In my experience, companies that have grown largely through acquisition have fallen far short of their expectations. The truth is that more than half of all of the companies moving through this process actually destroy shareholder value. Over the last 30 years, I have encountered three primary reasons for this failure.
The First Reason for Failure
The first reason for failure in these cases is that many executives do not understand the importance of achieving appropriate levels of commonality in their processes and systems. I recently interviewed a CEO on this topic who said that while the executives involved in his company were aware that there were potential gains available from the integration of processes and systems; they were considered minor in light of bigger objectives such as gaining market share. He perceived almost no relationship between an enterprise’s ability to leverage the broader capabilities of a combined enterprise and the capture of additional market share. The Fortune 100 company involved had grown through a multi-decade process of acquisitions and mergers, and had still remained fairly immature in terms of integration. They had common finance and human resource systems, and most of the business processes supported by those systems had been brought into a reasonably aligned position. As a result, the closing of financial books was much faster than the pre-alignment days, and fundamental processes such as the generation of payroll checks and annual activities surrounding performance appraisals and compensation adjustments were fairly uniform. However, the most fundamental processes and systems that comprised the company’s ability to add value were left largely untouched.
The company’s performance as reflected by metrics such as EPS, RONA, and the price of common stock remained lackluster. The company lost ground to both domestic and foreign competitors, and eventually divested itself of most of its vertically integrated operations in order to hold on to profitability. This corporate retreat, moving the burden of effectively managing operations to a supplier base, left the company at significant risk of material shortages, cost escalation, and quality problems. It also made the introduction of new technologies more challenging, and retarded some the company’s most promising opportunities for internal innovation.
Many companies, especially in the industrial manufacturing segments of American business, seem to have concluded that managing the most value-additive processes of their businesses is simply too difficult, and that keeping up with offshore competitors is not possible; hence the current trend toward disintegration. However, the evidence is not yet suggesting a broad improvement as a result of this trend; rather, many of the companies involved appear thus far to merely be holding their own.
The story of vertical integration is certainly an old one, and probably the most famous example was Henry Ford’s original manufacturing operation that literally changed the world. These days, vertical integration in the automotive industry is more often related to reaching forward toward the customer, such as General Motors’ formation of the General Motors Acceptance Corporation (GMAC). Achieving vertical integration through acquisition and merger became a larger feature on the business landscape in America more recently. Examples of late are the merger of Time and Warner in 1989, the purchase of Medco Containment Services by Merck & Company in 1993, and the series of moves made by aluminum manufacturers such as Reynolds to acquire can manufacturers such as BevPak.
The motivations for performing acquisitions and mergers to achieve vertical integration most often center around: assurance of a dependable source of supply, reducing throughput times in the supply chain, achieving lower costs through a shift away from outside procurement toward internal transfer pricing, and satisfying the need for specialized inputs such as proprietary material formulations, custom equipment or internal components, and so on. In addition, many companies who integrate vertically backward through the supply chain find that they can more consistently produce high levels of quality via the commonization of processes and systems throughout the enterprise.
Another CEO I interviewed only a few days later understood the need for commonality and integration very well. This CEO had presided over many acquisitions in the course of his 25+ years at the company, and was able to point to almost flawless expansion without any dilution in company value, hitting accretive value increase targets in most cases within the designated eighteen to twenty-four month window. (He also reflected on one acquisition attempt many years ago that failed, and the work that was required to pull that one apart again in order to avert disaster.) During the course of my interview, he explained in detail how all new acquisitions in that company were moved very rapidly to the enterprise’s suite of business processes and systems, including finance, human resources, supply chain management, and other critical processes. In finance alone, he pointed out, nineteen separate processes and two supporting information systems were involved. Growing from a single business unit, over the course of three decades this company became the largest one of its kind, and currently operates in more than 20 states. The company used acquisitions and mergers to expand horizontally into adjacent markets, and learned a great deal during those early years about how to filter potential acquisitions and mergers so that effort was expended only in cases where the combination of businesses would support the overall strategy of the business.
These types of acquisitions and mergers, directed toward horizontal integration, are a reasonably common way for companies to move into adjacent markets. Certainly LDDS, which grew to become the second largest long distance telephone carrier in the United States before it was acquired by WorldCom, is a case in point. In these cases, the companies involved usually expect to lower their per-transaction costs by leveraging existing experience and systems assets across a broader market, and further improve financial performance by redundancy reductions and a lower overall asset base. In this way, the expertise, business processes, systems, and other assets of the business are scaled only to the extent necessary to meet the needs of the combined enterprise, and redundant assets are targeted for reduction. The asset base per unit of sales is reduced; hence an improvement in Return on Net Assets (RONA).
The Second Reason for Failure
The second reason for failure is that many company leaders do not know how to go about achieving commonality in their processes and systems. Most of these executives have no idea that the superficial overview of processes and systems so often comprised in the due diligence phase of an acquisition leaves them with only the dimmest view of the opportunities available for improved earnings and growth. However, even when this is not the case there is usually such a dearth of understanding around the discipline of business process re-engineering, lean enterprise concepts, and six sigma quality principles that they have no idea how to remedy the situation.
