Postclosing Integration: Mergers, Acquisitions, and Business Alliances
Abstract
The integration phase is an important contributor to the ultimate success of the merger or acquisition, and ineffective integration is commonly given as one of the primary reasons M&As sometimes fail to meet expectations. This chapter outlines a practical process for realizing successful integration and how the acquirer determines the degree of integration necessary to achieve their objectives. The critical success factors include careful premerger planning, candid and continuous communication, adopting the right pace for combining the businesses, appointing an integration manager and team with clearly defined goals and lines of authority, and making the difficult decisions early in the process. This chapter concludes with a discussion of how to overcome some of the unique obstacles encountered in integrating family owned businesses and business alliances.
Keywords
Merger integration; Integrating acquisitions; Planning integration; Integration managers; Postmerger integration; Business alliance integration; Stakeholder analysis; Communication plans; Joint ventures; Partnerships; Family owned businesses; Small businesses; Closely held businesses; Corporate culture; Integration planning; Functional integration; Change management; Employee turnover; Customer attrition; Organizational change; Culture clash; Integration strategies; Integration tactics; Conflict resolution
Whether you think you can, or you think you can’t—you’re right.
Henry Ford
Inside Mergers and Acquisitions: Postmerger Integration Challenges
Immediately following the announcement that Amazon.com Inc. (Amazon) had reached an agreement to acquire grocery chain Whole Foods Markets Inc. (Whole Foods), the stock prices of grocers, consumer products companies, and brick-and-mortar retailers nosedived. Headlines screamed that Amazon Prime1 would spread Amazon’s marketing reach across the consumer spectrum from ecommerce to shoes to grocery shopping.
Pundits at times seemed almost giddy in imagining changes Amazon could make to Whole Foods. For example, some opined that Amazon could reconfigure the layout of Whole Foods stores given its finely honed data analytic capabilities. This could entail Amazon removing apparel departments entirely from Whole Foods stores and scaling back departments such as vitamins where pricing is high compared to competitors, perhaps replacing them with Kindle and Echo devices. The guesswork seemed to go on and on. But with the deal having closed on August 23, 2017, the surrounding euphoria began to abate as the hard work was about to begin.
High tech Amazon announced that it would integrate its “brick and mortar” acquisition into the firm’s ecommerce platform opening up an array of cross-selling opportunities. Amazon Prime would become a part of Whole Foods’ rewards program, offering Amazon Prime members savings and other in-store benefits. Eventually, popular Whole Foods private label products such as 365 Everyday Value, Whole Catch and pet foods oriented Whole Paws would be integrated with Amazon Fresh, Prime Pantry and Prime Now. Finally, Amazon Lockers for ecommerce pickups would become available in some Whole Foods stores. In addition, Whole Foods’ private-label products would be made available through Amazon.com and related services.
Amazon reiterated at the closing that John Mackey would remain as Whole Foods’ CEO and that its headquarters would stay in Austin Texas. And while many have predicted that Amazon could eventually automate Whole Foods with cashier-less store formats, the company has stated that it has no plans to replace Whole Foods cashiers with Amazon Go2 operations. Instead, Amazon indicated that they would try to conduct the postmerger integration in a manner that limited disruption in order to preserve what Whole Foods has accomplished and to retain its customer base. But typical of Amazon’s implementation zeal, Amazon slashed prices at the grocery chain within days of the closing. The speed with which this deal closed gave Amazon and Whole Foods’ management little time to engage in joint postmerger integration planning to overcome major hurdles in combining the two businesses.
The challenges for Amazon are substantial. Change is required but what is in question is the optimal pace of that change. Amazon must move to resolve operating inefficiency within Whole Foods without pushing valued staff, customers, and suppliers out the door. This would only accelerate and extend the same-store sales decline experienced by Whole Foods since early 2016.
Historically, Amazon has managed many of its acquisitions by defining clear goals to be achieved and allowing the acquired firm’s management to figure out how to best achieve these goals all the while being closely monitored by Amazon’s corporate office. In addition to the aggressive price cutting already in place, cost reduction efforts are currently focused on improving supply chain efficiency. Moreover, Amazon’s Prime membership loyalty program already is being used to drive more customers into Whole Foods stores. It is unclear the extent to which this will add new customers as many Prime members already shop at Whole Foods, but the allure of discounts could increase the average dollar amount and frequency of Prime members’ spending in Whole Food stores.
The greatest challenge may be the distinctly different corporate cultures of the two firms. Whole Food’s store managers are accustomed to autonomy in how they operate their stores. Whole Foods has a reputation for rewarding employee loyalty as measured by their tenure at the firm and less through performance accountability. In contrast, Amazon has sought to apply best practices across its operations prizing performance over tenure to sustain its meteoric growth. Accountability is the key to Amazon’s performance.
Different corporate cultures are a major reason why some mergers fall short of expectations. This has been especially true when the two firms involved in a merger are competing in very different markets and in different ways. The oft cited example of this challenge is the demise of the takeover of “low tech” Time Warner in 2001 by “high tech” AOL. The demographics and demeanor of the two firms were very different as was the pace of decision making.
How it chooses to manage Whole Foods longer-term depends on its vision for the business which at this point has not been disclosed. As a vertically integrated business, Amazon can make money at various points along its supply chain. As such, Amazon does not need to show a profit in running Whole Foods. Rather, it could just as easily operate Whole Foods as another means of binding existing customers to Amazon and as a conduit for channeling new customers into making purchases within its ecommerce infrastructure.
Chapter Overview
Integration today may be more challenging than at any time in recent memory. Workers tend to be more demographically and culturally diverse. With the pace of change accelerating, skills often are inadequate to meet the demands of the 21st century. Product life cycles grow ever shorter. Properly integrating complex intellectual property is likely to be critical in creating value in any deal. Keeping proprietary information out of the public eye during negotiation is almost impossible due to the ubiquitous nature of social media leading to leaks of sensitive information. Once public, this information can roil a variety of acquirer and target constituencies. Rumors can undermine worker morale at both the target and acquiring firms. Concerns about product and service quality can cause customers to seek alternative sources. Shareholder angst may soar if fears about the terms of the deal and the likelihood that the deal will be completed arise.
It is against this backdrop that the acquirer must weigh the risks of integrating the target firm fully, partially, or not at all into its own operations. Whether and when integration happens and the pace at which it takes place depends on the intent of the acquirer, the terms of the deal, and external factors beyond the control of either the buyer or seller.
For our purposes here, assume that integration is the goal of the acquirer immediately after the transaction closes. A practical process, as outlined in this chapter, makes for effective integration. The factors critical to a successful postmerger integration include careful premerger planning (including the selection of the appropriate postmerger integration strategy), candid and continuous communication, adopting the right pace for combining the businesses, appointing an integration manager and team with clearly defined goals and lines of authority, and making the difficult decisions early in the process. This chapter concludes with a discussion of how to overcome some of the obstacles encountered in integrating business alliances. A chapter review (consisting of practice questions and answers) is available in the file folder entitled “Student Study Guide” on the companion site to this book (https://www.elsevier.com/books-and-journals/book-companion/9780128150757).
The Degree of Integration Varies by Type of Acquirer and Deal
Deciding if and when to integrate an acquisition often depends on the type of acquirer: financial or strategic. Such acquirers differ primarily in terms of how long they intend to retain the business. Financial buyers—those who buy a business for eventual resale—tend not to integrate the acquired business into another entity, at least not in a significant way. Rather than manage the business, they are inclined to monitor the effectiveness of current management and intervene only if there is a significant and sustained deviation between actual and projected performance. Sometimes, financial buyers will “roll up” a fragmented industry by buying a firm within the industry and subsequently use it as a platform for acquiring additional businesses. Successive acquisitions are integrated into the initial acquisition in an effort to gain market share, improve cost positions, and eventually higher financial returns. In either case - whether the financial buyer manages the acquired firm as a standalone operation or uses it to consolidate an industry--the objective is the same. Take the business public through an initial public offering, sell to a strategic buyer, or sell to another financial buyer.
In contrast, strategic buyers want to make a profit by managing the acquired business for an extended period. How they manage the business postmerger can range from operating the target as a separate subsidiary to partially or wholly integrating the acquired business into the parent. Partial or complete integration of the target into the acquirer often reflects the desire to realize rapidly synergy to earn back any premium paid for the target.
