KUHN CAPITAL Thursday, October 19, 2017
Dispatches from the front

Not All Deals are Created Equal

We sometimes come across articles published elsewhere that seem particularly relevant and valuable to our clients. Joseph Bower, a professor of ours at Harvard Business School, has written such a piece, excerpted below. To order a reprint of the full story, titled "Not All M&As Are Alike — and That Matters," see the Harvard Business Review, March 2001.

We know surprisingly little about mergers and acquisitions, despite the buckets of ink spilled on the topic. In fact, our collective wisdom could be summed up in a few short sentences: Acquirers usually pay too much. Friendly deals done using stock often perform well. CEOs fall in love with deals and don’t walk away when they should. Integration’s hard to pull off, but a few companies do it well, consistently.

Given that we’re in the midst of the biggest merger boom of all time, that collective wisdom seems inadequate, to say the least. I recently headed up a year-long study of M&A activity sponsored by Harvard Business School. That study sought to examine questions of M&A strategy and execution with a new rigor. Our in-depth findings will emerge over the next year or two, in the form of various books, articles, and cases.

Our work has already revealed something intriguing, however. The thousands of deals that academics, consultants, and businesspeople lump together as mergers and acquisitions actually represent very different strategic activities.

Acquisitions occur for five reasons:
• to deal with overcapacity through consolidation in mature industries;
• to roll-up competitors in geographically fragmented industries;
• to extend into new products or markets;
• as a substitute for R&D; and
• to exploit eroding industry boundaries by inventing an industry.

Despite the massive number of books and articles published about mergers and acquisitions, no one has ever tried to link strategic intent to the implications for integration that result. It stands to reason that executives overseeing each of these activities face different challenges. If you acquire a company because your industry has excess capacity, you have to figure out quickly which plants to close and which people to lay off. If, on the other hand, you acquire a company because it is developing a hot technology, your challenge is to hold on to the acquisition’s best engineers. These two scenarios require the acquiring company to engage in nearly opposite managerial behaviors.

I will turn now to the problems that arise in different types of acquisitions, which I will examine using the resources-processes-values framework. Resources refer to tangible and intangible assets, processes deal with activities that turn resources into goods and services, and values underpin decisions employees make and how they make them. [ed note: see the full article for more on these terms.]

Scenario 1: The Overcapacity M&A
A great many mergers and acquisitions occur in industries that have substantial overcapacity; these tend to be older, capital-intensive sectors. Overcapacity accounts for 37% of the M&A deals in our breakdown. Industries in this category include automotive, steel, and petrochemical. From the acquiring company’s point of view, the rationale for acquisition is the old law of the jungle: eat or be eaten. This kind of deal makes strategic sense, when it can be pulled off. The acquirer closes the less competitive facilities, eliminates the less effective managers, and rationalizes administrative processes. In the end, the acquiring company has greater market share, a more efficient operation, better managers, more clout, and the industry as a whole has less excess capacity. What’s not to like? (Unless you overpaid.) Thousands of deals are undertaken with these objectives in mind. However, few of these deals have been judged successful after the fact.

You can’t run the merged company until you’ve rationalized it, so figure out how to do that quickly and effectively. Don’t assume your resources are better than the acquired company’s resources. And don’t expect people to destroy something they’ve spent years creating.

Impose your own processes quickly. If the acquired company is as large as yours and its processes are dissimilar, expect trouble. Some key people will leave, making it harder to rationalize the merged entities. Voluntary agreement is best, but early agreement is necessary. Don’t try to eradicate differences associated with country, religion, ethnicity, or gender.

Scenario 2: The Geographic Roll-up M&A
Geographic roll-ups, which appear at first glance to resemble overcapacity acquisitions, differ substantially in part because they typically occur at an earlier stage in an industry’s life cycle. Many industries exist for a long time in a fragmented state: local businesses stay local, and no company becomes dominant regionally or nationally. Eventually, companies with successful strategies expand geographically by rolling up other companies in adjacent territories. Usually, the operating unit remains local if the relationship with local customers is important. What the acquiring company brings is some combination of lower operating costs and improved value for the customers.

Because both overcapacity acquisitions and geographic roll-ups consolidate businesses, they can be difficult to tell apart except on a case-by-case basis. However, they vary in some fundamental ways. For one thing, their strategic rationales differ. Roll-ups are designed to achieve economies of scale and scope and are associated with the building of industry giants. Overcapacity acquisitions are aimed at reducing capacity and duplication. They happen when the giants must be trimmed down to fit shrinking world markets.

Acquired companies often welcome more streamlined, efficient processes. But if you encounter substantial resistance, you can afford to ease the target company’s employees into new processes. In geographic roll-ups, it’s more important to hold on to key employees — and customers — than to realize efficiencies quickly.

