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Getting More Than You Bargained For By Morrey M. Ewing
INTRODUCTION:
The story is familiar. Company A meets Company B. The attraction is immediate. Company A merges with Company B. Company AB lives happily ever after! That, at least, is how it's meant to go.
xxx,Sadly, not unlike Boy meets Girl, making a merger work is a risky affair that can end in regret. The intended partners may turn out to be much less - or more - than they seemed. Forming a perfect union may prove more challenging than expected. How can the leaders of A and B overcome these pitfalls? What factors influence success or failure? Can farsighted leaders, knowing the risks, ensure a better outcome?
xxx,Consider that any merger offers potential, for good and ill. How can leaders of the merging companies fully grasp that entire potential, even expand it, while ensuring that none of that value goes unrealized?
xxx,One distinction is key - a 'merger' is not an 'acquisition.' In acquisitions, A remains A, made stronger yes, by B, but not changed in its nature. B learns how to do business the 'A' way. In a true merger, learning and change flow in both directions.
LESSONS FROM EXPERIENCE:
No formula for mergers brings a guarantee. Still, accounts by those experienced in mergers reveal three distinct processes, each with its own, compelling objective:
1) Assessing - To unearth the real value of the merged enterprise
2) Negotiating - To jointly define the potential value and how to pursue it
3) Merging - To lock in the initial value, then keep pushing for more
Strikingly, as they unfold, these prove to be three overlapping processes, not discrete steps in a sequence. Each also has its absolute demands. If we neglect any, we will be dragged back to do them again, often under increased pressure.
1) Assessing
What do we mean by 'unearth the real value'? We mean pressing, and getting answers to, penetrating questions not normally asked until much later. Why? Every merger must inevitably overcome a risk of infatuation, of wish fulfillment. "We know the kind of company we have been seeking for some time. We want to acquire scale, scope or capability much faster than we could build ourselves. Here, at last, is a partner that can do that for us, at a price we can afford."
xxxAll companies considering a merger engage in full due diligence, precisely to cull the apparent from the real. Why can they fail to 'unearth the real value'?
•Due diligence varies, but typically stresses four aspects of a merger prospect:
•Does it truly have the quantitative and qualitative benefits we want, e.g., cash flow, access to new markets, a product family we lack, lower costs?
•Do unexpected weaknesses threaten its value, or make success less likely?
•Do legal barriers exist that prevent us from concluding the deal we want?
•Is it worth the value we assign to it, implicit in our merger offer?
•These are valuable questions all, but oriented to deals, to "go ? no go" decisions. Later, many wish they had probed more deeply into three enduring issues:
a) What assumptions influence the expected value of the merged enterprise?
Every merger's expected value is a product of potential times likelihood. Underlying those factors are assumptions that must hold true for the value to be captured. A few examples may help.
xxxAn investment dealer sought to join another, partly due to its unique, retail brokerage system. Post merger, the system proved not 'scalable to the new, higher volumes. The failure of this assumption lessened the merger's value.
xxxA famous technology firm recently went up for sale. Its current client base is admirable ? among the world's top brand names. Contracts last for two years. Still, buyers would want to confirm that those clients will stay. Some will do so only if they see dramatic progress in product and service quality.
xxxThe hardest case is a merger whose value assumes an ability to harness the expertise or relationships of key individuals. Which of their people create this value, and how does one retain them? Tracking the source of such value is itself tricky. Leaders spin merger webs on paper and in isolation, rarely in sight of real people doing real work. Outsiders’ assumptions looking in are especially suspect. Nor should they assume that their prospective partner will pinpoint its own value. Having learned who’s who, how does one unlock their knowledge or skill, so they share it with their new colleagues?
xxxThe least likely assumptions may need heroic efforts to help them come true, and failing that, contingency plans. We should give all parties a stake in realizing the assumptions. We can make the price, or the deal, contingent on our success. We can also plan for the assumptions collapsing altogether.
b) What risks could undermine the newly merged enterprise?
When two businesses combine, several risks appear and others grow. For instance, some merger partners risk pooling their weaknesses, as well as their strengths. This occurs especially if a merger’s purpose is to make progress on just one or two dimensions, such as market share, or geographic coverage. Other elements of the business can get weaker, if we fail to focus on them.
xxxA common risk is for the two firms to choose their preferred ways of doing business, based on the choice of leaders in the new structure. The best person for Controller, post-merger, may not have built the better financial controls, pre-merger. Still, that leader’s system may prevail, because he or she does.
xxxToo often in mergers, both leaders and employees risk getting drawn into internal obsessions. Distracting changes tend to multiply in such areas as who has what job, who reports to whom, what standard procedures to use, who gets paid how much, and who gets what office, to name just a few.
xxxAll this can take the eye off the ball of serving customers and capturing new market opportunities. As a result, customers may suffer. The merger may force them to invest in new relationships and learn new ways of doing business, when the old ways served them well. Some customers may have to deal with a company they had once rejected, or that once rejected them.
xxxEqually, an internal focus raises the risk of being blind-sided by competitors. Often, rivals will choose this moment for a direct attack, while the merger absorbs all the effort of the merging parties. Worse, when mergers seem mainly to benefit shareholders or executives of the new enterprise, competitors can use this stick to attack it, to upset its best customers.
xxxValued employees from either business are also exposed. If neglected, they may wonder if a meaningful role will be left for them in the new company. Alert competitors may exploit this opportunity, and go recruiting. Some enterprising employees may even launch a new competitor, themselves.
c) What is the imagined future for the new enterprise?
