Many M&As that look promising on paper fail because they are unable to win the full support of managers. To avoid such failures, Philippe Haspeslagh argues that companies need to develop a clear acquisition strategy and a transparent and fair process for examining it
Treating value via mergers and acquisitions remains an enduring challenge, as many forces conspire in favour of overpaying, failing to deliver the planned benefits and destroying other value in the process.
In this article, I will argue that companies must have a clear acquisition strategy to achieve successful transactions. They also need to present a step-by-step process for clarifying integration trade-offs, to achieve consensus in the acquirer and win the support of managers on both sides.
The acquisition justification process can be seriously flawed
All the financial studies on acquisition performance have one conclusion: the game is stacked in favour of the seller. Study after study has shown that acquisitions on average do create value, but that the benefit of synergies tend to accrue to the seller in the form of an acquisition premium.
A lot has to do with how expectations of synergy are set. In theory, buyers build up expectations by modelling value and expected synergies, and setting a price that does not reveal all the potential benefits. But in practice, the anticipated premium is known. The question is can the synergies be stretched to meet the difference between expectation and reality?
The need for secrecy means bids are often put together by a small number of people in business development and finance, with the assistance of key advisers. For example, when Daimler-Benz purchased Chrysler, only three people were apparently aware that the deal had been struck – excluding the finance director and operating managers.
Hostile acquisitions or mergers are particularly sensitive to market reactions, because the market has clear expectations. Witness the recent reaction to the attempt by Dutch media group VNU to acquire IMS, the health industry research provider, in the face of disappointing results from previous US acquisitions. Thus, such acquisitions need to be “sold” to investors and the analyst community, and this is essentially done on the basis of job and cost cutting and the potential efficiencies. As a result, tracking the achieved synergies and communicating this information to the market becomes the central focus of the integration process and the yardstick by which merger progress is measured. In the meantime, actual strategies and business performance may be deteriorating.
Why the process contains the seeds of failure
The fact that acquisition justifications tend to stretch synergy expectations, are elaborated by a small group – often without an operating perspective – and focus too heavily on cost synergies creates at least five perverse effects.
■ In the early stages, the lack of interaction between those advocating an acquisition and operating management often leads to unrealistic expectations that could easily be dispelled by someone familiar with the situation on the ground. In one example of an oil company acquisition conceived at headquarters, significant synergies were expected from improved logistics through access to a terminal in a neighbouring country. But anyone on the ground could have explained that the zone around the terminal was in the hands of rebels, and that the two countries involved were effectively at war.
■ Even if each potential synergy is plausible in and of itself, it will probably be impossible to realise all synergies simultaneously, as integration will require trade-offs between benefits. For example, integrating the sales forces of two former competitors can yield huge cost advantages, however, it is rarely accomplished without some loss of market share.
■ Pressures following the acquisition tend to focus attention almost exclusively on the value creation from cost synergies, to the detriment of the less easily quantifiable or tangible benefits that may enhance top-line and capability development. In many situations, managers know that the true success of an acquisition will depend on its impact on future growth, yet the drive for cost synergies may undercut the efforts that could achieve such growth. In numerous cases, we have seen integration approaches that focus too heavily on cost synergies undermine the new product development capacity of the merged organisations. For example, when Hewlett-Packard purchased Compaq, then chairwoman and CEO Carly Fiorina over-delivered on the promised $2.5bn of synergies, but put the overall strategy in trouble.
■ The process utterly fails to ensure the support of operational management in merged organisations. The benefits of M&As are not realised by those concocting the deal, but depend on the willingness and ability of many people across both organisations to interact and work together.
■ The integration results in single-minded attention to value creation, to the detriment of the focus on value preservation. And while the focus of the formal process of “capturing the benefits” reports good progress against targets, employees leave, customers are lured by competitors and the flywheel of the acquired organisation may lose momentum.
The importance of clarifying the logic of integration
A process is needed that balances value preservation with value creation, and focuses on the benefits to be achieved from the acquisition and on the implementation requirements needed to realise them.
Often, difficult integration choices have to be made that go against the wishes of many parties. This means that all actors need to regard the process for clarifying integration trade-offs as fair: different perspectives must be heard and acknowledged. Without such a process, it is difficult to expect more than cursory compliance with decisions.
David Jemison of the McCombs School of Business at the University of Texas at Austin and I have developed a proven process that has been used in numerous deals on both sides of the Atlantic. The process is based on a series of key observations.
■ Most management teams that agree to an M&A don’t, in fact, agree to the same one. Both sides in an M&A, as well as the acquirer’s key decision makers, see an M&A slightly differently. In a sense, they all sign up to a different version of the deal. These differences may be accentuated by the fact that the logic of an agreement is fuzzy, because some fuzziness over what is being agreed can make it easier to reach an agreement. At the same time, each individual and each side may be focused on particular benefits that they want to see realised.
All of this means that, unless there is a clear process to clarify and create support for the integration logic, early post-acquisition infighting will lead to the postponement of the M&A or open strife between parties.