If a strong culture is in place, introduce different values subtly and gradually. Carrots work better than sticks — especially with high-priced, hard-to-replace employees.

Scenario 3: The Product or Market Extension M&A
The third category is the M&A deal created to extend a company’s product line or international reach. Sometimes these are similar to geographic roll-ups; sometimes they involve deals between big companies. They also involve a bigger stretch — into a different country, not just into an adjacent city or a state.

The likelihood of success depends in part on the companies’ relative sizes. If near equals merge, the problems that crop up in overcapacity deals are in play: difficulties imposing new processes and values on a large, well-established business. If, on the other hand, a large player (think GE) is making its nth acquisition of a small company, chances for success go way up.

Know what you’re buying. The farther you get from your home base, the harder it is to be confident of that knowledge.

Be aware that processes you consider core may turn out to be very different from those used by the target company. Cultural differences and governmental regulation often interfere with the implementation of core processes.

Take the time to figure out how the target company achieved the success that led you to buy it. If it’s brilliant at product development and you’re not ...well, you figure it out.

Keep in mind that the bigger you are relative to your target company, the better your chances for success.

Scenario 4: The M&A as R&D
The next-to-last category, acquisitions as a substitute for in-house R&D, is related to product and market extensions, but I’ll treat it separately because it’s so new and untested. An assortment of high-tech and biotech companies use acquisition instead of R&D to build market position quickly in response to shortening product life cycles. As John Chambers, Cisco’s president and CEO, says, "If you don’t have the resources to develop a component or product within six months, you must buy what you need or miss the opportunity." Since 1996, Cisco has acquired 62 companies, as it races to dominate the Internet server and communication equipment fields. From the target company’s point of view, an acquisition is often desirable, since it takes a massive amount of money to build a sustainable company in technical markets. And potential acquirers (such as Microsoft) can easily crush you if you compete with them directly.

Again, know what you’re buying. Netscape and a host of other high-tech companies bought second-rate technology again and again. This doesn’t lead to first-rate business results. Cisco, by contrast, has industrial-strength evaluation processes.

There is no time for slow assimilation when substituting acquisitions for R&D. The new people won’t work if the vision and values aren’t compatible. Cultural due diligence is especially important when bringing in people who are giving up the CEO title and have the wealth to walk away.

Put well-regarded, powerful executives in charge of acquisition integration. Divest them of all other responsibilities during an important integration. Make this into a core competency, and a high-visibility assignment.

Spend equal amounts of time keeping the new people happy and fitting the new product or technology into existing activities.

Scenario 5: The Industry Convergence M&A
The first four categories involve changing the relationships among a particular industry’s players. The final one involves a radically different kind of reconfiguration. It entails inventing an industry and a business model based on an unproven hypothesis: that major synergies can be achieved by culling resources from existing industries whose boundaries seem to be disappearing. The challenge to management is even bigger than in the other categories. Success depends not only on how well you buy and integrate but also, and more importantly, on how smart your bet about industry boundaries is.

As with M&A as R&D, this approach is hard to analyze rigorously. In this case, though, this difficulty is not because it’s a new kind of activity. (When William Durant formed the vertically integrated GM, he was creating an industry.) The problem here is that attempts to gain strategic leverage by assembling disparate companies are idiosyncratic. Despite the players’ sizes, this is entrepreneurial activity in progress, and success right now seems to depend as much on the entrepreneur’s skill and luck as on anything else.

Successful convergence deals seem to follow a sequence of steps. First, the acquirer’s accounting-and-control systems are installed at the target company. Next, the acquirer starts to rationalize the nonessential processes (but there seems to be no great rush). Finally, the portfolio is pruned of businesses that don’t fit the acquirer’s strategic objectives.

After those adjustments have been made, subsidiaries are allowed a high degree of freedom. Attempts to integrate the business are driven by specific opportunities to create value, rather than by any perception that symmetrical organizations and systems are important.

Top managers are integrally involved in deciding where to impose links; strategic integration is not a natural bottom-up activity. Intervention must be made with considerable diplomatic skill. (Successful despots do exist, but they are well-liked despots, and that is no accident.)

Varying Flavors, Differing Challenges
Rapid strategic change is a necessity for most companies in these days of globalization, hypercompetition, and accelerated technological change. Accomplishing change through acquisition appeals to a great many managers. What I have found by studying the record is that acquisitions come in several distinct flavors, and that each type presents managers with a different set of challenges.

The recommendation here is simple. M&A is a means to an end. If the strategy is unclear, there is no reason for a company to go down one of the more difficult paths it can follow.

Ryan Kuhn

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