So-called transformational deals involve acquiring new markets, products, distribution channels, and operations/facilities such that the successful integration of the target firm will result in a complete strategic realignment of the acquiring firm. Such deals tend to be the most challenging to integrate, because they involve combining different (and sometimes resistant) corporate cultures as well as new technologies, production methodologies, and selling strategies. Such deals often are undertaken to move the acquirer away from a maturing to a higher growth industry; as such, value creation is reliant more on revenue than cost synergies.
Usually less challenging during integration are consolidating acquisitions that involve absorbing similar companies in the same industry, with much of the value creation realized through cost reduction and improving operating efficiency. They tend to be less difficult than transformative deals because the acquirer has greater operational and customer familiarity.
Acquisitions of small companies are sometimes referred to bolt on transactions and generally involve buyouts of new technologies, products, or intellectual property. Finally, standalone transactions are those in which the target is kept separate from the acquirer’s organization. This may be done to preserve the target’s culture, in accordance with the terms of the negotiated contract (e.g., earnouts), to minimize the parent’s vulnerability to potential target liabilities, or simply because the buyer expects to sell the unit within a relatively short time period.
The Role of Integration in Successful Acquisitions
Rapid integration is more likely to result in a merger that achieves the acquirer’s expectations. Why? Integration done quickly (and sensibly) generates the financial returns expected by shareholders and minimizes employee turnover and customer attrition. According to PriceWaterhouseCoopers, the pace of integration has improved in recent years with key aspects of the postmerger integration process being completed in six months or less.3 The areas of greatest improvement are leadership selection, stakeholder communication, and time to implement operating plans. The sooner key positions are filled and reporting relationships established the faster people can focus on implementing integration. Early and frequent communication with customers and employees reduces anxiety by setting expectations. Finally, quickly implementing the desired policies and practices accelerates the realization of synergy.4
This does not mean that restructuring ends entirely within this time period. Integration may continue in terms of plant sales or closures for years following closing. Almost one-half of acquirers either sell or close target firms’ plants within 3 years of the acquisition. Acquirers having more experience in managing the target’s plants are more likely to retain their operations than those whose experience in operating such plants is limited. If we extend the period to 5 years following closing, plant divestitures and closures increase by an additional 9–10%. Moreover, in some countries, employee protections preclude the rapid elimination of redundant employees, slowing the acquirer’s ability to realize synergies and often increasing the cost of reducing the workforce due to large payouts to terminated employees required by law.5
Realizing Projected Financial Returns
A simple example demonstrates the importance of rapid integration to realizing projected financial returns. Suppose a firm’s current market value of $100 million accurately reflects the firm’s future cash flows discounted at its cost of capital (i.e., the financial return the firm must earn or exceed to satisfy the expectations of its shareholders and lenders). Assume an acquirer is willing to pay a $25 million premium for this firm over its current share price, believing it can recover the premium by realizing cost savings resulting from integrating the two firms. The amount of cash the acquirer will have to generate to recover the premium will increase the longer it takes to integrate the target company. If the cost of capital is 10% and integration is completed by the end of the first year, the acquirer will have to earn $27.5 million by the end of the first year to recover the premium plus its cost of capital ($25 + ($25 × 0.10)). If integration is not completed until the end of the second year, the acquirer will have to earn an incremental cash flow of $30.25 million ($27.5 + ($27.5 × 0.10)), and so on.
The Impact of Employee Turnover
Although there is little evidence that firms necessarily experience an actual reduction in their total workforce following an acquisition, there is evidence of increased turnover among management and key employees after a corporate takeover. Some loss of managers is intentional as part of an effort to eliminate redundancies, overlapping positions, and incompetent managers. For example, target firm CEOs commonly are replaced following a takeover. Their departure often is associated with a longer term improvement in the target firm’s operating performance.6 Other managers, often those the acquirer would like to retain, frequently quit during the integration turmoil.
Talent often represents the primary value of the target company to the acquirer, especially in high-technology and service firms. The loss of employees can represent a significant “brain drain,” which degrades the target’s value, making any premium paid difficult for the buyer to recover. The cost of employee turnover also may be high simply because the target firm’s top, experienced managers are removed as part of the integration process and replaced with new managers—who tend to have a high failure rate in general. When a firm selects an insider (i.e., a person already in the employ of the merged firms) to replace a top manager (e.g., a CEO), the failure rate of the successor (i.e., the successor is no longer with the firm 18 months later) is 34%. When the board selects an outside successor (i.e., one not currently employed by the merged firms) to replace the departing senior manager, the 18-month failure rate is 55%. Therefore, more than half of the time, an outside successor will not succeed, with an insider succeeding about two-thirds of the time.7 The cost of employee turnover does not stop with the loss of key employees. Current employees have already been recruited and trained; lose them, and you will incur new recruitment and training costs to replace them with equally qualified employees. Moreover, the loss of employees is likely to reduce the morale and productivity of those who remain. To minimize unwanted employee turnover, acquirers often raise significantly target firm employee compensation to retain employees following takeovers.8
Acquisition-Related Customer Attrition
During normal operations, a business can expect a certain level of churn in its customer list. Depending on the industry, normal churn as a result of competitive conditions can be anywhere from 20% to 40%. A newly merged company will experience a loss of another 5%–10% of its existing customers as a direct result of a merger,9 reflecting uncertainty about on-time delivery and product quality and more aggressive postmerger pricing by competitors.10
Rapid Integration Does Not Mean Doing Everything at the Same Pace
Rapid integration may accelerate realization of synergies, but it also contributes to employee and customer attrition. Therefore, intelligent integration involves managing these tradeoffs by quickly identifying and implementing projects that offer the most immediate payoff and deferring those whose disruption would result in the greatest revenue loss. Acquirers often postpone integrating data-processing and customer-service call centers, if such activities are pivotal to maintaining on-time delivery and high-quality customer service.
State labor protections may also affect the pace with which postmerger integration can be realized. Many state and federal laws view workers not covered by collective bargaining agreements or individual employment contracts as “at will” employees. As such, they can be dismissed by their employers for any reason and without notice.11 A number of states have modified the general rule that employees are at will by ruling that employees have implied rights under common law to fair treatment by their employers.12 Consequently, acquirers may be limited in how fast they can eliminate redundant workers following closing which impacts the magnitude and timing of realizing cost synergies. Reflecting these considerations, acquirers of targets in states with weak labor protections often realize somewhat larger announcement date returns than takeovers of targets in states with stronger labor protections.13
Integration Is a Process, Not an Event
Integrating a business into the acquirer’s operations involves six major steps: premerger planning, resolving communication issues, defining the new organization, developing staffing plans, integrating functions, and building a new culture. Some activities are continuous and unending. For instance, communicating with all major stakeholder groups and developing a new corporate culture are largely continuous activities, spanning the integration period and beyond. Table 6.1 outlines this sequence of activities common to effective postmerger integration efforts.
Table 6.1
There is no “one size fits all” formula that ensures that the integration effort will achieve anticipated synergy and strategic goals.14 The degree of integration as well as formal and informal coordination mechanisms15 can vary widely. They may differ in growing, mature, and declining industries. For acquirers and targets in the same industry, extensive integration is most beneficial in mature industries, while limited integration is much more appropriate in growing and declining industries.16 Formal coordination mechanisms are most beneficial in declining industries, while in growing industries only informal coordination mechanisms are valuable.17
Premerger Integration Planning
Premerger integration planning should coincide with the onset of due diligence.18 During this period, the acquirer is accumulating information about the target that is generally not available publicly. This enables the acquirer to make more accurate assessments of potential synergy, a reasonable timetable for realizing synergy, and costs that are likely to be incurred during postmerger integration. The planning activity involves prioritizing the critical actions that must be completed to combine the businesses. Planning enables the acquiring company to refine its original estimate of the value of the target and deal with postclosing transition issues in the context of the merger agreement. Furthermore, it gives the buyer an opportunity to insert into the agreement the appropriate representations and warranties as well as conditions of closing that facilitate the postmerger integration process. Finally, the planning process creates a postmerger integration organization to expedite the integration process after the closing.
Putting the Postmerger Integration Organization in Place Before Closing
To minimize potential confusion, it is critical to get the integration manager involved in the process as early as possible—ideally well before the negotiation process begins. Doing so makes it more likely that the strategic rationale for the deal remains well understood by those involved in conducting due diligence and postmerger integration.
