole will be greater than the sum of its parts. Unfortunately, the facts tell a different story. One plus one does not equal three; too often it moves shareholder returns to the wrong side of zero. A once-exceptional organization can quickly take a turn toward mediocrity or, worse, demise if leaders don’t plan meticulously, acquire intelligently, evaluate assiduously, and integrate attentively.
Study after study puts the failure rate of mergers and acquisitions between 70 and 90 percent. Many researchers have tried to explain those abysmal statistics, usually by analyzing the characteristics of deals that worked and those that didn’t. That’s a start, but that only informs decision-makers about the features of the deals that caused them to fail or prevented them it. It doesn’t truly get to the core of the cause/effect relationships among planning, evaluating, and integrating.
Traditionally leaders have lacked a more comprehensive approach, a way to determine how to merge for an exceptional advantage—a robust examination of the causes of both successes and failures. It all starts with a strategic purpose for the transaction and a commitment to distinguish between deals that might improve current operations and those that could dramatically transform the company’s growth prospects. A clear strategic advantage for the acquisition should lead the way.
Formulate a Solid Business Strategy
Both organic and acquisitive growth strategies often exist for a limited period, but sometimes an organization identifies expansion as a long-term objective and considers both forms of growth as part of their evolving strategy. Among all other influences, the desire to grow has one of the most dramatic, often hazardous effects on strategy. Limits and tradeoffs take a back seat to the desire to escalate, increase, or expand. The low-hanging fruit of growth opportunity entices. Therefore, perceived opportunities for growth tempt leaders to go in new directions—paths that can blur uniqueness, trigger compromises, and undermine competitive advantage. Adding new products, features, services, or markets is both alluring and appealing, but doing so without screening these opportunities or adapting them to the company’s existing strategy also invites trouble. Organic growth encourages its own kind of mischief, but acquisitive growth goes beyond, to an arena where true damage can occur. Caution should prevail.
Businesses make the decision to acquire for a number of reasons. On the one hand, companies will decide to acquire when they want to boost their current performance, to hold on to a premium position, or to cut costs. This kind of acquisition delivers bottom-line results but almost never changes the company’s trajectory. The improvements stop the leaking of assets but don’t truly put significant numbers of them in the coffers. For this kind of deal, CEOs often have unrealistic expectations about how much of a boost to assume; they pay too much; and they don’t understand how to integrate after the fact. Many of these deals fail to delight, even when they don’t truly fail.
Business leaders also make decisions to pursue acquisitions either to augment their organic growth efforts or to replace them when they have been exhausted, both decisions designed for top-line growth. Another, less familiar reason to acquire a company is to reinvent the business model and fundamentally redirect the company. Almost nobody understands how to identify the best targets to achieve this goal, how much to pay for them, and how or whether to integrate them. Yet they are the ones most likely to confound investors and pay off spectacularly—when they work. Even more caution required in this scenario.
Whatever the reason for considering an acquisition, senior leaders and board members face the challenge of offering and demanding a disciplined approach—an intellectual framework to guide decisions and serve as a counterweight to the quick and easy fix of unfettered growth. This requires an examination of which industry changes and customer needs the organization will respond to and which ones it will reject. Penetrating existing markets and reinforcing the company’s position help to maintain distinctiveness and competitive advantage, but a goal to squelch their enemies (competitors) usually provides only distraction and ill-advised compromise. Of course, major changes in the industry may require an organization to change its strategy, but taking a new position must be driven by the ability to find new tradeoffs and leverage a new system of complementary activities.
When executives feel motivated to pursue a new strategy that includes an acquisition, almost always they want to acquire new resources and capabilities. Sometimes that means a true strategic direction change; at other times it involves changes to the tactics. At no time should the decision to acquire compromise the strategic principle and strategic advantage I explained in Chapter Two—at least not without a conscious awareness that you’re gambling with the mortgage if you do so.
In any strategic initiative, the company should not concede its strategic principle—the power that exists at the intersection of distinction, passion, and profitability. This strategic principle explains why customers choose your products or service, why you make money at what you do, and why people want to work for your organization. It forms the foundation of your competitive advantage, the area that exerts the greatest influence on your business. Therefore, any deal that threatens your strategic principle is one you want to walk away from. But which deals should you walk toward?
It all starts with a well-thought-out strategic objective for growth, a decision that is rational and data-driven. It should not start with a directive from the board or a mandate from the owner or CEO to “double in five years.” When I hear that sort of goal, the professional hairs on the back of my neck stand up—and for good reason. The day-to-day decisions that drive that sort of growth objective often serve as the sniper’s bullets that take the company down. Leaders start making window-dressing hiring decisions they never have made before, they negotiate short-term pricing deals that can’t sustain them, and they opt for the quick fix instead of steadfastly positioning themselves for future rewards.
Instead, decision-makers should carefully craft the criteria for an acquisition—the “must haves” of the deal. They should also list and prioritize the “wants” of the deal but carefully and astutely distinguish these from the “must haves.” These criteria should have specific measures attached to them—ways by which everyone will agree success will be measured. Finally, everyone should evaluate the value each decisive factor will have. Borrowing from my mentor, Alan Weiss, I encourage clients to adopt an OMV (objectives, measures, values) orientation to these discussions:
• What are we trying to do?
• How will we agree we’ve done that?
• What good will it do?
The value of the deal merits the most discussion because that quite literally is where the money is. Beyond growing for the sake of growing, what good will this do in terms of actual dollars? What will the tangible payoffs be? Don’t confuse value with opportunism.
