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disciplineto M&A mania

Phanish Puranam is a

doctoral candidate in the

management department

at the Wharton School,

University of Pennsylvania.

Harbir Singh is Edward H.

Bowman Professor of

Management and chair of

the management

department at the

Wharton School,

University of Pennsylvania.

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Maurizio Zollo is assistant

professor of strategy at

Insead.

Mergers and acquisitions are as likely to fail as to succeed.

PhanishPuranam, Harbir Singh, and Maurizio Zollo aim

to improve the chances of success.

ergers and acquisitions (M&A) are among the most dramaticand visible manifestations of strategy at the corporate level.

With a single deal, the strategic course of the organizations involvedcan be altered permanently. Capital market reactions may create enor-mous changes in shareholder value and the careers of individual man-agers at all levels may be profoundly affected.

The importance of M&A in corporate strategy can be ascribed to asingle important fact: they allow the company's portfolio of resources tobe transformed very quickly. Acquirers can gain immediate access totechnology, products, distribution channels, personnel, and desirablecost and market positions.

The M&A phenomenon shows no signs of slowing and has evenembraced the high-technology sectors where it was formerly rare.However, a harsh reality underlies this surge in activity, whether it bein high- or low-technology industries: about half of these transactionsfail. The results are the same, whether measured in terms of capitalmarket reactions, financial results, or employee retention.

Yet, these results do not imply that companies should abandon M&A.I~deed, the success rates are not substantially different from those forinternal (organic) development and other forms of external develop-ment such as partnering.

Further, there is considerable variation in success rates: someacquirers seem to show a systematic capability for generating valuefrom transactions, while others seem to destroy value just as systemati-cally. .

What can we learn from this mixed record? This article raises a set offundamental issues that need to be addressed by managers undertakingM&A activities. The discussion covers strategic and implementationissues. It concludes by suggesting how M&A can be made a successfulbusiness process for a company, delivering deal after valuable deal.

~

I jssues

The 1990s saw a shift by corporate strategiststoward resource-based thinking. In this view,companies are seen as bundles of productiveresources and capabilities. These bundles gener-ate competitive advantage for companies whenthey are difficult to replicate and also difficult toseparate and trade in markets. An implication ofsuch resource-based thinking is that for anacquisition to make economic sense for theacquirer, there have to be unique sources ofvalue creation in the deal that are specific to thecombination of acquirer and potential target.

To illustrate, no competitive advantage willaccrue through buying a company that is worththe same to all potential acquirers. The situationis similar to an auction and ensures that the win-ning bidder will pay at least as much as the tar-get is worth to it, or to any other bidder, hencethe transaction is like exchanging cash for anequivalent amount of cash. If, however, AcquirerA values the target (correctly) at a higheramount than other potential acquirers, A willpay less than it values the target for, as the priceonly rises to the valuation of the second-highestbidder.

Acquisitions are made for a variety of reasons:to realize economies of scale and scope; to accessresources such as technology, products, and dis-tribution channels; to build critical mass ingrowth industries; to remove excess capacity andconsolidate a mature industry; or to change therules of competition as deregulation and techno-logical change trigger convergence across indus-tries.

However, unless each transaction is assessedfor the unique value-creation potential of thecombination, it is unlikely to generate competi-tive advantage for the acquiring company.Operationally, this amounts to m'anagers askingwhat the key resources of the target company arein each transaction and how they will generatevalue when combined with the resources of theacquirer.

The answers from this kind of analysis aresometimes startling. Take the example of CiscoSystems, which stunned analysts in 1999 when itpaid $7bn for Cerent, a start-up with $50m in

~ PART 3 STRATEGY

n "

-- NegotiationrangeI

Best scenario valuationwith synergies

Reservation price

Valuation withoption value

Most probable DCFvaluation with synergies

Comparable transactions

Market value

Book value

negotiation range upward after negotiationshave begun - after all, it is much more likely thatinformation uncovered during negotiations willprove to be negative rather than positive.

Working out the negotiation range does twothings. First, it drives home the fact that withoutaccurate information on the quality of the tar-get's resources, the valuation should be stated asa range, rather than an exact figure. Further, foreach significant point in the negotiation range,there is a clear strategic rationale with someexplicit assumptions. As negotiations on acquisi-tion price proceed, it is easy to evaluate whatassumptions are being challenged and in whichdirection. Second, the negotiation range tends toprevent managers persisting with the deal in theface of negative evidence. The upper bound rep-resents a reservation price, at which a disciplinedacquirer should walk away from the deal.

(Implementation issues

Combining two distinct organizations with theirrespective structures, systems, and histories is a

complex task, but it must be done if the strategymotivating the acquisition is to be implemented.

As stated earlier, resource-based thinking sug-gests that companies are bundles of productiveresources. However, acquirers may not want tokeep the whole bundle. The first task of acquisi-tion implementation, therefore, is to decidewhich resources to retain and which to divestafter the acquisition. Resource-based thinkingsuggests this can be difficult, because theresources that make up a company are closelytied,to each other.

This can lead to unanticipated consequences.For instance, even if a target company isacquired primarily for its technical developmentteam, separating it from the sales group candestroy a source of inputs that made the techni-cal team valuable. Thus, knowing how to "decon-struct" the target company into organizationalsubunits and knowing what linkages to preserveare very important.

The second task is to "connect" resources inthe target company with those in the acquiringcompany in a manner that generates the uniquevalue that (should have) motivated the trans-action. This includes decisions on the extent towhich the target companies, or more precisely itsorganizational subunits, will retain their admin-istrative identity after acquisition and the speedat which integration must take place.