A postmerger integration organization with clearly defined goals and responsibilities should be in place before the closing. For friendly mergers, the organization—including supporting work teams—should consist of individuals from both the acquiring and target companies with a vested interest in the newly formed company. During a hostile takeover, of course, it can be problematic to assemble such a team, given the lack of cooperation that may exist between the parties to the transaction. The acquiring company will find it difficult to access needed data and to involve the target’s management in the planning process before the transaction closes.
If the plan is to integrate the target firm into one of the acquirer’s business units, it is critical to place responsibility for integration in that business unit. Personnel from the business unit should be well represented on the due diligence team to ensure they understand how best to integrate the target to realize synergies expeditiously.
The Postmerger Integration Organization: Composition and Responsibilities
The postmerger integration organization should consist of a management integration team (MIT) and work teams focused on implementing a specific portion of the integration plan. Senior managers from the two merged organizations serve on the MIT, which is charged with realizing synergies identified during the preclosing due diligence. Involving senior managers from both firms captures the best talent and sends a comforting signal to all employees that decision makers who understand their particular situations are in agreement. The MIT’s emphasis during the integration period should be on activities that create the greatest value for shareholders. Exhibit 6.1 summarizes the key tasks the MIT must perform to realize anticipated synergies.
The MIT allocates resources to the integration effort and clarifies non-team member roles and enables day-to-day operations to continue at premerger levels. The MIT should be careful to give the teams not only the responsibility to do certain tasks but also the authority and resources to get the job done. To be effective, the work teams must have access to accurate information; receive candid, timely feedback; and be kept informed of the broader perspective of the overall integration effort to avoid becoming too narrowly focused.
Developing Communication Plans for Key Stakeholders
Before announcing an acquisition, the acquirer should prepare a communication plan targeted at major stakeholder groups. Each stakeholder group is discussed in more detail below.
Employees: Addressing the “Me” Issues Immediately
Employees need to understand early on what is expected of them and why. Simply telling employees what to expect following a takeover is not enough. They need to know why. Any narrative provided by the acquiring firm to explain the justification for the takeover and its implications for employees of both the target and acquired firms can be disruptive in that it can create angst by challenging current practices and core beliefs.
How employees feel about a takeover (i.e., their emotional mindset) can determine its ultimate success.19 Methodologies exist such as “critical incident techniques” to determine how employees feel about a takeover.20 Without employee acceptance, employees can resist integration efforts either openly (actively) or passively. The latter is perhaps the most insidious as employees can appear to be cooperating but in fact are not. They are either slow to respond to requests for information or behavioral changes or not responding at all. In the absence of overt resistance (openly refusing to do something), passive resistance (sometimes called passive aggressive behavior) undermines the effective integration of the acquirer and target firms.
Acquirer and target firm employees are interested in any information pertaining to the merger and how it will affect them, often in terms of job security, working conditions, and total compensation. For example, if the acquirer expects to improve worker productivity or reduce the cost of benefits, it is critical to explain that the long-term viability of the business requires such actions as the markets in which the firms compete have become increasingly competitive.
Target firm employees often represent a substantial portion of the acquired company’s value. The CEO should lead the effort to communicate to employees at all levels through on-site meetings or via teleconferencing. Communication to employees should be as frequent as possible; it is better to report that there is no change than to remain silent. Direct communication to all employees at both firms is critical. Deteriorating job performance and absence from work are clear signs of workforce anxiety. Many companies find it useful to create a single information source accessible to all employees, be it an individual whose job is to answer questions or a menu-driven automated phone system programmed to respond to commonly asked questions. The best way to communicate in a crisis, however, is through regularly scheduled employee meetings.
All external communication in the form of press releases should be coordinated with the PR department to ensure that the same information is released concurrently to all employees. Internal e-mail systems, voice mail, or intranets may be used to facilitate employee communications. In addition, personal letters, question-and-answer sessions, newsletters, and videotapes are highly effective ways to deliver messages.
Customers: Undercommitting and Overdelivering
Attrition can be minimized if the newly merged firm commits to customers that it will maintain or improve product quality, on-time delivery, and customer service. Such assurances are more credible if the merged firms dedicate a customer service team to each major customer. Each team’s responsibilities would include all communications with the customer and the resolution of issues that might arise while minimizing the amount of change each customer experiences. Commitments should be realistic in terms of what needs to be accomplished during the integration phase. The firm must communicate to customers realistic benefits associated with the merger. From the customer’s perspective, the merger can increase the range of products or services offered or provide lower selling prices as a result of economies of scale and new applications of technology.
Suppliers: Developing Long-Term Vendor Relationships
The new company should seek long-term relationships rather than simply ways to reduce costs. Aggressive negotiation may win high-quality products and services at lower prices in the short run, but that may be transitory if the new company is a large customer of the supplier and if the supplier’s margins are squeezed continually. The supplier’s product or service quality will suffer, and the supplier eventually may exit the business.
Investors: Maintaining Shareholder Loyalty
The new firm must be able to present to investors a compelling vision of the future. In a share exchange, target shareholders become shareholders in the newly formed company. Loyal shareholders tend to provide a more stable ownership base and may contribute to lower share price volatility. All firms attract particular types of investors—some with a preference for high dividends and others for capital gains—and they may clash over their preferences, as America Online’s acquisition of Time Warner in January 2000 illustrates. The combined market value of the two firms lost 11% in the 4 days following the announcement: Investors fretted over what had been created, and there was a selling frenzy that involved investors who bought Time Warner for its stable growth and America Online for its meteoric growth rate of 70% per year.
Communicating with shareholders (and other constituencies) through social media can be an efficient and timely means of allaying fears arising when deal insiders have more information than outsiders. For example, disclosing acquisition announcements on Twitter tends to attenuate negative market reaction around the announcement date.21 Using Twitter and other social media to keep investors abreast of postmerger integration progress can be an important tool in reducing acquirer share price volatility during this period of uncertainty.
Lenders: Reassuring Lenders
The acquirer generally must get permission from the target firm’s lenders to allow it to assume responsibility for any outstanding debt held by the target firm. Lenders must be confident that the new firm will generate sufficient cash flow to ensure that the principal and interest payments on their debt will be paid on a timely basis. Additional borrowing to finance the deal cannot violate loan covenants (i.e., commitments by the borrower to maintain certain financial ratios or limitations on the payment of dividends) on debt held by the acquirer or target firms in order not to allow lenders to immediately demand repayment of any outstanding balances. Many loan agreements have “cross-default” clauses such that if a borrower is in default (i.e., fails to satisfy certain obligations) with respect to one lender other lenders can also demand repayment. A firm may be technically in default for a number of reasons such as missing or being late on the payment of principal and interest or experiencing declining interest coverage ratios (i.e., operating income to interest expense). Lenders are most likely to be satisfied if the combined firms result in a new company with substantially greater unencumbered liquid assets (i.e., those not used to collateralize existing debt and which can be readily converted to cash) and increased predictable cash flow in excess of what is needed to keep the company operating.
Communities: Building Strong, Credible Relationships
Good working relations with communities are simply good public relations. Companies should communicate plans to build or keep plants, stores, or office buildings in a community as soon as they can be confident that these actions will be implemented. Such steps often translate into new jobs and increased tax collections for the community. There is evidence that acquirers viewed as “socially responsible” are more likely to experience easier postmerger integration and higher announcement date financial returns than acquirers viewed as less socially responsible.22
Creating a New Organization
Despite the requirement to appoint dozens of managers—including heads of key functions, groups, and even divisions—creating a new top management team must be given first priority.
Establishing a Structure
Building new reporting structures for combining companies requires knowledge of the target company’s prior organization, some sense as to the effectiveness of this organization, and the future business needs of the new firm. Prior organization charts provide insights into how individuals from both companies will interact within the new company, because they reveal the past experience and future expectations of individuals with regard to reporting relationships.
The next step is to create a structure that meets the business needs of the new firm. Common structures include functional, product or service, and divisional organizations. In a functional organization, people are assigned to specific departments, such as accounting, engineering, and marketing. In a product or service organization, functional specialists are grouped by product line or service offering, and each has its own accounting, human resources, sales, marketing, customer service, and product development staffs. Divisional organizations, in which groups of products are combined into divisions or strategic business units (SBUs) are the most common. Such organizations have their own management teams and tend to be highly decentralized.