A couple of years ago, I was asked to accompany the corporate IT executives from one our clients to a business unit in the northeastern part of the United States. Out mission was to see whether we could determine why that division was struggling to perform even the most rudimentary activities, and yielding such poor financial results. When I arrived with my companions, I discovered that there was no adequate documentation of any business process in the division. In fact, as we went through interview after interview, I discovered that I was the only person there who knew how to document a business process in flow chart form, calling out inputs, outputs, responsibilities, and resources consumed. I was even more alarmed when I interviewed manager after manager and found that none of them (with the exception of the division general manager) could articulate any quantitative objectives for their own performance, or the performance of their division.
Moving them toward process commonality in order to gain enough leverage to generate profitability required first of all that the existing business processes be understood, so that we could identify existing performance levels and changes required. At the same time, corporate level objectives needed to be communicated and translated into divisional goals and objectives, flowed down through the business unit in a manner that linked them appropriately from top to bottom. This practice was foreign to the leaders of that unfortunate division, and it was a protracted struggle to move them into alignment. Because this company had moved so rapidly through the acquisition process, paying only cursory attention to systems and almost no attention to process commonization, earnings performance was dismal. Unfortunately, as I discovered over the ensuing year, this had been a pretty common approach over the acquisition-based history of the corporation. It was an ingrained part of the culture of management, and sorting it out was a real adventure. It remains to be seen whether the company will ever gain a real grip on the criticality of getting their fundamental business processes aligned, or whether – like so many others – they will merely attempt to overlay a common information system and hope for the best. It is important to begin with the processes and enable those processes with effective information systems. Approaching the business the other way, with systems leading process execution, is often a dangerous path.
The Third Reason for Failure
The third reason many of these activities fail to achieve expected performance levels is that executives are frequently unable to follow through on the difficult decisions related to post-acquisition and post-merger consolidation. During the course of the interviews I conducted as I prepared to write this book, one of the questions I always asked was: “What, in your experience, have been the top three things to avoid when undertaking a merger or acquisition?” One of the most frequent answers among those CEOs who were most successful was: “Failure to make the tough calls. You can’t appease everyone, and businesses that end up with co-directors, co-CEOs, or co-leaders of any kind are businesses heading for trouble.” The point is that it is best to make tough decisions up front, as the actual business combination is being formulated, and implement them not long after the deal is closed. This is true not only of decisions pertaining to people, but also facilities, equipment, and critical information systems. An air of confidence -not arrogance, or insensitivity, but resolute confidence – and steadiness of direction is an important element of the leadership required to pilot any company through the tumultuous waters of a merger or acquisition.
Few acquisitions have gone as visibly and dramatically wrong as the 1984 acquisition of EDS by General Motors. By virtually all accounts, the attempt to introduce a plain-speaking, no-holds-barred management shakeup at GM failed miserably. Most historians seem to agree that this acquisition, which cost the corporate giant hundreds of millions of dollars, was largely the product of conflicts generated when tough decisions were consistently avoided. Throughout his tenure as a General Motors employee, Ross Perot identified and exposed massive investments in various automation and acquisition projects that were dramatic failures, and repeatedly asked the board of directors at GM to intervene. They consistently refused. Even as he was being bought out and forced to leave, Perot was dumbstruck at the willingness of the board to spend the money they had authorized simply to have him, and his dissention, gone. One excellent account of this phenomenon published as a corporate governance case study, says: “In a press conference held immediately after he signed the buyout agreement, Perot told reporters, “Is spending all this money the highest and best use of GM’s capital? . . . I want to give the directors a chance to do the right thing. It is incomprehensible to me that they would want to spend $750 million on this. I am hopeful that people will suddenly get a laser-like focus on what needs to be done and do it.” Following the announcement of the buyout, and Perot’s press conference, GM stock declined $3, and EDS stock lost $4.50.”
Getting the management of a company to recognize the tough decisions that need to be made, and act on those matters in an effective and timely manner is often difficult. In the turbulent aftermath of a corporate merger or a significant business acquisition, it is especially challenging – and uniquely critical to the company’s success.
Another reason that surfaces, though not as often, is generally poor execution of the due diligence activity (touched on briefly in previous paragraphs). The most common underlying cause for that, in my experience, is an inadequate exploration of processes and systems during the due diligence phase.
To be fair to the executives involved, it is important to understand that mergers and acquisitions are revolutionary rather than evolutionary changes. The level of disruption to both organizations is severe, and there is a psychological toll taken on management and employees alike that can be devastating. The deadlines are aggressive, the sheer tension around the event is high, and there is often a jockeying for position in the new organization. It is very tough to keep one’s eye on the ball in these situations. I am hopeful that the information provided in this article will enable company executives and executives-in-development to foresee those problems, and improve our overall batting average.