Commentary & Analysis
Murders and Accusations or “Why not to do a deal at all.”
No, that title isn’t a typo. Mergers and acquisitions are getting lots of attention again. That means mine will probably be the most contrarian voice on the subject. Over the past 14 years, I’ve watched 8 different deals up close. So let me apologize in advance: I’m not a fan of mergers or acquisitions. Here’s why..
By Wayne Peterson
Published: September 17, 2013
No, that title isn’t a typo. Mergers and acquisitions are getting lots of attention again. That means mine will probably be the most contrarian voice on the subject. Over the past 14 years, I’ve watched 8 different deals up close. So let me apologize in advance: I’m not a fan of mergers or acquisitions. Here’s why:
“Mergers” arent. “Acquisitions” don’t.
There are very few “mergers.” The term is a fig leaf. In almost all cases, someone is acquiring someone else. So let’s drop the term “merger.” In most acquisitions, things die. Often, they die badly and needlessly. What tends to die in acquisitions? Let’s look at four things.
- Shareholder Value Dies. An acquisition is an incredibly bad idea for everyone except for a seller who is being cashed out. Everyone else involved in an acquisition tends to lose. They often lose badly. There is good research demonstrating that acquiring companies average a 10% drop in value over the five years following the acquisition. 80% of mergers fail to deliver their anticipated value, regardless of the deal size, structure, financing, or good intentions of the principals involved. For smaller-scale companies, the results can be devastating. I saw the fallout for a client who had pursued an ill-advised tuck-in two years earlier. The deal took nine months to complete. It was expensive. The acquired firm successfully liquidated its equipment and operation, and a handful of people moved to the new firm. Two years later, all the acquiring firm had to show for the effort and expense was a one mediocre salesperson.
- Competitive Advantages Die. I watched a client firm be acquired by another regional competitor because the selling shareholder was no longer actively involved in the business and was ready to cash out. For the selling shareholder the deal was a good one. For both the acquiring company and the acquired company the deal was a huge disappointment despite very conservative expectations. Eighteen months later the combined revenue of the two companies was barely 80% of the pre-deal level. Significant customer defections were the driver. Different companies offer different kinds of value even to the same marketplace. Therefore, they will attract different kinds of customers who are looking for different kinds of value. And if the kinds of value that two companies offer are substantially different, the likelihood of a successful merger or acquisition is very low. That’s because some group of customers, most likely the customers of the acquired company, are going to be disappointed. I’ve even seen cases where the customers of an acquired company felt actively betrayed and said so in a customer survey and again in focus groups.
This isn’t hypothetical or academic. I watched the deal I mention above become a huge disappointment as many of the customers of the acquired company chose to go elsewhere. The warning of that risk was in plain sight but misunderstood and misinterpreted. During the due diligence and planning process, the two companies compared their respective customer lists. They were pleased to see very little overlap in the top 50 for each company. And what should have been a warning flare was treated as good news. For two companies to have existed for decades as nominal competitors in the same region was a clear signal that they created different kinds of value for different customer segments. In other words, they had completely different and incompatible competitive strategies. The fact that they were of similar sizes and had similar equipment meant almost nothing to their customers.
- Organizational Cultures Die. Trying to force two incompatible organizational cultures together is like trying to transplant an organ when the donor and the recipient aren’t compatible. Tissue rejection sets in. That’s because organizations are much more like organisms than like mechanisms. And the typical plans for putting two organizations together are almost exclusively mechanical. Those plans bear a strong resemblance to the instructions for bolting a cargo hitch on to your Ford pickup.
To successfully integrate two organizations into one, there’s work that needs to be done beforehand and work that needs to be done after the deal is inked. On the front side, an assessment needs to determine whether the two cultures are compatible at all. And that means you have to assess elements of the enterprise that make the dealmakers very uncomfortable.
Make peace with the reality that the acquiring culture is going to win. It always does. On the back side, significant effort will be required to integrate two separate cultures into one. And that effort is rarely made. It’s overlooked because of the huge distraction of integrating processes, systems, and structures. The expectation is that everything will be fine if everyone will simply go along and get along. Because someone is acquiring someone else, a dynamic of winners and losers is inevitable even if it’s not explicitly acknowledged.
Organizational defensive routines run rampant following an acquisition. And defensive routines are simple to understand and powerful. They have four simple steps. First, we say and do things that are inconsistent. Second, we act as though they are not inconsistent. Third we make those inconsistencies or ambiguities undiscussable. Finally, we make the undiscussability of the undiscussable also undiscussable. (Yes, that’s a mouthful.) It’s a self-sealing process. You’re rolling your eyes and shaking your head, aren’t you? You’ve seen defensive routines in action, up close, and too often. Those defensive routines will slow or stop well-intentioned integration intentions and efforts as lip-service is given but nothing changes.
Defection of key employees — often referred to as brain drain — gets little mention. But those defections are a frequent byproduct of an acquisition. Ironically, it can be high value employees both from the acquiring firm and the acquired firm who vote with their feet when everything is ambiguous and the integration isn’t managed well. These defections fuel a loss of organizational memory and organizational knowledge. And they directly affect the ability of the combined organization to fulfill the promises that have been made to its customers. If value delivered to a customer is coming from an enthusiastic member of that organization, the loss of that individual can directly affect the value being delivered.