The popularity of decentralized versus centralized management structures varies with the state of the economy and with the stage of the industry life cycle (growth, stable, and declining). During recessions, when top management is under great pressure to cut costs, companies may tend to move toward centralized management structures, only to decentralize when the economy recovers. Highly decentralized authority can retard the pace of integration because there is no single authority to resolve issues or determine policies.
In a centralized structure senior management can dictate policies governing all aspects of the combined companies, centralize all types of functions that provide support to operating units, and resolve issues among the operating units. Still, centralized control can destroy value if policies imposed by the headquarters are inappropriate for the operating units—such as policies that impose too many rigid controls, focus on the wrong issues, hire or promote the wrong managers, or establish inappropriate performance measures. Moreover, centralized companies often have multiple layers of management and centralized functions providing services to the operating units. The parent companies pass on the costs of centralized management and support services to the operating units, and these costs often outweigh the benefits.
The benefits of a well-managed, rapid postmerger integration suggest a centralized management structure initially with relatively few management layers. The distance between the CEO and division heads, measured in terms of intermediate positions, has decreased substantially, while the span of a CEO’s authority has widened.23 This does not mean all integration activities should be driven from the top. Once integration is complete, the new company may move to a more decentralized structure in view of the well-documented costs of centralized corporate organizations.
Developing Staffing Plans
Staffing plans should be formulated early in the integration process. The early development of such plans provides an opportunity to include key personnel from both firms in the integration effort. Other benefits include the increased likelihood of retaining employees with key skills and talents, maintaining corporate continuity, and team building. Fig. 6.1 presents the logical sequencing of staffing plans and the major issues addressed in each segment.
Personnel Requirements
The appropriate organizational structure is one that meets the current functional requirements of the business and is flexible enough to be expanded to satisfy future requirements. Before establishing the organizational structure, the integration team should agree on the specific functions needed to run the combined businesses and project each function’s personnel requirements based on a description of the function’s ideal structure to achieve its objectives.
Employee Availability
Employee availability refers to the number of each type of employee required by the new organization. The skills of the existing workforce should be documented and compared with the current and future requirements of the new company. The local labor pool can be a source of potential new hires for the combined firms to augment the existing workforce. Data should be collected on the educational levels, skills, and demographic composition of the local workforce as well as prevailing wage rates by skill category.
Staffing Plans and Timetable
A detailed staffing plan can be developed once the preceding steps are completed. Gaps in the firm’s workforce that need to be filled via outside recruitment can be readily identified. The effort to recruit externally should be tempered by its potentially adverse impact on current-employee morale. Filling needed jobs should be prioritized and phased in over time in recognition of the time required to fill certain types of positions and the impact of major hiring programs on local wage rates in communities with a limited availability of labor.
Compensation Plans
Merging compensation plans must be done in compliance with prevailing regulations and with sensitivity. Total compensation consists of base pay, bonuses or incentive plans, benefits, and special contractual agreements. Bonuses may take the form of a lump sum of cash or stock paid to an employee for meeting or exceeding these targets. Special contractual agreements may consist of noncompete agreements, in which key employees, in exchange for an agreed-on amount of compensation, sign agreements not to compete against the newly formed company if they should leave. Such agreements are not without costs to the firm. While they can protect an employer’s intellectual capital and contribute to employee retention, managers whose options in the job market are limited may go to extreme lengths to avoid dismissal by limiting discretionary investment such as R&D spending to improve earnings. Such decisions can limit the firm’s future product innovation and long-term profitability.24
Other types of special agreements may take the form of golden parachutes (i.e., lucrative severance packages) for senior management. Finally, retention bonuses often are given to employees if they agree to stay with the new company for a specific period.25
Personnel Information Systems
The acquiring company may choose to merge all personnel data into a new database, merge one corporate database into another, or maintain the separate personnel databases of each business. A single database enables authorized users to access employee data more readily, plan more efficiently for future staffing requirements, and conduct workforce analyses. Maintenance expenses associated with a single database also may be lower. The decision to keep personnel databases separate may reflect plans to divest the unit in the future.
Functional Integration
So far, you have learned about the steps involved in planning the integration process. Now let’s look at functional integration—the actual execution of the plans. The management integration team must first determine the extent to which the two firms’ operations and support staffs are to be centralized or decentralized. The main areas of focus should be IT, manufacturing operations, sales, marketing, finance, purchasing, R&D, and the requirements to staff these functions. However, before any actual integration takes place, it is crucial to revalidate data collected during due diligence, benchmark all operations by comparing them to industry standards, and reset synergy expectations. Successful M&As are often those in which a substantial amount of management time is spent in integrating successfully the two firms functional departments.26 Why? The postmerger integration phase does not impact postmerger performance directly but rather indirectly through the successful execution of the roles and responsibilities assigned to the combined firms’ functional departments.
Revalidating Due Diligence Data
Data collected during due diligence should be reviewed immediately after closing. The pressure exerted by both buyer and seller to complete the transaction often results in a haphazard preclosing due diligence review. For example, to compress the time devoted to due diligence, sellers often allow buyers access only to senior managers. For similar reasons, site visits by the buyer often are limited to those with the largest number of employees—and so risks and opportunities that might exist at other sites are ignored or remain undiscovered. The buyer’s legal and financial reviews typically are conducted only on the largest customer and supplier contracts, promissory notes, and operating and capital leases. Receivables are evaluated, and physical inventory is counted using sampling techniques. The effort to determine whether intellectual property has been properly protected, with key trademarks or service marks registered and copyrights and patents filed, is often spotty.
Benchmarking Performance
Benchmarking important functions such as the acquirer and target manufacturing and IT operations is a useful starting point for determining how to integrate these activities. Standard benchmarks include the International Standards Organization’s (ISO) 9000 Quality Systems—Model for Quality Assurance in Design, Development, Production, Installation, and Servicing. Other benchmarks that can be used include the US Food and Drug Administration’s Good Manufacturing Practices and the Department of Commerce’s Malcolm Baldrige Award.
Reset Synergy Expectations
Companies re-examining synergy assumptions after closing achieve higher synergies than those that do not. Companies that are most successful in realizing incremental value resulting from integrating the target firm often are those that use their pre-deal estimates of synergy as baseline estimates (i.e., the minimum they expect to achieve) and actively seek new synergy opportunities during integration. Such firms are four times more likely to characterize their deals more highly successful than executives of acquiring firms that do not reset their synergy expectations. Additional value is often realized by making fundamental operational changes or from providing customers with new products or services that were envisioned during the due diligence process.27
Integrating Manufacturing Operations
The objective should be to reevaluate overall capacity, the potential for future cost reductions, the age and condition of facilities, the adequacy of maintenance budgets, and compliance with environmental and safety laws. The integration should consider carefully whether target facilities that duplicate manufacturing capabilities are potentially more efficient than those of the buyer. As part of the benchmarking process, the operations of both the acquirer and the target company should be compared with industry standards to evaluate their efficiency properly.
Efficiency may be evaluated in terms of following processes: production planning, materials ordering, order entry, and quality control. The production planning and materials ordering functions need to coordinate activities because the amount and makeup of the materials ordered depends on the accuracy of sales projections. Inaccurate projections create shortages or costly excess inventory accumulation. Order entry may offer significant opportunities for cost savings. Companies that produce in anticipation of sales, such as automakers, often carry large finished-goods inventories; while others, such as PC makers, often build only when an order is received, to minimize working capital. Finally, the efficiency of quality control can be measured as the percentage of products that have to be reworked due to their failure to meet quality standards.
Plant consolidation begins with adopting a set of common systems and standards for all manufacturing activities. Standards often include the time between production runs, cost per unit of output, and scrap rates. Vertical integration can be achieved by focusing on different stages of production. Different facilities specialize in the production of selected components, which are then shipped to other facilities to assemble the finished product. Finally, a company may close certain facilities whenever there is excess capacity.
Integrating Information Technology
IT spending constitutes an ever-increasing share of most business budgets—and about 80% of software projects fail to meet their performance expectations or deadlines. Nearly one-half are scrapped before completion, and about one-half cost two to three times their original budgets and take three times as long as expected to complete.28 Managers seem to focus too much on technology and not enough on the people and processes that will use that technology. If the buyer intends to operate the target company independently, the information systems of the two companies may be kept separate as long as communications links between them can be established. If the buyer intends to integrate the target, though, the process can be daunting. Nearly 70% of buyers choose to combine their information systems immediately after closing, and almost 90% of acquirers eventually combine these operations.29
Recent evidence suggests that the successful integration of the acquirer’s and target’s IT systems requires an extensive investigation of the target’s IT function during due diligence. This heightens the probability that the combined firm’s IT functions will better support the firm’s business strategy.30 Examples include the acquirer’s efforts to improve manufacturing efficiency, procurement, order entry, and customer service.