Does the acquiring company wish to buy a business simply because it is available? That’s what International Telephone and Telegraph did. From 1960 to 1977 ITT acquired more than 350 companies—at one time at the rate of one acquisition per week. They included well-known businesses such as Sheraton hotels, Avis Rent-a-Car, Hartford Insurance, and Continental Baking, the maker of Wonder Bread. During these 17 years, ITT grew from a medium-sized business with $760 million in sales to a global corporation with $17 billion in sales.
In the 10 years between the 1980s and 1990s, ITT continued on its buying spree, creating a broad group with interests ranging from hotels to pumps. In 1995, the company embarked on a continuous course of restructuring through strategic divestitures and acquisitions, which culminated in 1995 when ITT split into three separate, independent companies.1 Ten years later the company was sold, and by 2011, it had separated into three standalone, publicly traded, independent companies, but not before earning the dubious distinction of being the first major defense contractor convicted of criminal violations. In reality, the serial acquiring frenzy did not create value; the group became unwieldy; and stakeholders paid the price for the company’s lack of acquisition rationale and solid strategy formulation.
Start With a Comprehensive Understanding of Likely Futures
Once you have reached the conclusion that you should acquire, set the criteria for a successful deal before any mention of a particular company. On the other hand, you can generate this list of criteria as part of your strategy formulation, before you’ve even reached such a conclusion. In fact, my best clients create this list and then augment or edit it at each juncture as the economic and industry landscapes change.
For instance, one of the large companies I worked with found itself mired in one labor dispute after another. They had started sending work to China because the cost of shipping the materials there, having the work done there, and then shipping the finished product back was far less than having their workers do the job at their own plant. They didn’t make this information public, nor did they telegraph their decision to pursue acquisitions that would allow them to bring non-union companies under their umbrella.
They set their labor-related criteria years before they started searching seriously for an actual target. When opportunity presented itself by way of a comparably sized company that did similar work, they were ready to close the deal almost overnight. They now operate the two companies separately, with different leadership in different states, and everyone involved considers this a successful deal—well, everyone except the union representatives. The parent company doubled in size. The target stayed in business and retained its culture and talent, and more money ended up in the coffers.
A more conventional approach would be for the parent company to start with a list of criteria and then begin the arduous process of evaluating potential targets vis-à-vis the list. Sometimes this “dating” stage takes years before the “marriage” can take place, particularly with small, family-owned businesses that have strong emotional commitments to their employees and family members who want to retain their positions. Leaders in these kinds of companies want to make sure they are making an ethical, moral, socially responsible business decision before they hand you the keys to their parents’ or grandparents’ legacies. Their need for handholding and reassurances sometimes unrealistically goes beyond the needs of a typical publicly traded or even a large privately held enterprise.
Be Realistic About Possible Synergies
People considering an acquisition use the word “synergy” as though it represents one of the acquisition sacred cows. But too often the word characterizes a far-off nirvana, not a likely scenario.
When you consider synergy, can you justify, in detail, what you hope it will achieve? What confirmation will you need to see? And what evidence exists to suggest the synergy will occur? You can measure and quantify things like cost reduction, but sales growth synergies will be much harder to calculate and achieve. Repeated research has taught us the general business lesson that companies cannot cut their way to success. Top line growth, more revenue, and more profit create the formula for strategic success, whether or not an acquisition takes place.
Identify the Trap Doors
Companies that have successfully acquired in the past have learned that effective due diligence holds the key to success. Just about everyone agrees that you must engage in financial and legal due diligence; others suggest assiduousness with regard to other kinds of evaluations that I’ll address later.
During the strategy formulation stage, however, you’ll want to engage in what is known as commercial due diligence. That is, you’ll want to know how market or competitive uncertainty will impact the value of a company, the feasibility of realizing profits and revenues in the near future, and the validity of assumptions about revenue projections that are based on the success of new products, customers, or markets.
Deloitte, a company that specializes in helping clients with M&As, suggests these kinds of commercial due diligence analyses:
• Evaluate future market trends, competitive strength of the business, and underlying drivers of these trends.
• Analyze customers and their key purchase criteria.
• Estimate the achievability of forecasted assumptions, in light of market and company analysis.
• Hire an M&A specialist/M&A strategy team to analyze the buy-side and sell-side of the deal.2
Sometimes internal officers of the parent company attempt to do most of the due diligence themselves, but I discourage this approach for two reasons. First, unless your team has been involved in a number of acquisitions, they lack expertise in this arena. Second, your functional leads probably already have enough to do without adding the extra work of examining another company. Taking eyes off the parent company during an acquisition accounts for too many disappointments in the archives of failed M&A work.
In 1987, Ferranti overlooked another kind of trap door when it purchased International Signal and Control (ISC), a U.S. defense contractor based in Pennsylvania. Unknown to senior leaders at Ferranti, ISC’s business primarily consisted of illegal arms sales started at the behest of various U.S. clandestine organizations. On paper, the company looked extremely profitable on sales of high-priced “above board” items, but in fact, these profits did not exist. With the sale to Ferranti, all illegal sales ended immediately, leaving the company with no obvious cash flow.