What do these steps mean from the perspec-tive of the company which is the target? Selectiveretention of resources amounts to corporaterestructuring. Further, connecting resources inthe two companies implies making changes inreporting relationships, monitoring, reward sys-tems, and location.

In short, post-acquisition implementation bythe acquirer invariably results in the targetexperiencing a great deal of change.

Organizational change can be stressful foremployees and a source of demotivation. Indeed,"post-merger stress" is a recognized problemthat may undermine the strategic logic behindthe transaction. More importantly, change candamage the valuable resources that made thetarget company attractive in the first place.

Some resources, such as a good product designteam, a skilled research team, a competent sales-force, or an efficient manufacturing unit, are

BRINGINGSOME DISCIPLINETO M&AMANIA I 87

valuable because they embody a group of peoplewho have learned to work well together. Theseteams have "organizational routines" that worksmoothly, time after time, to create productiveoutcomes. When personnel are lost, or the pat-terns of communication, reporting, and incen-tives are changed, these routines may bedisrupted. Of course, not all valuable resourcesare based on organizational routines, but man-agers must discriminate between resources thatare and those that are not.

Returning to the acquirer's perspective, themanagerial task is to choose the resources toretain and connect them appropriately to theresources of the acquiring company. This has tobe done in a way that minimizes the harmfulconsequences of change.

Solutions vary by context, but two examplesilluminate approaches by acquirers in differentsectors of the economy. NationsBank, before itmerged with the Bank of America in 1998, hadgrown through a series of acquisitions. Nations-Bank created value in its acquisitions by replicat-ing its own efficient systems and processeswithin the acquired organization. The resourcesit sought were location and customer relation-ships. Its acquisition "formula" was based on anestablished, routinized, and constantly honedpost-acquisition integration process. The processwas clearly and honestly described to the topmanagement of the target company during nego-tiations and to the entire acquired organizationon the day of the announcement.

Given its value creation strategy, Nations-Bank would invest considerable effort in plan-ning the details of converting systems andprocesses, changes in reporting structures andincentive systems, and limiting redundancies.These changes would be implement~d withinweeks of announcement, so that each newlyacquired unit became seamlessly integrated intoa homogenous organizational framework.

Cisco Systems, another company that hasgrown through acquisitions, designs, makes, andsells telecommunications equipment such as theswitches and routers that control the internet.Cisco creates value by combining the technologi-cal expertise of target companies with its ownmarketing, distribution, and manufacturingexpertise.

~ PART ~

... Acquisitionvalue chain IL~,___L~,,~:.Z:~

value chain is a useful device to prompt thinkingabout how M&A can be organized as a businessprocess (Figure 2).

A trait of many acquisitive companies is tocreate a separate unit that specializes in manag-ing acquisitions. The unit need not be large, butdoes require the presence of a core of dedicatedpersonnel who develop acquisition managementskills on many transactions. Such a group mayalso be involved in managing alliances and part-nerships, which share some characteristics of theacquisition process, particularly in the selectionand negotiation stages. Versions of this coreM&A team exist in several active acquiring com-panies such as Cisco, Symantec, Intel, Hewlett,Packard, Sun Microsystems, and (formerly) atNationsBank.

In any given transaction, the transactionteam comprises members of this core group andmembers from the part of the acquiring companythat will house the acquired unit. In addition,experts from functions such as human resources,legal affairs, corporate finance, and informationsystems serve on this team for the phases of theacquisition that require their expertise.

Cisco and Symantec, for instance, have creat-ed "virtual" transaction teams of experts from

Key members of the transactionteam will typically be partytoeverystage of the acquisition

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various business functions. Such an innovationclearly makes sense in industries that sufferfrom chronic shortages of skilled personnel.

Key members of the transaction team, whocome from the acquiring business unit and theM&A group, will typically be a party to everystage of the acquisition, beginning with targetselection and ending with post-implementationevaluation. This ensures continuity and consist-ency at each stage, so pre-acquisition strategy iseffectively implemented.

Having a core group that specializes in man-aging acquisitions allows' tacit experience toaccumulate within this team. However, researchshows that a company can make the most of thisexperience if it invests in a process of "knowl-edge codification" - articulating the lessonslearned from experience and setting them downin manuals to guide future transactions.

These "cookbook" manuals are valuable tofuture managers. However, the real value lies inthe brainstorming and detailed analysis thattake place after every transaction and precedecodification. This generates a deeper under-standing of the complex processes involved.

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ConclusionWhen a merger or acquisition fails. shareholder value isdestroyed and society at large suffers if the productiveresources in the target are destroyed or underused.

Managers can improve their prospects of success inthe following ways:

BRINGINGSOMEDISCIPLINETO M&A MANIA ~

1 Establishinga value rangefor the target thataccountsfor incomplete knowledge and guardsagainstbias in making decisions.

2 Undertaking a transactionasa businessprocesswith defined stages.

3 Developingand retaining M&A expertise.

4 Beingaware of the dangersin ignoring warningsignsthat emergeduring negotiations.

5 Understandingwhen to walk awayfrom a deal.

As understanding of the complexities of these pro-cesses increases, the success rates of mergers andacquisitionsshould rise.

Copyright@ PhanishPuranam,HarbirSinghand Maurizio201102001

Collis, DJ. and Montgomery, CA (1995) "Competingon Resources:Strategy in the 1990s," HarvardBusinessReview,July-August, 118-28.

Haspeslagh,P.e.and Jamieson,D.B. (1991) ManagingAcquisitions, New York: FreePress.

Zollo, M. (1999) "The Challenge of LearningtoIntegrate," FTMastering Strategy, Dec 6.