Cybercrime (i.e., criminal activities carried out by means of computers or the internet) represents a major challenge in postmerger integration of information technology systems. Poor cybersecurity protection at either the acquirer or target firms can create significant vulnerability as IT defense systems may be down or because of employee error due to confusion as to how the two systems work together. Culture clash can slow cooperation in integrating systems and frustrated employees may steal proprietary information.31
Integrating Finance
Some target companies will be operated as standalone operations with separate finance functions, while others will be completely merged, including finance functions, with the acquirer’s existing business. International acquisitions involve companies in geographically remote areas and operate largely independent of the parent. This requires considerable effort to ensure that the buyer can monitor financial results from a distance, even if the parent has its representative on site. The acquirer should also establish a budgeting process and signature approval levels to control spending at remote locations.
Integrating Sales
Significant cost savings may result from integrating sales forces, which eliminates duplicate sales representatives and related support expenses, such as travel and entertainment expenses, training, and management. A single sales force may also minimize customer confusion by allowing customers to deal with a single salesperson when buying multiple products.
Whether the sales forces of the two firms are wholly integrated or operated independently depend on their relative size, the nature of their products and markets, and their geographic location. A small sales force may be readily combined with the larger sales force if they sell sufficiently similar products and serve similar markets. The sales forces may be kept separate if the products they sell require in-depth understanding of the customers’ needs and a detailed knowledge of the product. It is quite common for firms that sell highly complex products such as robotics or enterprise software to employ a particularly well-trained and sophisticated sales force that uses a “consultative selling” approach. This approach entails the firm’s sales force working with the customer to develop a solution tailored to their specific needs and may require keeping the sales forces of merged firms separate. Sales forces in globally dispersed businesses often are kept separate to reflect the uniqueness of their markets. However, support activities such as sales training and technical support often are centralized.
Integrating Marketing
Enabling the customer to see a consistent image in advertising and promotional campaigns may be the greatest challenge facing the integration of the marketing function. Steps to ensure consistency, however, should not confuse the customer by radically changing a product’s image or how it is sold. The location and degree of integration of the marketing function depend on the global nature of the business, the diversity or uniqueness of product lines, and the pace of change in the marketplace. A business with operations worldwide may be inclined to decentralize marketing in the local countries to increase awareness of local laws and cultural patterns. Companies with a large number of product lines that can be grouped into logical categories or that require extensive product knowledge may decide to disperse the marketing function to the various operating units to keep marketing personnel as close to the customer as possible.
Integrating Purchasing
Managing the merged firm’s purchasing function aggressively and efficiently can reduce the total cost of goods and services purchased by merged companies. A merger creates uncertainty among both companies’ suppliers, particularly if they might have to compete against each other for business with the combined firms. Many will offer cost savings and new partnership arrangements, given the merged organization’s greater bargaining power to renegotiate contracts. The new company may choose to realize savings by reducing the number of suppliers. As part of the premerger due diligence, both the acquirer and the target should identify a short list of their most critical suppliers, with a focus on those accounting for the largest share of purchased materials expenses.
Integrating Research and Development
Often, the buyer and seller R&D organizations are working on duplicate projects or projects not germane to the buyer’s long-term strategy. Senior managers and the integration team must define future areas of R&D collaboration and set priorities for future R&D research. However, barriers to R&D integration abound. Some projects require considerably more time (measured in years) to produce results than others. Another obstacle is that some personnel stand to lose in terms of titles, prestige, and power if they collaborate. Finally, the acquirer’s and the target’s R&D financial return expectations may differ. The acquirer may wish to give R&D a higher or lower priority in the combined operation of the two companies. A starting point for integrating R&D is to have researchers from both companies share their work with each other and co-locate.
Integrating Human Resources
Such departments have traditionally been highly centralized, responsible for evaluating management, conducting employee surveys, developing staffing plans, and providing training. They may be used to evaluate the strengths and weaknesses of potential target company management teams and workforce, integrate the acquirer’s and target’s management teams, implement pay and benefit plans, and communicate information about acquisitions. Due to expense and a perceived lack of responsiveness, the trend in recent years has been to move the HR function to the operating unit, where hiring and training may be done more effectively. Despite this trend, the administration of benefit plans, management of HR information systems, and organizational development often remains centralized due to their complexity and requirements for specialized expertise.
Building a New Corporate Culture
Corporate culture is a common set of values, traditions, and beliefs that influence management and employee behavior within a firm. There is a significant body of research underscoring the importance of building a strong culture and leaving the evolution of a firm's culture to chance can incur many tangible and intangible costs.32 See Table 6.2 for a listing of the characteristics of high performing corporate cultures.
Table 6.2
| Leaders who are admired and build organizations that excel at achieving results and at taking care of their people and customers |
| Clear and compelling vision, mission, goals, and strategy |
| Clear roles, responsibilities, success criteria, and a strong commitment to engaging, empowering, and developing people |
| Positive, can-do work environment |
| Open, candid, straightforward, and transparent communication |
| Teamwork, collaboration, and involvement |
| Constant improvement and state-of-the-art knowledge and practices |
| Willingness to change, adapt, learn from successes and mistakes, take reasonable risk, and try new things |
Adapted from Warrick, D., 2016. Leadership: A High Impact Approach. Bridgepoint Education, San Diego.
Large, diverse businesses have an overarching culture and a series of subcultures that reflect local conditions. When two companies with different cultures merge, the newly formed company often will take on a new culture that is quite different from either the acquirer’s or the target’s culture. Cultural differences can instill creativity in the new company or create a contentious environment. Corporate culture also can be a source of competitive advantage if it can be changed to reinforce the firm’s desired business strategy. Postmerger integration can be a time for senior managers to diagnose the acquired firm’s corporate culture and to decide strategies for modifying the new firm’s culture to be compatible with that desired for the combined firms.
But this is far easier said than done, because it is often unobservable core beliefs held by employees that drive their observable behaviors. In a 2016 survey of more than 7000 business executives, 82% of survey respondents viewed culture as a potential source of competitive advantage. Despite this recognition, most executives admitted to only a limited understanding of their firm’s cultures, with only 28% believing they actually understood their firm’s culture.33
Tangible symbols of culture include statements hung on walls containing the firm’s mission and principles as well as status associated with the executive office floor and designated parking spaces. Intangible forms include the behavioral norms communicated through implicit messages about how people are expected to act. Since they represent the extent to which employees and managers actually “walk the talk,” these messages are often far more influential in forming and sustaining corporate culture than the tangible trappings of corporate culture.
Employees, customers and other constituencies can readily see the extent to which a firm’s top management values honesty and integrity if their public pronouncements are consistent with what is actually happening. Management that blames their firm’s poor performance on factors beyond their control often is viewed as untruthful. In contrast, management willing to take responsibility for a firm’s underperformance often is viewed by investors as willing to take the needed corrective actions. As such, investors reward such firms by bidding up their share prices and penalize others whose management is viewed as deceitful.34
Trust is undermined after a merger, in part by the ambiguity of the new organization’s identity. Employee acceptance of a common culture can build identification with and trust in the corporation. As ambiguity abates and acceptance of a common culture grows, trust can be restored, especially among those who identified closely with their previous organization.35 Firms whose cultures are “employee-friendly” in which workers trust management and feel well-treated tend to show higher market values than those that are not. This should not be surprising as satisfied employees tend to be more productive and the cost of employee turnover is lower.36
The culture emerging from Belgian brewer InBev’s takeover of US brewer Anheuser-Busch in 2008 clearly reflected a combination of the two firm’s premerger cultures. InBev had been viewed as a risk taker and bottom line oriented while Anheuser-Busch was far more paternalistic. The combined firms represented more of the best of both. Anheuser-Busch’s training programs and long-term incentive plans have been rolled out to the combined firms operations worldwide. Once viewed as highly risk averse, Anheuser-Busch managers have been willing to take greater risk and have become more innovative with a wave of new products since 2009.37
With the pace of change not only accelerating but becoming increasingly technologically complex, an acquirer may choose to focus on developing a collaborative culture, one in which employees expect to participate on teams, share ideas, and assist others in achieving their goals. Steve Jobs is credited with saying “Great things in business are never done by one person, they are done by a team of people.” Reflecting this widely held belief, cross-functional collaboration is engrained in the American business environment, particularly in technology firms.