In 1989, the UK’s Serious Fraud Office started a criminal investigation of alleged massive fraud at ISC. In December 1991, James Guerin, founder of ISC and co-chairman of the merged company, pleaded guilty to fraud committed both in the United States and United Kingdom. The U.S. trial encompassed all offences which would have formed part of any UK prosecution, so no UK trial ensued. But the resulting financial and legal difficulties forced Ferranti into bankruptcy in December 1993.3
Ferranti would not have bankrupted itself by buying ISC had it conducted commercial due diligence (CDD) and spoken to a few (nonexistent) customers instead of just relying on accountancy firm KPMG’s audit. KPMG had given Ferranti International Signal clean bill of health weeks before the discovery of frauds totaling 215 million pounds. The auditors at KPMG didn’t anticipate fraud, so they didn’t expect to see it; however, if decision-makers had engaged in or hired a specialist to conduct more commercial due diligence, they would have realized neither the customers nor the key purchase criteria existed. After the fact, analysts admitted that the fraud was designed and executed with extraordinary care and skill. Two fictitious contracts—one for the United Arab Emirates and the other for Pakistan—had been created to deceive the accountants into accepting a certain level of profit—one that didn’t exist.
But due diligence is not just about finding problems. In particular, good CDD identifies and quantifies the synergies, helps the acquirer to value the business through clear assumptions, and provides useful information for negotiation. Very importantly, CDD should identify both trap doors and key integration actions.
Facilitate the Deal
To keep from hampering the deal, much of the requisite evaluation must start in the strategy formulation stage. Begin by asking whether all the necessary internal and external processes and relationships are in place. If fever and passion grip the organization at some point, as they often do, an acquisition, however poor, quickly turns into a runaway train. Don’t let the train leave the station too soon, but equally important, don’t block the tracks with internal approvals that aren’t in place, processes that have bogged down, or regulatory approvals that haven’t shown up. Above all, avoid annoying the seller and allowing a competitor to slip in and woo your frustrated target away from you. Poorly briefed sellers can lose their patience and confidence over run-of-the-mill terms with which they are unfamiliar; similarly, if relationships break down during the critical final days of the deal, an unforeseen trap door will open in the earth, and all the players and their good intentions and due diligence will fall through it. As Enterprise pats itself on the back, Dollar rues the day it let the Vanguard deal slip through their fingers—and it all happened so quickly.
Tie Implementation to Strategy
When researchers survey business leaders on their opinions about why an M&A initiative has failed, often they flag implementation as the primary cause of problems. Blaming implementation rather than looking at the acquisition strategy, however, looks at effect, not cause. The reasons for failure may show up during the implementation stage, and people will eagerly jump on the “incompatible cultures” bandwagon, when, in reality, leaders hadn’t thoroughly or effectively evaluated exactly what they intended to purchase.
If decision-makers have given the green light to the acquisition, a holistic approach to the deal should begin. Human resources, IT, legal, and finance should work closely with business units to define specific roles and responsibilities required for the entire M&A process, but it doesn’t stop there. Functional and business leaders must have a clear understanding of how their roles will change not only during the acquisition process but also of how their worlds will change forever after. It all starts with a clear understanding of the new business.
All tangible benefits don’t come in dollars, however. Sometimes the company will enjoy tangible benefits related to the ability to attract better talent, decreased turnover, key customers, etc. And sometimes the value will relate to intangible benefits to the CEO, the CEO’s direct reports, or to the company itself. For example, the company may enjoy improved repute in the industry or better customer satisfaction. Sometimes senior leaders find themselves in a game they never intended to play in the first place, as the leaders of ITT did. At other times, parents receive unexpected rewards when they position themselves to play a bigger, more rewarding game. That’s what Enterprise did.
In 2007, Enterprise Rent-A-Car marked their 50th anniversary and had much to celebrate. With more than $9 billion in global revenue, they were the largest car rental company in the world and one of the largest family-owned and -operated companies in the United States. That all changed when Enterprise owners learned in February of 2007 of the proposed merger of their two biggest airport rivals, Vanguard (which owned National and Alamo) and Dollar Thrifty Automotive Group. This transaction, had it come to fruition, would not only have compromised Enterprise’s growth strategy, it would also have placed an almost insurmountable barrier to Enterprise’s goal to expand airport business.
Enterprise had a strong growth strategy and realized that to continue to grow at the rate they desired, they needed to increase their share of airport rentals, so they immediately recognized the threat of standing by idly as four rival brands combined into one competitor—a monolith that would have endangered their best efforts. That didn’t happen. Instead, Andy Taylor signed the papers to buy Vanguard on August 1, less than six months after he read the article in the New York Times that his rivals intended to merge.4 The deal paid for itself in less than three years, and total revenues for all three brands now surpass $16 billion—pretty healthy growth during a six-year period when many other companies shuttered their doors or wish they had.
Enterprise’s success holds no mystery, secret sauce, or unavailable formula. They did most things right—and quickly. They had a clear growth strategy in place, one that remained open to acquisitions. Second, Enterprise has little bureaucracy at the top, so senior leaders can respond to industry trends (the proposed merger of Vanguard and Dollar) in unprecedented time frames, and senior leaders recognized that after formulation, evaluation, and integration had to follow.
Evaluate
Although this section is devoted to an in-depth discussion of the role of evaluation in an M&A process, appraisal, valuations, and assessment of the target company should happen at each turn—before, during, and after the decision to acquire has been made. Evaluation has neither a “start” nor a “start date.” Rather, it involves a circular, continuous process of reevaluating new information as it becomes available and reassessment of existing data as new events shape reality. At all times, the parent company’s strategic objective must serve as a lighthouse for all the ships at sea, a beacon that will show the way to success.