■ There is more than one way to integrate. Acquiring managers have a tendency to see integration as a process of “making them the same as us”. However, the correct approach balances the need to preserve the value of what is acquired with the requirement to create synergies. The framework we use for this is the strategic autonomy/organisational interdependence framework. This distinguishes between three integration archetypes.
The first is absorption: This is indicated when most of the benefits derive from combining resources, and there is no value in keeping differences in culture or approach. An example of absorption is when two retail banks in the same country create one new organisation with a single culture to realise the cost benefits of a single branch network.
The second archetype is symbiosis: This is indicated when benefits arise from co-ordination and collaboration across functions in both organisations, while, at the same time, the preservation of the business culture of the acquired organisation is key to performance. A commercial and retail bank acquiring an investment bank, for example, must preserve the culture of the latter until the former has developed its own business culture.
The third type of integration is preservation: This is indicated when the business cultures of two merged organisations are vastly different, and most benefits from the acquisition derive from better general management rather than any operational integration. An example of this type of integration would be the acquisition of a prestige brand by an automotive manufacturer or a partial downstream integration for learning purposes.
■ The challenge is not to execute planned synergies only. The better the acquisition, the more benefits are created that were not in the original plan. The challenge is to set the right tone, remove uncertainty and create an atmosphere in which people can engage with each other constructively. This varies depending on whether we are dealing with an absorption, symbiosis or preservation acquisition, but in all cases a broader approach than the typical synergy framework is needed.
■ Every acquisition has many different business elements requiring a different approach. For example, purchasing may require immediate combination, brand management may need to be preserved and engineering better co-ordinated. It is important to clarify, communicate and create support for these different approaches. Why should people in R&D believe your assurances that nothing will change for them when in the next building their colleagues in sales are rationalised into your global sales pipeline?
■ There are always business elements where each side has a different approach and where different integration strategies can be defended. Consider the integration of the engineering function. Should the emphasis be on absorption through the development of common platforms that embed engineering knowledge? Should separate development be allowed, while working towards common disciplines, tools and practices? Or do we leave engineering functions largely autonomous to better support differentiated end-products?
This is where fair process is essential in encouraging people into a process that examines different integration approaches. This is illustrated by an example where the integration of a sales force was hotly debated. The acquirer insisted on the cost benefit of sales integration, but the benefits were disputed. However, the acquirer used the counter arguments to develop an even better sales solution, which included differentiated marketing units, product training for the salesforces and a new margin-related bonus system.
Practical steps in the process
A process which applies these principles typically consists of a series of workshops, either with the acquiring management or, as soon as as possible, between both sides.
The first step is to clarify the purpose of the acquisition – its strategic and operating logic – to ensure mutual understanding and agreement. This means examining in quite specific terms how the acquisition is supposed to create value by: rationalising and combining resources; better co-ordination and skill transfer; or better management.
An assessment of the different business cultures is also required. In this case, the crucial question is: to what extent does future success depend on the acquired company retaining its specificity? This leads management to accept the tradeoffs, style and integration process for their acquisition.
Attention must also be paid to identifying potential sources of value destruction. Managers must be made to see more clearly how the handling of the interface between two companies following an acquisition, the type of leadership exercised and the integration support process required will differ depending on whether an absorption, symbiosis or preservation approach is chosen.
The second step is developing a more detailed integration blueprint, which identifies a (limited) number of business elements to be examined separately. Depending on the situation, this can entail segments, functions or processes. For those elements where there is an overlap between the companies, the specific sub-cultures should be examined for compatibility to determine whether it makes sense to preserve the sub-cultures. Brainstorming is needed on the advantages and disadvantages of combining, co-ordinating or preserving each of them, while attention should be paid to how to remedy the side effects and minimise the drawbacks of these options.
The results of this second step should then be used to design an integration process, including a steering structure, a task force process, a communication plan and support. From this point on, our process resembles (or becomes) the typical process offered by several leading consultants. However, there are some subtle but important differences.
First, whereas the standard integration products fit the cost-driven elements of absorption well, our process places greater emphasis on the creation of the appropriate atmosphere for collaboration, leading to top-line development over time. Second, rather than having a task force for every function or area progressing at the same rhythm, we propose a narrower, prioritised approach, with each track proceeding at its own speed and in its own style. Finally, more energy is devoted to ensuring managers involved in the interface roles are well prepared.
Acquisition integration: not business as usual
Experienced acquirers understand and practise many of the elements I have described. For the vast majority, however, acquisition situations do not remain business as usual. Instead, they are wrought with emotion, risk and pressure.
In such circumstances, the capacity of an acquirer to be decisive and understand the perspective and value drivers of the other side is severely tested. In my experience, a balanced and fair process that is seemingly slow and more complex than the usual narrower focus on synergy planning has a greater chance of success in the long run.
Too many acquisitions disappoint, despite assurances that synergy promises are on target. For this reason, a broader view of the integration challenge is required to increase an organisation’s capabilities.
Philippe Haspeslagh is the Paul Desmarais Chaired Professor of Active Ownership, and director of the strategic issues in the M&A programme at Insead.