With new product innovation becoming more complex, firms require a greater diversity of skills. We can now communicate via email with others located anywhere on the globe. Social media means we are all tied together 24/7. The proliferation of collaborative software enables workers to coordinate decision making with other project members. The greater emphasis on matrix organizations in which the traditional hierarchy is replaced by employees reporting to a functional and a product manager requires continuing collaboration and communication to achieve consensus building.
While the results of such efforts often are significant, so are the potential pitfalls. The fuzzy reporting relationships and the need to get input and acceptance by other team members often slow decision making to a crawl. Also, more than one third of the value created through collaborative efforts is a result of 3%–5% of a firm’s employees.38 Collaborative efforts can frustrate the firm’s most productive members because of the demands on their time to attend meetings, respond to emails, and to help others. Such employees can eventually experience “burn out” and leave the company. While better ideas are often generated by a collaborative effort, they should not overburden decision making such that attractive opportunities are lost.
The potential for culture clash may be best illustrated by AT&T’s $80 billion takeover of Time Warner in mid-2018, following winning a lengthy antitrust lawsuit. What lies ahead for AT&T is the need to reconcile its bureaucratic way of doing things with Time Warner’s “Hollywood-type” culture in order to retain key talent and encourage innovation. Time Warner is seen as faster paced and more creative than AT&T which is unaccustomed to the idiosyncrasies of movie and TV production. AT&T could treat Time Warner executives as it did executives at DirecTV, slashing salaries and benefits following its takeover of that firm. The lavish perks common in the entertainment industry such as extravagant offices and travel arrangements also are likely to be eliminated. Other potential conflicts could include the political leanings of the two firms, with AT&T executives more conservative politically than their Hollywood counterparts.
Identifying Cultural Issues Through Cultural Profiling
The first step in building a new corporate culture is to develop a cultural profile of both the acquirer and acquired companies through employee surveys and interviews and by observing management styles and practices. Sometimes it is difficult to identify the root causes of observable behaviors. As such, it may be helpful to work backwards by hypothesizing what is driving such behaviors in order to understand their origin. The information is then used to show the similarities and differences between the two cultures as well as their comparative strengths and weaknesses and to diagnose potential problems that need changing.
The relative size and maturity of the acquirer and target firms can have major implications for cultural integration.39 Start-up companies typically are highly informal in terms of dress and decision making. Compensation may be largely stock options and other forms of deferred income. Benefits, beyond those required by state and federal law, and “perks” such as company cars are largely nonexistent. Company policies frequently do not exist, are not in writing, or are drawn up only as needed. Internal controls covering employee expense accounts are often minimal. In contrast, larger, mature companies are often more highly structured, with well-defined internal controls, compensation structures, benefits packages, and employment policies all in place because the firms have grown too large and complex to function in an orderly manner without them. Employees usually have clearly defined job descriptions and career paths.
Once senior management reviews the information in the cultural profile, it must decide which characteristics of both cultures to emphasize. The most realistic expectation is that employees in the new company can be encouraged to adopt a shared vision, a set of core values, and behaviors deemed important by senior management. Anything more is probably wishful thinking: a company’s culture evolves over a long period, but getting to the point where employees wholly embrace management’s desired culture may take years at best or never be achieved.
Overcoming Cultural Differences
Cultural differences can be very difficult to overcome because they may have become entrenched in an organization over many years. For example, in a firm in which the CEO for the past decade had been very directive and intolerant of dissent, employees may be reluctant to share their ideas. Consequently, efforts to change the culture can take many years.
Sharing common goals, standards, services, and space can be a highly effective and practical way to integrate disparate cultures. Common goals drive different units to cooperate. At the functional level, setting exact timetables and processes for new product development can drive different operating units to collaborate as project teams strive to introduce the product by the target date. At the corporate level, incentive plans spanning many years can focus all operating units to pursue the same goals. Although it is helpful in the integration process to have shared or common goals, individuals must still have specific goals to minimize the tendency of some to underperform while benefiting from the performance of others.
Shared standards or practices enable one unit or function to adopt the “best practices” found in another. Standards include operating procedures, technological specifications, ethical values, internal controls, employee performance measures, and comparable reward systems throughout the combined companies. Some functional services can be centralized and shared by multiple departments or operating units. Commonly centralized services include accounting, legal, public relations, internal audit, and information technology. The most common way to share services is to use a common staff. Alternatively, a firm can create a support services unit and allow operating units to purchase services from it or to buy similar services outside the company.
Mixing offices or even locating acquired company employees in space adjacent to the parent’s offices is a highly desirable way to improve communication and idea sharing. Common laboratories, computer rooms, and lunchrooms also facilitate communication and cooperation.40
Digital Tools and Change Management
Programs designed to change corporate culture often fail due to employee opposition or a lack of management commitment. Success rates tend to be higher if “digital tools” are properly applied to accelerate and simplify the ability of an organization to adopt a new set of desired behaviors.41 Such tools offer the prospect for immediate feedback, personalizing communication to the employee’s experience, circumventing hierarchy, building shared purpose, and communicating progress. Each of these areas is described in more detail below.
Immediate feedback involves offering employees the right information when they can actually use it to adjust their behavior to what is desired by the corporation. For example, establishing a short messaging system (SMS) can keep widely dispersed employees informed about new products, customer developments, and market changes.
Personalizing communications makes information more important to the user as it can show how the individual fits in the overall organization and how their actions contribute to achieving corporate goals. This requires limiting broadcast messages throughout the corporation and increasing focus on directly communicating information relevant to a specific employee’s function such as finance, human resources, engineering, marketing, etc.
Circumventing hierarchy involves direct communication with employees across business unit or organizational lines. This enables more employees to see firsthand material communicated by senior management without having it reviewed and filtered by their supervisors. However, this is not without risk in that information that can put the firm at a competitive disadvantage can more easily leak into the marketplace.
Building shared purpose is especially challenging in organizations which are widely dispersed geographically. Giving employees in all regions access to the same databases, activities conducted by other team members, and online opinion forums facilitates information flow. Shared information and commentary can help employees to understand what is expected and how others are adapting to the new cultural behaviors. For example, all employees could be given online access to databases showing job vacancies, hiring practices, candidates identified and interviewed, and eventual job placements. By achieving greater transparency, employees in remote locations can have more confidence in the fairness of the human resource system.
Communicating progress toward corporate goals can help employees see the “fruit” of their collective effort by tracking the firm’s progress against key corporate goals. When employees see progress, it creates a sense of success, confidence in current business strategies, and greater acceptance of desired corporate behaviors.
The Role of Accounting: Its Strengths and Limitations
Objective accounting assists in developing organizational transparency and establishing cause and effect relationships. This helps to reduce complexity to a more workable and understandable format. Accounting helps make sense out of complexity.42
In premerger planning, historical financials can paint a dark picture for a firm with a problematic past. Objective accountants can help frame potential opportunities in terms of sales and operating profit growth. These are portrayed as proforma financials to display what a combination of businesses could look like. By focusing on the future and less on the past, acquirers incorporate new information into their decision making. During premerger negotiations, acquirers can focus on historical performance or future opportunities. They tend to concentrate on the target’s historical performance in an attempt to get a lower purchase price, while sellers focus on what is possible to justify a higher selling price.
For the acquirer, sole reliance on the potential performance of the combined businesses can (and often does) lead to overpaying for the target. Consequently, for internal planning purposes, acquirer management should be well aware of the lessons of the past. These include the effects of business cycles on sales, the limitations of regulations and unionization, the vagaries of selling into international markets, the impact of product substitutes, etc. One thing does not change: the more an acquirer pays for a business (including assumed liabilities), the greater the challenge in earning or exceeding minimum required returns demanded by investors.
After the deal closes, postmerger integration teams must implement the terms of the agreement in an organized and timely manner while minimizing disruption to the ongoing operations of the businesses. Failure to do so contributes to customer, employee, and supplier attrition and shareholders displaying their disaffection by dumping their shares. Accounting metrics help to define managerial aspirations (which are communicated as corporate goals) and by comparing actual performance to plan enable an objective evaluation of how well the combined firms are achieving these managerial aspirations.