Any discussion of strategy should include an examination of the company’s strategic forces, the power that drives the business’s strategy and governs its tactics. Tregoe and Zimmerman described this strength as a company’s driving force—“the primary determiner of the scope of future products and markets.” This driving force helps you understand why you are in the business you’re in and not another, why you make the products you make and not others, and why you serve the markets you serve and not others. It also helps you evaluate whether your own company’s driving force will match or complement the driving force of a target company you’re considering. The “driving force” concept holds the key to strategically managing major product and market choices that your organization must resolve, and it serves as the touchstone for making the strategic decisions you will face as you consider a merger or acquisition.5
When senior leaders in the parent company have made strategic decisions, either consciously or unconsciously, they have reached agreement about the driving forces. Often leaders use the organization’s driving force as a litmus test for generating and evaluating future alternatives because it provides a mechanism for developing, specifying, and understanding the different available alternatives. For example, McDonald’s driving force is method of distribution. People go to the fast-food restaurant not for fine dining, gourmet fare, or ambiance. They want inexpensive food fast, available without leaving the car. So, when decision-makers at McDonald’s consider alternative futures, they usually stay within the framework that has worked.
When senior leaders consider an acquisition, they need to make the implied obvious and the discussion concrete, not abstract. They should first examine their own driving forces and speculate about how they might profit from adding to or complementing them. But they will also want to examine any driving forces–related threats that might lurk post-acquisition, an often-overlooked aspect of due diligence. Like physicians who embrace the Hippocratic Oath, acquisition decision-makers must first do no harm. They can’t infer benefits post acquisition just because at first blush the companies’ strategies seem aligned and their driving forces compatible. They must dig for evidence to support their hopes. Therefore, in addition to weighing the general benefits they hope to gain, senior leaders would do well personally and professionally to examine the following driving forces and strategic factors to determine how their lives and the lives among those in their chain of command will change with an acquisition.
Markets Served
A market is a group of current or potential buyers who share common needs. An organization whose driving force is market needs will provide a range of products to fill current and emerging demands of customers in that market. These companies will constantly search for alternative ways to respond to these customers.
With that in mind, to understand whether a target company serves a given market as part of its strategy, begin by asking, “To whom do they sell?” What drives profits up or down, and what is happening within the company to do that? Enterprise had answers; Hewlett-Packard didn’t.
As Enterprise considered acquiring Vanguard, they spotted the obvious market share attractions: Both National and Alamo had already established themselves across the country. Further, neither Alamo nor National was a major contender in non-airport rentals, which meant they had virtually no overlap with Enterprise’s facilities, technology, or personnel.
Working out why the business is really for sale helps too; the seller may have spotted an unapparent problem looming in the market. That’s what seems to have happened when dot-com investors and traditional businesses acquired new economy start-ups and misjudged the market dramatically. People often overestimate the impact of new technologies and other market shifts in the short term, but underestimate them in the long term.
Enterprise’s acquisition of Vanguard brought more than market share: it brought the key customers—very different customers—under the Enterprise umbrella. National attracted the business travelers, sometimes called the “rental experts” because they want to get in and out of their vehicles as fast as possible, without stopping to fill out forms or stand in line. And these customers are willing to pay a premium for those benefits—the Emerald Club serving as a major driver of reservations and repeat business. Alamo, on the other hand, appealed to vacationers, often from outside the United States. who headed to places like Las Vegas and Disney World. Its customers generally looked for bargains on the internet. Each brand had significant value and offered its customers what was most important to them.
Products Offered
Companies that use products and services as their driving force ask themselves continuously, “What will we sell?” These senior leaders of these organizations realize that products or services play a key role in the future of the company. Therefore, the most profitable strategy for this kind of company is to continue to deliver products similar to those it has, and leaders look for novel ways to improve these products. For example, Coca-Cola has had the number-one or -two position in the soft drink industry since its inception more than 125 years ago. Originally developed for medicinal purposes, it quickly seized the soft drink market and became the most recognizable brand in the world.
Decision-makers at Coke have added new products to their portfolio, including variations on Coke, sports drinks, and juices. They have even introduced recipes on their Website that include Coke as an ingredient. They improve next year’s model by responding to trends, like adding vanilla or cherry to the recipe, but they haven’t deviated too far from their success formula: develop soft drinks and similar products that people use for entertainment.
When companies aspire to merge with a company that offers similar—but not exactly the same—products and services, the vast sea of the unknown takes on scary proportions. That’s what happened when eBay bought an internet telephone upstart called Skype in 2005 for $2.6 billion, hoping online buyers would prefer video calls to e-mail.
Senior decision-makers inferred that online buyers and sellers would want to talk to each other. They learned a tough and expensive lesson. After four unfulfilling years, eBay sold 65 percent of Skype at a loss to private investors. eBay eventually saved most of the day and recovered some of its losses, which makes the series of transactions less than desirable but not totally dismal.6
In addition to evaluating a company’s products, consider, too, its production capability. Production capability includes the manufacturing know-how, processes, systems, and equipment required to make specific products and the capability to improve those processes. The target company’s products can differ from the acquirer’s while still offering the utilization of existing production systems and equipment.