- Brands Die. Strong organizational cultures and strong brands go hand-in-hand. It’s rare to find a strong brand where there is not a strong organizational culture. A brand can be every bit as meaningful to those inside an organization as to its customers. And brands often die in an acquisition, sometimes intentionally.
There are three questions I ask business owners and CEOs when I’m trying to understand what kind of value the company intends to create for its customers, and therefore how it intends to compete in the marketplace. I get clear answers to the first two most of the time. It’s the third one that’s hard. The three questions are: Who are you? What do you do? Why does it matter? The answers to those can quickly give me a sense of the probable brand strength I’m going to find.
When customers are invested in (have an attachment to, have an affinity for, have a meaningful history with) a company brand, that attachment almost never survives the disappearance of that brand identity. And yet the value of a brand is rarely considered during the due diligence process for a graphic communications company. Here’s why:
Few firms wading into the surf of acquisitions make the right kind of preparation. Nearly all the common preparation is financial and legal. Due diligence is limited almost entirely to those two realms. Everything else is based on assumptions. Those assumptions include the anticipated responses and behaviors of employees (including key employees), customers, and competitors. In very few cases are those assumptions tested.
The outside players are the primary drivers. It’s easy to see why. Investment bankers, attorneys, and accountants have a vested interest in getting the deal done. And they have little if any vested interest in the success of the enterprise afterward. For a selling shareholder that’s fine. Those essential experts, necessary to the process, have interests most closely aligned with those of the selling shareholder. Like a selling shareholder, they want a deal done quickly and cleanly. And like most selling shareholders, they don’t want downstream encumbrances or challenges. That positions those functional experts almost directly at odds with the interests of the acquiring company.
The process itself is built with a strong bias toward things that are easy to measure and value. That’s where investment bankers, accountants, and even attorneys, are most comfortable. So the due diligence is limited to things that are tangible. Raise the issues of cultural fit, employee behavior, competitor behavior, customer behavior, or brand value and those advisors get uncomfortable in a hurry. I had one M&A accountant refer to organizational culture as a “social disease.” And yet those are the factors that most directly affect the performance of an enterprise post-acquisition.
Accusations and frustrations fly when acquisitions fail to deliver on the expectations that motivated them. And yet we’re in an industry in “wholesale transition” as one CEO described it, which motivates many to consider an acquisition.
What To Do Instead:
The motivation for an acquisition (by the acquiring company) is to improve results: competitive results, market results, or financial results. And an acquisition can look like a faster and easier way to get larger. But since it rarely works, let me suggest two alternative places to focus your attention, energy, and investment.
- Get better at organic growth. Instead of trying to buy someone else’s book of business, develop the internal capability to meet a new customer need. Research my firm has done confirms that nearly all new services are developed in the context of a single customer relationship. That means it’s the need of a given customer that prompts the development of that service, which is then refined and polished and offered to others. Customer relationships within which new services are developed get stronger because they get deeper during the development process. More and better information is exchanged, stronger and better individual relationships are created. Collaboration builds bonds. Collaborating with the customer to meet a new need through a new service also builds a deeper understanding of the customer’s business which brings more opportunities to the surface. It becomes a self-reinforcing, virtuous cycle. All of those facts argue for developing new services and capabilities rather than grabbing them through acquisition. The development path is far less disruptive and the new services are far easier to integrate into the enterprise.
- Build alliances. Yes, that sounds like heresy. Graphic communication firms of all kinds have never been strong on alliances. They’ve been led to believe that their performance will inevitably erode and that risk will climb if they sell services not performed in their own operations. After all, your “value added” will decline. While that advice may have had value when graphic communications firms were purely manufacturing operations, it no longer holds. So look for allies rather than acquisition candidates and then cultivate those relationships intentionally.
Alliances with other resources and other firms can be faster to create, much less difficult to manage, and far less risky then any acquisition. And as a response to competitive needs and customer needs, they tend to be far more effective. Specific resources can be identified and brought to bear to meet specific customer needs. They can be organized around specific projects and specific campaigns. Given the quality of freelance talent that is available today, alliances make much more sense. And our research demonstrates that customers care little about what you do on your own floor, but care a great deal about your willingness to take responsibility for a whole program or campaign.
Too many acquisitions are made either for the wrong reason or for no reason. Growth is the worst motivator for an acquisition. In far too many cases, firms that pursued acquisitions have been disappointed as they found themselves in the cycle of “acquire and shrink, acquire and shrink” rather than acquire and grow. The risk, the expense, the difficulty, and the distraction of an acquisition should make it much less attractive than it tends to be. That 80% or more of acquisitions fail to deliver their expected results (even when those results are conservatively estimated) should give you pause. Frankly, an acquisition should be a last resort and not a first choice. It should be seen as a high risk and difficult path to travel, and not as something easy, fast, or attractive.
If you’re determined to pursue an acquisition, then break out of the rut that fails. Get the hard work of strategic due diligence done. Get solid confirmation of the strategic and cultural fit. Then develop an integration plan where your customers, culture, and brand get more attention and more resources than are focused on “leveraging synergies” in the back office and on the plant floor. Do those things and you just might find yourself in the 20% of acquisitions that deliver the results expected.