Accountants by explaining cause and effect relationships between and among variable over which management has some degree of control provide significant insights into how spending should be prioritized during the postintegration period. By tying individual business unit, department and employee goals directly to accounting metrics, accounting can help shape the postmerger organization and culture. What accounting metrics do not do is to give insight into how the desired changes will affect the employees that have to implement these changes. The net result often is that strict adherence to achieving the accounting metrics create employee anxiety and passive aggressive behavior which imperils the pace of integration and jeopardizes the achievement of the desired goals.
Common Performance Tracking Metrics
Common accounting indicators employed to measure actual progress compared to plan are divided into two major categories: revenue and cost. The selected metrics are generally those that tend to drive value creation. Revenue metrics often include growth in net revenue, revenue from cross-selling acquirer and target products into each other’s customers, gains in market share, and the percentage of revenue coming from new products developed as a result of the merger. Cost metrics may include the following: cost savings due to integration; integration costs; headcount reduction; and selling, general, and administrative expenses as a percent of revenue.
Many deals in recent years have a better job of realizing synergy and improving profitability following postmerger integration.43 This improvement has in part resulted from employing better performance tracking systems and tying management compensation to achieving specific goals.
Integrating Business Alliances
Business alliances also must pay close attention to integration activities. Unlike M&As, alliances usually involve shared control. Successful implementation requires maintaining a good working relationship between venture partners. When this is not possible, the alliance is destined to fail. The breakdown in the working relationship is often a result of an inadequate integration.44
Integrating Mechanisms
Robert Porter Lynch suggests six integration mechanisms to apply to business alliances: leadership, teamwork and role clarification, control by coordination, policies and values, consensus decision making, and resource commitments.
Leadership
Although the terms leadership and management often are used interchangeably, there are critical differences. A leader set direction and makes things happen, whereas a manager ensures that things continue to happen. Leadership involves vision, drive, enthusiasm, and selling skills; management involves communication, planning, delegating, coordinating, problem-solving, and making choices. Successful alliances require both sets of skills. The leader must provide direction, values, and behaviors to create a culture that focuses on the alliance’s strategic objectives as its top priority. Managers foster teamwork in the shared control environment of the business alliance.
Teamwork and Role Clarification
Teamwork is the underpinning that makes alliances work and engenders trust, fairness, and discipline. Teams reach across functional lines, often consisting of diverse experts or lower level managers with problem-solving skills. The team provides functional managers with flexible staffing to augment their own specialized staff. They tend to create better coordination and communication at lower levels of the alliance as well as between partners in the venture. Because teams represent individuals with varied backgrounds and possibly conflicting agendas, they may foster rather than resolve conflict.
Coordination
Alliances do not lend themselves to control through mandate; rather, in the alliance, control is best exerted through coordination. The best alliance managers are those who coordinate activities through effective communication. When problems arise, the manager’s role is to manage the decision-making process, not necessarily to make the decision.
Policies and Values
Alliance employees need to understand how decisions are made, what has high priority, who will be held accountable, and how rewards will be determined. When people know where they stand and what to expect, they are better able to deal with ambiguity and uncertainty. This level of clarity can be communicated through policies and procedures that are well understood by joint venture or partnership employees.
Consensus Decision Making
Consensus decision making does not mean that decisions are based on unanimity; rather, decisions are based on the premise that all participants have had an opportunity to express their opinions and are willing to accept the final decision. Operating decisions must be made within a reasonable timeframe. The formal decision-making structure varies with the type of legal structure. Joint ventures often have a board of directors and a management committee that meet quarterly and monthly, respectively. Projects normally are governed by steering committees. Many alliances are started to take advantage of complementary skills or resources available from alliance participants. The alliance can achieve its strategic objective only if all parties to the alliance provide the resources they agreed to commit.
Integrating Family Owned Firms
The integration process described in this chapter deals with the challenges of combining public firms. While there are significant similarities when acquiring a family or privately owned firm, the acquirer often is confronted with a range of issues not necessarily found in public firms.
The acquirer is not just buying a company but also a long history of strong ties between individuals with extensive shared experiences. In such situations, the pace of integration often is much slower than in public firms as the buildup of respect and trust may take much longer.45 The integrating mechanisms discussed in the previous section for business alliances often apply to integrating family or privately owned firms.
Chapter 10 describes the hurdles associated with such businesses including primitive internal controls and reporting systems, limited product and customer diversification, and employee interests and time horizons differing from those in public firms. As such, a prudent acquirer may choose to discount the offer price from what they believe to be the true value of the target in recognition of the daunting challenges associated with integrating successfully nonpublic firms.
Some Things to Remember
Managers in M&As that are successfully integrated often demonstrate leadership by candidly and continuously communicating a clear vision, a set of values, and clear priorities to all employees. Successful integration efforts are those that are well planned, appoint an integration manager and a team with clearly defined lines of authority, and that make the tough decisions early in the process, be they about organizational structure, reporting relationships, spans of control, personnel selection, roles and responsibilities, or workforce reduction. The focus must be on those issues with the greatest near-term impact. Because alliances involve shared control, the integration process requires good working relationships with the other participants. Successful integration also requires leadership that is capable of defining a clear sense of direction and well-defined priorities and managers who accomplish their objectives as much by coordinating activities through effective communication as by unilateral decision making.
Chapter Discussion Questions
- 6.1 Why is the integration phase of the acquisition process considered so important?
- 6.2 Why should acquired companies be integrated quickly?
- 6.3 Why is candid and continuous communication so important during the integration phase?
- 6.4 What messages might be communicated to the various audiences or stakeholders of the new company?
- 6.5 Cite examples of difficult decisions that should be made early in the integration process.
- 6.6 When Daimler Benz acquired Chrysler Corporation, it announced that it could take 6–8 years to integrate fully the combined firm’s global manufacturing operations and certain functions such as purchasing. Speculate as to why it might take that long?
- 6.7 In your judgment, are acquirers more likely to under- or overestimate anticipated cost savings? Explain your answer.
- 6.8 Cite examples of expenses you believe are commonly incurred in integrating target companies. Be specific.
- 6.9 A common justification for mergers of competitors is the potential cross-selling opportunities it would provide. Comment on the challenges that might be involved in making such a marketing strategy work.
- 6.10 Billed as a merger of equals, Citibank and Travelers resorted to a co-CEO arrangement when they merged. Why do you think they adopted this arrangement? What are the advantages and disadvantages of such an arrangement?
Answers to these Chapter Discussion Questions are available in the Online Instructor’s Manual for instructors using this book (https://textbooks.elsevier.com/web/Manuals.aspx?isbn=9780128150757).
The majority of retail sales growth is online and much of that growth it going to Amazon.com (Amazon). Its major retail competitor, Walmart Stores Inc. (Walmart), has been jockeying to catch up, but it still has a long way to go. In 2016, Amazon recorded $136 billion in net sales, a 27% increase over 2015. Of this total, $94.7 billion came from e-commerce and remainder from services (e.g., cloud servers).46 In stark contrast, Walmart’s e-commerce business accounts for about $15 billion. How can Walmart close this gap?
Walmart has been ramping up its investment in e-commerce in recent years adding approximately one million new products monthly to its website. At the end of 2016, it still only offered about 11 million items to its e-commerce customers. Amazon, through its own direct fulfillment and Amazon Marketplace,47 offers nearly 350 million products to its customers. That number alone would seem to make it extremely difficult for Walmart to make much headway in penetrating Amazon’s online business.
Walmart’s options are limited: focus on organic growth by reinvesting excess cash flow in e-commerce related activities, joint ventures with third-parties, or acquire e-commerce firms with the potential to leapfrog the competition. Previously, the firm had been trying to do it on its own. While its online revenue growth has been rapid, it was still slower than industry leader Amazon. Joint ventures take time to negotiate and sometimes are difficult to implement when you don’t have control. Walmart needed a bold move to jumpstart its e-commerce business. That move turned out to be the acquisition of Jet.Com Inc. (Jet).
Having started in July 2015, Jet’s business model offers incentives intended to siphon away Amazon customers. The firm’s site offered a unique pricing scheme in which price adjustments were made to customers while they were shopping online encouraging them to buy more of what Jet had in its warehouse nearest to the customer. This makes it less expensive for Jet to ship and warehouse inventory.