Methods for Sales and Distribution
In addition to evaluating their target’s key customers, Enterprise executives examined Vanguard’s methods for selling their services. Not surprisingly, Vanguard had a much deeper understanding of airport operations. At Orlando, Los Angeles, and other big airports, National and Alamo mangers presided over thousands of rental transactions every day. Their systems and processes operated on a much bigger scale than Enterprise’s did. After thorough evaluation, the senior leaders at Enterprise eventually adopted Vanguard’s programs because they determined they were better than Enterprise’s existing ones for airport rental.
The way products reach the customer, and the systems and equipment to support the method, drive this kind of company. Sometimes this driving force can combine with another to form something greater than the individual entities, as it did with Enterprise. But sometimes it won’t. Would people buy Girl Scout cookies off the shelf at the supermarket, even if they knew the profit to the Girl Scouts would remain the same? Doubtful. The driving force behind the success of Girl Scout cookies has everything to do with little girls selling to their neighbors and nothing to do with the actual product or any other driving force.
Acquiring companies that have ignored the importance of methods of distribution have paid greatly, as Quaker Oats did. In 1997, ending what some analysts have called the worst acquisition in memory, the Quaker Oats Company sold Snapple to the Triarc Companies for $1.4 billion less than Quaker paid for the drink company in 1994.
Quaker bought Snapple, which had been a successful pioneer in the market of fruit and tea drinks, just as sales growth in “new age beverages,” was slowing. From the outset, critics said that Quaker had paid at least $1 billion more than Snapple was worth.
Senior leaders at Quaker dove head-first into a new marketing campaign and set out to introduce Snapple to every grocery store and chain restaurant they could. But they sabotaged their own efforts by damaging relationships with Snapple’s independent distributors. Quaker soon discovered that its highly regarded skills in distribution to supermarkets and grocery store chains mattered little in a business that had previously relied on sales to convenience stores, gasoline stations, and similar outlets.
Their efforts failed miserably as the domino effect of the acquisition became apparent. Snapple had built its success on sales to small, independent stores; the brand just couldn’t hold its own in large grocery stores. Further, with Snapple’s woes overshadowing the rest of Quaker’s operations, including Gatorade and the strong performance of the company’s cereals and packaged foods, Quaker’s stock stagnated while the overall stock market doubled. After just 27 months, Quaker Oats sold Snapple for $300 million—a loss of $1.6 million for each day that the company owned Snapple. Numerous executives lost their jobs, including CEO William Smithsburg, whose reputation suffered.7
New Technology Options
When technology drives an organization, the company offers only products and services that originate from or capitalize on its technological capability. In such an organization, technology determines the scope of products offered and markets served, rather than the products and markets determining the technology. The technology-driven organization seeks a variety of applications for its technology. It does this through the products or services it develops from this technology, or from selling the output of its technology to those who would develop further products or services.
Even though the company does not always initiate the technological breakthroughs, many technology-driven organizations focus on converting breakthroughs made elsewhere to a variety of applications. For instance, the U.S. Center for Disease Control does not engage in all the cutting-edge research and development to fight disease. Rather, it serves as the conduit for these breakthroughs to protect the health of Americans.
In 2005, Sprint paid a whopping $36 billion for a majority stake in fellow telecom company Nextel to boost its use base, and revenues and to create a wireless powerhouse. The “merger of equals” never came together as Sprint and Nextel planned.
Both companies thought they would be able to quickly merge customers and catch up to Verizon and AT&T. But Nextel’s network ran on a different technology than Sprint’s, making it difficult for the combined company to optimize its wireless infrastructure assets. Sprint had to put its radios on all of Nextel’s towers, and vice versa. Nextel’s push-to-talk technology grew less popular over the years, and customers began fleeing the network in droves, as did Nextel executives.
Sprint finally shut down the Nextel network in July 2013, with the final blow coming in the form of a software code. Sprint had planned for years to close Nextel’s inefficient second-generation technology so the airwaves could be used for more profitable, newer data services. The shutdown also removed the encumbrance of maintaining multiple network technologies in the competitive wireless industry. Many blame “cultural differences” for the failure of the acquisition, but that offers a generic explanation for a specific cause related to a failure to evaluate how the driving force of technology differed in the two companies.8
Financial Synergy
Sometimes an acquiring company will evaluate a target and determine that the products, services, or markets served align closely enough to take the plunge—a push that they hope will help them create more profit—only to discover that they have plummeted into the abyss. For example, in 2008, Nelson Peltz, the owner of Arby’s roast beef sandwich restaurants, acquired Wendy’s, the fast-food chain famous for its made-to-order “square hamburgers” and chocolate desserts, for approximately $2 billion. The deal transpired after two chaotic years during which Wendy’s sold or spun off operations, reduced its corporate staff, and suffered a tarnishing blow to its wholesome image when a woman falsely claimed she found part of a finger in her chili.
The combined company not only failed to attain financial synergy, in the midst of the Great Recession, it lost money in seven of its 10 quarters. Three years later, in 2011, the marriage of square burgers and roast beef sandwiches ended, but not without more financial trouble and role reversal. Arby’s started as the suitor in the relationship, and ended the jilted lover.9
Bank of America learned, too, that it had been better off without Countrywide, even though their approaches to products, markets, and sales had been similar at one time. Once the nation’s largest mortgage lender, Countrywide pioneered lending programs that aggressively reached into minority and low-income neighborhoods. But by early 2008, as the mortgage bubble was bursting, the firm was hobbled by soured loans and it needed a buyer. Kenneth D. Lewis, then Bank of America’s chief, saw an opportunity to seize the company for a bargain price, the first of many expenses that led to a flood of red ink.