Jet offers about 10 million items to customers which show little overlap with Walmart’s online offering. Led by co-founder and CEO Marc Lore, Jet is among the fastest growing and most innovative e-commerce firms in the US. The firm has demonstrated the ability to rapidly grow the business reaching a monthly annualized rate of 12 million units after only one full year of operation. Moreover, the firm has a growing customer base of urban and millennial customers with more than 400,000 new shoppers added monthly and an average of 25,000 daily processed orders. The firm is noted for its “best-in-class” technology rewarding customers in real time with savings and offers more than 2400 retailer and brand partners to consumers.
Walmart and Jet announced on August 8, 2016 that they had reached an agreement in which Walmart would acquire Jet for $3.3 billion consisting of $3 billion in cash and a contingent payout of $.3 billion in Walmart stock. The size of the purchase price appears to have been a record for an e-commerce startup. Despite the firm’s meteoric growth, Jet was not profitable at the time of the acquisition and was burning through its cash holdings.
Jet brings Walmart at least three things: access to its attractive millennial dominated customer base, its e-commerce capabilities including logistics and distribution, and its management team. Of these, retaining the management team may be the most crucial to Walmart. Toward this end, Walmart issued 3.5 million Walmart shares to Marc Lore, to be paid over a five-year period. Known as restricted stock units48 (RSUs), these shares represent a portion of the $300 million of Walmart equity included in the deal. The agreement stipulated that Lore would have to pay back a significant portion of his share of the $3.0 billion cash payment and forfeit unvested RSU interests if he left before 5 years. Lore’s RSUs vested as follows: 10% at closing, 15% at the end of the first year, 20% at the end of the second year, 25% at the end of the third year, and 30% at the end of fourth year.
Buying Jet may turn out to be the easiest part of the deal, which closed on September 20, 2016. To ensure that the full potential of the deal is realized Walmart needs to merge the firms’ disparate cultures, properly position their respective brands, and exploit their logistics and distribution capabilities. Of these, the most difficult challenge for Walmart to transition to an e-commerce retail model is likely to be changing its culture.
E-commerce demands an entrepreneurial culture where risk taking is the norm. The size of the challenge is daunting. Walmart is a bureaucratic cost-cutting behemoth steeped in the ways of traditional “brick and mortar” retailing. Walmart has 260 million customers who visit the firm’s 11,257 stores weekly in 28 countries and e-commerce sites in 11 countries. The firm’s 2.3 million employees worldwide generated 2016 net revenue of $482 billion.
Marc Lore is the man Walmart is relying on to help the firm make the transition to a much larger online retailer. For Walmart and Lore to be successful in this merger, Jet’s ecommerce business needs to blend with the other Walmart operations such as logistics and distribution, marketing, and suppliers. This will require substantial coordination.
Walmart and Jet will maintain their distinct brands, with Walmart.com focusing on delivering the firm’s Everyday Low Price strategy, while Jet will continue to provide a unique and differentiated customer experience. Over time, the two firms will collaborate to develop new offerings to help customers to save time and money.
Cultural differences between the two firms are stark. Based in Hoboken New Jersey, Jet had regular in-office happy hours as well as a kitchen cupboard full of liquor, and employees could drink at their desks. In contrast, Walmart, headquartered in Bentonville, Arkansas, has a conservative corporate culture that includes a company-wide prohibition of alcohol at company functions. Both firms attempted to strike a compromise in which happy hours would be moved to nearby bars. But with fewer employees attending offsite happy hours, Jet executives were concerned about its impact on morale. Soon Walmart relented allowing happy hour to return to the Jet office. Jet’s culture seems to be having an impact on Walmart’s culture. Walmart had a wine and beer tailgate party for its e-commerce team at a San Francisco Giants game in May 2017. Walmart is also allowing other startups it has acquired to host weekly office happy hours.
Since the deal closed, Lore, as Walmart’s domestic CEO of e-commerce, has been shaking things up. He is realigning leadership to better match how customers are shopping today. The leadership reorganization is taking place not just at the stores but on its website and Jet.com. Among Walmart President and CEO Doug McMillon’s first communications to employees following the takeover included statements such as “we need more speed and less bureaucracy” to better serve shoppers to save them money and time. Some positions must be eliminated, he noted, “to stay lean and fast.” Reflecting this new philosophy, the decision was made to combine corporate IT personnel at Walmart’s Arkansas headquarters with its e-commerce team in Silicon Valley. Historically, brick and mortar retailers launched brick and mortar websites with separate management teams. As the world has changed, many consumers shop both online and in store causing retailers to integrate these separate teams into a single team.
Walmart’s hope is to use the best talent from both firms. Walmart has made good use of Jet’s personnel by integrating them into senior positions within Walmart. For example, Lore’s team will work with Walmart US CEO Greg Foran and a combination of individuals from Walmart and Jet.Com. Six members of the Jet management team assumed senior positions within Walmart and three senior Walmart executives were promoted to new management positions with Walmart’s e-commerce operations, while three other senior Walmart e-commerce managers were either retired or terminated.
In less than one year following the takeover of Jet.com, Walmart announced that online sales rose by 29% in the US and 15.5% globally. Walmart ended 2017 as the second largest online retailer by revenue and among the top three by traffic (behind Amazon and eBay). A big part of that growth is the availability of more items. Walmart’s US e-commerce division more than quadrupled the number of items available for purchase online from the start of the 2017 to almost 50 million at yearend.
Walmart has a long way to go to catch up to Amazon, but it does have some online firsts. Its drive-up grocery business Pickup Today grew 27% from 2016. Walmart also introduced free two-day shipping on millions of items for orders over $35. In 2016 and 2017, Walmart also acquired ShoeBuy (January 2016 for $70 million) and Moosejaw (February 2016 for $51 million) and ModCloth (March 2017, purchase price undisclosed). The firm also gained control of Hayneedle as a result of its buyout of Jet, giving the company more expertise and availability in high-end market segments like shoes, outdoor gear, and furniture.
By incorporating the smaller electronic retailer’s inventory, retail partnerships, and operations within Walmart’s giant infrastructure, the company should be able to bolster online revenue growth. An important advantage Walmart has over Amazon is its approximate 4800 US stores including 3500 super centers, many of which are used to ship online orders. In late 2016, the firm began offering discounts to customers that pick up online orders in a nearby Walmart store.
To change its perceived bureaucratic and ponderously slow decision-making, Walmart must create a culture and reward system that will appeal to Jet’s best and brightest while not creating dissension among the vast majority of Walmart’s employees who toil in the brick and mortar business. Walmart has to ensure that its stodgy culture doesn’t suffocate the spirit of innovation that makes Jet so inventive and that it can retain Jet’s management team long enough to transform Walmart’s e-commerce operations.
Unfortunately, the odds of Walmart’s pulling off a successful integration where the innovativeness of Jet combines with Walmart’s massive scale are not promising. History shows that large traditional businesses that acquire small entrepreneurial firms often end up destroying them. Cultural clashes and the resulting rapid turnover among an acquired company’s key staff tend to diffuse the energy and negate the benefits of the acquisition. Successfully integrating Jet and Walmart is where this battle to accelerate the firm’s online revenue will be won or lost.
Discussion Questions
- 1. Should the success or failure of Walmart’s acquisition of Jet be judged based on Jet as a standalone business or as part of implementing the Walmart’s larger online strategy? Explain your answer.
- 2. What key external and internal factors are likely to impact Walmart’s postmerger integration of Jet?
- 3. What is the key premise(s) underlying Walmart’s belief that the two firms can be successfully integrated? Be specific.
- 4. Speculate as to whether the Jet acquisition will be successful in moving Walmart from a largely brick and mortar retailer to one having a much larger online business? Explain your answer.
- 5. Describe Walmart’s online strategy. Do you think Walmart has a reasonable chance of overtaking Amazon? Explain your answer
- 6. What is corporate culture? Why is it important?
- 7. Why did the earnout focus on the length of time managers stayed and not financial performance targets for Jet? What might your answer to this question tell you about Walmart’s primary motivation for buying Jet?
Answers to these questions are found in the Online Instructor’s Manual for instructors using this book (https://textbooks.elsevier.com/web/Manuals.aspx?isbn=9780128150757).