In January 2008, Bank of America agreed to pay $4 billion for Countrywide—a bargain. That bargain quickly turned bitter two years later when the penalties began. In 2010, Countrywide incurred a $110 million penalty for overcharging “cash-strapped borrowers.” Two months after that, Countrywide agreed to pay $600 million to settle a lawsuit with its shareholders. And two months after that Bank of America paid $20 million to cover former Countrywide CEO Angelo Mozilo’s $67.5 million civil fraud settlement with the Securities and Exchange Commission.
Three months later, in January 2011, the company paid more than $2.5 billion to buy back problematic mortgages and resolve claims from Fannie and Freddie. Throughout 2012 Bank of America paid more than $22 billion in settlements and fines.10
Would more robust financial due diligence have saved Bank of America from this fate? It’s easy to speculate and play Monday-morning quarterback. But one thing remains clear: even when the strategy for acquiring a target is related to streamlining resources, consolidating costs, or aligning products, acquiring companies do well to look beyond what’s in the books and examine what’s in the culture of the target.
Financial performance—with a clear focus on revenue growth more than cost control—is the single most important grade in evaluating acquisitive success because even small changes in revenue can outweigh major changes in planned cost savings. But a dropoff in sales immediately after the acquisition will also be one of the worst things you can experience. Unfortunately, leaders find these kinds of dips in revenue, profits, and sales all too common, given confusion among the newly merged team and the customer base. Too often, you can never make up these losses.
Therefore, immediately and inexorably tie sales momentum—especially with key customers—to both implementation of the strategy and revenue growth. Make this the number-one priority. The new owners, not just the sales force, should get out in front of customers, tell them what’s going on, and reassure them. It’s amazing how rarely that happens. But if you don’t control the message and make it the message customers want to hear, rumors and negative assumptions will fill the void. This step forms the natural link between evaluation and integration.
Integrate
Does the integration plan cater to customers in detail? Acquirers fall easily into the trap of focusing so heavily on internal reorganization that they ignore customers at the most critical time. Has the parent considered integration benefits? If so, senior leaders should have a plan prepared as a part of the valuation exercise and position themselves to take rapid action. This is often not the case automatically, however. In the heat of finalizing the deal, integration is often left until the last minute or ignored entirely.
Evaluation of the parent company’s strategy and strategic forces sets the stage for examination of the target’s strategy. Only after senior leaders have aggregated the data from a thorough assessment of both companies can the integration process begin—a process that will circle back to more strategic questions that will showcase cultural differences, the parts of the companies that should be integrated, and the parts that should remain separate. Not all acquisitions require integration, however. Sometimes the parent company will decide to run the newly acquired company as a separate entity with no future plans to join anything. More often some integration needs to occur.
Teams of experts typically work with functional leads to integrate IT systems, HR systems, and financial reporting protocols. Just as often, however, these same companies overlook one of the most significant causes of M&A failure: an inadequate understanding of cultural differences.
As I explained in Chapter Three, corporate culture involves the pattern of shared assumptions that a company has adopted and adapted over a period of time as they solved their problems and adjusted to the world around them. During a merger, the goal is to join two companies that might have adopted and adapted to the world in very different ways. When this happens, problems occur.
People talk about cultural differences compromising the success of M&A deals as though everyone defined culture the same way. To further muddy the water, many view culture as some sort of complicated, abstract, nebulous force that may or may not be with you as you begin the trek of fusing the ways companies do business. Although all aspects of culture play a role in any major transaction, the cultural differences that derail M&A deals have more to do with beliefs about the ways the companies make money, and less to do with customs and interactions.
Some authors refer to “incompatible business models” undermining a deal, but what does that really suggest? It means that when companies make money in vastly different ways, doing extremely different things, and no one recognizes or addresses these differences, the merged company risks destabilization. Though decision-makers should consider the mission, vision, and values of a target company, more importantly, they should ask these questions about a target company the “Critical Five Factors”:
• How do they make money?
• Who are their best customers?
• What value do they provide them?
• How do they do that?
• What threats and opportunities might alter these in the future?
I find that too often the leaders of the company trying to make a decision about whether to acquire can’t answer these questions for their own company, so certainly they don’t think to ask them about another company’s Critical Five Factors. No hope springs eternal, therefore, that the answers from both companies will guide a seamless integration. Here are some ways to ask the questions that will determine what kinds of important cultural differences you’re likely to face.
How Do They Make Money?
Senior leaders should begin asking this question in the strategy formulation stage, continue asking it through evaluation, and never abandon it as integration decisions begin to surface. “Do we really understand how this business makes money?” Different companies in the same market make money for different reasons. In retail, Wal-Mart focuses on low prices, Nordstrom’s on customer service, and Neiman Marcus on exceptional quality. Each company has been successful in the same industry for vastly different reasons. To determine whether a target will augment or complement your business model, you’ll need to make time to understand how the target operates—how it makes its money and where it could be losing out. From this analysis, the acquirer must make a comprehensive assessment of if or how the parent and target will be integrated into the new joint operation—where the operational and business development gains are to be achieved.
Companies make money in a variety of ways, and thousands of business books can show you the various formulas for determining the role revenue, cost savings, cash flow, and returns on investments and assets should play. When the deal moves to the due diligence phase, the finance people will have myriad lenses to look through to examine the financial fit of the organization. But you’ll also have to consider how these financial decisions affect the behaviors of all employees, from the senior leadership team down through the chain of command.
Can each employee at each level tell you the company’s mission statement? When I asked this question to an audience of 200 people from different companies, three of the 200 hands proudly shot up to proclaim that the executive of that company could remember the mission statement, but the other 197 sat stoically. Yet, when I asked these same people to tell me what’s on a Big Mac, the entire audience recited in unison, “Two all beef patties, special sauce….” In other words, a commercial that has not been on TV for more than 20 years stayed in their memories more prominently than their own mission statements! If you resemble the majority of that audience, you’re missing a basic element of your strategic direction. If the leaders of your target company don’t know theirs either, what chance do you have of landing on the same page?
In addition to defining the organization’s identity, the mission guides its development through time. Although it should be resistant to capriciousness, as the external landscape changes, leaders must tweak the mission statement as they recognize how to translate purpose into practice. In other words, the mission statement helps you know who you are. Successful organizations have a clear sense of purpose that defines long-term directions so that they don’t let shortsightedness jeopardize their best efforts.
You’ll also want to know whether they have a clear strategy for the future, a plan for what they have to do to make money. You should also detect widespread agreement about goals and have an indication that the leadership team has gone on record about the objectives they aspire to reach. Ideally, you should discern that other organizations change the way they compete in the industry with your target company, but if the company is for sale that may prove unrealistic. Whatever answers you receive to your questions, one conclusion should remain clear: We can work with this company to align our mission, vision, and strategy so that we can start making money fast.
Who Are Their Best Customers?
For obvious reasons, an existing customer base makes a company attractive from a strategic standpoint, but from a cultural viewpoint, decision-makers need to look beyond who the customers are to understand how the target company interacts with them. You’ll want to know whether or not senior leaders of the target company listen to their customers and whether or not customer input directly influences decisions to change. You’ll need evidence that the executives of the company understand what their customers want, what they expect, their perceptions of playing a role in influencing decisions, and which customers would miss them if they went away.
This goes beyond understanding their value proposition, although that’s a significant first step. You’ll want to know that the company’s leaders have listened to the voice of the customer and actually let that voice direct their direction—that they understand their customers, satisfy them, and anticipate their needs. This information will help you better understand the value they have provided in the past and are likely to provide in the future.
What Value Do They Provide Those Customers?
When I work with other consultants to help them decide on their value propositions, I encourage them to start with the generic one: “I improve the client condition.” That helps them stay focused on meeting the client’s needs, not on selling their processes or systems—no matter how good those may be. As the consultants evolve, they often choose something more specific to their skills set and interest. For example, a sales expert might say that she helps organizations increase their market share. An executive coach may state that she works with executives who want to improve their performance. In each case, the consultant clearly articulates how she improves the client’s condition.
So, too, should your target organization communicate how their customers are better off because they use the products or services of the company. Sometimes the company will sell a commodity, so you’ll want to understand why that product or service and not their competitors’.
But you don’t hire a brain surgeon or buy a Bentley that way. If you were to find yourself in need of a brain surgeon, you would want the best surgeon you could get, and cost would not play much of a role, provided you had the means to pay for the best. You would want to know about the doctor’s repute, experience, and success rate. If you were in the market for a luxury car, you would consider things other than a basic mode of transportation.
As you examine your target company’s brand and repute, what do you find? Do they respond well to competitors and other changes in the business or industry environments? What about their record for taking prudent risks and reaping the benefits? What evidence do you see that they continue to learn and grow? Once again, if the company is for sale, the news might not all be good. So you’ll want to evaluate their willingness to improve their processes and protocols as you simultaneously determine what those are. That willingness to adapt will contribute to or detract from your efforts to integrate the cultures.
How Do They Provide That Value?
In addition to finding out what they do to create value for their customers, you’ll want to know whether their tactics for meeting their strategic goals match or could match yours. What resources, like advanced research and development or thought leaders, do they have that they use wisely and that you might tap into? How do they empower employees and involve them in reaching objectives? What key talent must you retain to keep things on track? What patents and other intellectual property do they own? What processes and procedures have served them well? The answers to these questions will do two things. First, you’ll understand which among their sacred cows you’ll spare, and second, you might discover ways to improve your own ways of doing business.
Do different functions and units of the organization work together well? Do departmental or group boundaries interfere with cooperation? What about their team orientation versus value for solo contributions? Some companies have an “up or out” mentality, whereas others make room for the strong solo contributor who never wants management responsibility. Have they invested in the development of their top performers and kept them from taking their talents to the competition? You’ll want to understand what key talent needs to stay, but you’ll also benefit from knowledge about their promotion procedures as well as their succession planning.
One of the biggest impediments to integration involves change—the change itself, the fear it brings, and the speed with which it happens. Everyone on both sides of the deal will expect change; the fear will surface when people don’t understand what those changes will be or when they will occur. During these critical times, indecision will be your enemy.
The tough calls about priorities should happen without delay. Otherwise, people develop a what-shoe-will-fall-next phobia that will interfere with both morale and productivity. So, remove uncertainty by making the top-priority, value-enhancing changes quickly.
You’ll need a plan to communicate messages about the change, another step that too many companies neglect. During any M&A deal, stress remains high; people at all levels of the organization misinterpret messages; and rumors spread. Repeat key messages and avoid hype and empty promises.
What Will the Future Bring?
During a night in the hospital, nurses will routinely visit a patient’s room to take vital signs, looking for indications that the patient’s health has improved or deteriorated. If things have worsened, the nurse will immediately notify a doctor to develop a new course of action. Similarly, if the patient shows remarkable improvement, things will change too. Businesses could learn many lessons from this protocol: monitor at regular intervals and then make small, relevant adjustments as needed. If they did, they could spot both challenges and opportunities while they lurked on the horizon. But too often, senior leaders wait until these crucibles knock on the door.
If you had evaluated Blockbuster in 2002, while Netflix was in its infancy and the web still nascent technology, and you asked the first four critical questions, you would have given the company high marks as an acquisition target. But, if you had asked how well prepared they were to deal with emerging distribution systems, you would have felt less confident about their ability even to sustain their value. With some foresight, you might have predicted they were six years from irrelevancy and nine years from bankruptcy. The same test would apply to companies in the music and publishing industries over the last five to seven years.
Sophisticated Due Diligence on People and Succession Planning
Most parent companies conscientiously concentrate on integration of business systems but ignore a more important part of the transaction: the assimilation of people. A year or two after close, senior leaders may realize they should have done things differently, but by that time much damage can accrue.
I have helped clients with people decisions at each juncture of the acquisition process—before, during, and after an acquisition. For instance, I was one of eight succession-planning experts who worked directly with John Tyson after his company’s acquisition of International Beef Products in 2002. This is what John Tyson told Harvard Business Review journalists about our work:
The CEO realized that his ad hoc approach to leadership development was not working. He formed a senior executive task force to look into the problem. The team included himself, his direct reports, and a small group of external succession-planning experts, who were there to ensure objectivity and high standards and to help facilitate buy in. The task force members took nothing for granted. They sat down with a blank sheet of paper and mapped out their ideal leadership development system for Tyson. The blueprint they came up with integrated succession planning and leadership development, made sure that promising leaders would be well versed in all aspects of the company’s business, and put the accountability for succession planning and leadership development squarely on the shoulders of John Tyson’s direct reports. “Leaders at all levels were either in or out,” Tyson recalled. They couldn’t waffle about contributing their time and effort to the new talent development system; they couldn’t “protect” talent, hoard resources, or declare themselves immune from succession planning, he said.11
Our work with Tyson helped the combined companies position themselves for immediate success. Leaders realized they each had to take responsibility for driving the initiative and making the tough calls. No one expected overnight success or easy answers. But when billions of dollars stand in the balance, what reasonable person would expect simplicity?
Usually I enter the process earlier. Often I’ve worked with a company to make the decision to acquire; at other times executives call me in after they’ve made the decision to buy but before they close the deal. These clients realize they have to have immediate, accurate, objective data about key talent before they make the final decision to buy, the decision to retain or dismiss redundant talent, and the decisions regarding compensation packages. To this end, I have developed a Succession Planning Report that captures the following:
• Career history.
• Performance review data.
• Career aspirations.
• Success criteria (e.g., strategic thinking, learning speed, analytical reasoning, motivation, leadership potential, teamwork orientation, people skills, financial acumen).
• Cognitive assessment: learning speed, critical thinking, numerical reasoning.
• Leadership knowledge.
• Function work experience: HR, warehouse, finance, IT, sales, legal, manufacturing, administration.
• Primary strengths.
• Development imperatives.
• Leadership effectiveness.
• Promotion status.
Once decision-makers have this one-page report for each key person, they can begin the process of determining who will lead what. If you have two seemingly competent CFOs, for instance, how do you know which one to keep? The tendency will be for the acquiring company to keep its senior leaders in place, but this often spells disaster. Frequently I spot a star among the target’s team, a star who will leave if not given a position and the compensation package that goes with it.
Like evaluation, integration continues from the minute the buyer signs on the dotted line, until everyone alive has forgotten that two separate companies ever existed—in other words, forever. Although commonality exists regarding best practices for making the integration go smoothly—embracing both the art and science of the amalgamation—differences and unique outliers surface too. Let nothing surprise you.
And have a clear plan for running your own business while you divert resources to the new initiative.
Conclusion
Recent history has taught some hard lessons about M&As—one of the most salient being that many, if not most, acquisitions should never have happened. The second lesson indicates that the first lesson might be moot if the parent had done more and better positioning for the acquisition. That doesn’t mean more of the same due diligence all conscientious companies always would have done. That means a different formulation approach, starting with an in-depth understanding of the parent’s strategy and culture. Only after senior leaders have aggregated these data should they begin the arduous journey of setting criteria, considering targets, evaluating these targets vis-à-vis the criteria, and negotiating deals. Then, they will be ready to apply the same robust examination of the target’s Critical Five Factors.
Are you currently running the existing business well enough to sustain the strain of integrating another one? A company should start an acquisition from a position of strength and a firm foundation, as acquisition puts a substantial strain on the acquirer’s resources. If a company faces difficulties on the home front, an acquisition is unlikely to solve them.
No matter what the facts tell you, don’t assume the sanctity of all integration. Consider emotion too—yours, your employees’, and your customers’. Who in Chicago will soon forget Macy’s demanding the name change of Marshall Field’s in 2006, compromising a brand name that has stood for excellence in Chicago since 1881? Too often the acquiring company insists on improving things, replacing things, and renaming things that didn’t need to change in the first place. Marshall Field’s could have retained its name, brand, and loyal customers were it not for the wrong-minded attempts at corporate Macy’s.
The parent will have to make numerous unpopular integration decisions, but none has to be demoralizing. If you found the company worth buying in the first place, it’s probably worth trusting, funding, and encouraging it to thrive without unnecessary interference.