One of the most powerful factors driving the success of mergers is the scope for imagination its founders bring to the task. In defining elements of the new business, some only consider the two previous models. They may choose A’s approach over B’s, or try a bit of each.
xxxWhat if they mixed (and then stirred) the vision of A’s leaders, and their tight cost controls, with the close customer knowledge of B, and its innovative compensation plan? What entirely new businesses might they build to exploit these strengths, which may look quite unlike either founding business?
xxxWhat if the founders challenged all activities where both merging firms trail the ‘best in class’? What if they stimulated interest in becoming the leader in these fields, leveraging the openness to new ways that a merger can promote? What if they worked together to find and learn from companies who can outperform both of them in these activities?
xxxThink how this perspective alters the classic merger issue? how to integrate two cultures. (Culture just means 'how we do things around here'.) Rather than impose one culture on another, merger partners could design a culture around the company they want to become. Each partner could contribute some elements, but many should be wholly new, built to fit the future need.
xxxEven a merger created to serve very narrow goals may lead us down new paths. For instance, suppose we merge with a business to acquire its expertise in managing costs. We want to learn from and leverage that skill. Once we do, what entirely new territory could we enter, as a result? How could we defeat our competitors in new ways? How will we invest the extra returns we hope to generate? How will we reward our shareholders?
xxxSuch strategic questions apply to more than the total enterprise. Each department, team and employee must also consider how to respond, to foster or exploit this new capability. E.g., to equip all leaders of a business to track and drive down costs, IT must define the new management information they will provide. Finance must design new control techniques to promote company-wide. Marketing should decide how to take advantage of low cost leadership, in pricing, advertising, or building relationships.
xxxEach company is then building a vision of the new business that exceeds A+B, or even AxB. A truer analogy may be A, raised to the power of B.
In Assessing, then, we seek to unearth the true value of the merger, not just now, but over time. We challenge the limits of what seems possible, in the constant search for a larger prize. Out of a deeper knowledge of assumptions, risks, and how to manage them, we aim to increase the chance of capturing that prize.
2) Negotiating
Still, assessment is a form of 'planning', and planning is never complete nor enough. We can only try to prepare ourselves sufficiently ? both before the merger, and during. Even then, we soon recognize that our need to assess continues, long after the ink is dry.
xxxOverlapping with assessing is Negotiating. In most acquisitions, think of this step as simply 'deal-making' or 'trading'. At the moment we strike such a deal, we can measure and capture most or all of the value.
xxxIn true mergers, however, both parties may want to define the potential future value they want from the relationship, and during the exchange, begin building it. In this way, they can "start as they mean to go on."
xxxThis is easier said than done. While instinct may urge us to 'go for the deal', in negotiating a merger, we must foster a relationship with potential new partners. We meet to explore what we could do together, and how. When this process works, it must deftly balance three differing needs:
•To address each other's hopes and fears for potential value in the merger
•To establish the legal and financial basis for the merger, in a contract
•To set up the new organization for success
Addressing Hopes and Fears
If both sides perform their assessment in depth, and unearth the real value, the expressing of hopes and fears comes readily. The challenge is often that the quality of thinking is much higher on one side, than on the other. Frequently, one party has a much deeper understanding of its own hopes and fears, risks and assumptions, than the other. In a straight acquisition, it may prefer to retain this difference, as an advantage. In a merger, keeping quiet can be harmful.
xxxTake two manufacturers, each seeking a merger for different reasons. Alpha Inc. is an industry leader concerned that its products and markets are maturing. It wants easy access to new growth markets where high flying Omega Industries is concentrated. Omega is much smaller, but with big ambitions. If only it could use a merger with the more established Alpha to accelerate its climb to the top.
xxxAlpha has been down this path many times in past, completing several mergers along the way, while passing on others. A professionally run company, it knows that early growth firms like Omega, with driven CEO-founders and 'get it done' cultures, can chafe under its process disciplines. It knows that if Omega's key people want to learn from Alpha's strengths, while offering new insights and ideas, the combined business could dominate. Instead, if Omega sees Alpha's established ways as merely stodgy, its people will soon rebel and quit the merged enterprise, taking much of the merger value with them.
xxxNothing could be more useful to Alpha than sharing its hopes and fears, to help its less experienced partner know and manage the risks of going forward. In mergers, the party that is best prepared can benefit by enabling its prospective partner to catch up. A deeper mutual understanding can yield a bigger win for both sides. Sharing insight and expectations can also build trust, both before and after any merger takes place. Finally, if Alpha and Omega ought not to merge, they will be more apt to find this out before they close the deal.
Crafting a Legal and Financial Agreement
Ideally, agreements to merge need to address two very different goals. One is the need to write a binding contract to define the legal, structural and financial transaction. A second need is to look past the transaction to envision the future.
xxxLegal agreements set terms and conditions, and offer remedy for any failure to meet them. To this end, legal and financial specialists swarm around the deal, day and night, to ensure that it closes. The work is fast-paced, hard-edged, and seems finite. The deal either happens or not, and public or private investors either approve the terms or not. Declarations of victory or defeat follow at once.
xxxSeveral challenges face this familiar process. First, as a high profile, finite effort, it can often leave the false impression that most of the work is done. The negotiating of legal words on paper is at best a small part of the task, and while necessary, is far from sufficient to set the new business up for success.
xxxContract negotiations can also mislead by being so exceptional. Conducted in secret, involving only a handful of players from each side, governed by a ticking clock, within a hothouse atmosphere, this process drives towards clear-cut success or failure. In all these ways, contract negotiations differ greatly from the day-to-day struggle that lies ahead to reap the rewards of the merger.
xxxContract talks also focus on one transaction, at a moment in time, at an estimated current value, with legal and financial protections in case of default. For long-term success, a merger must be based on much more. Its horizons must envision a stream of business activity and relationships, developed over many years, leading to continuous growth in value, and built on shared purpose and trust in the new organization. So, we need something deeper and more enduring than just a legal contract.
Setting up the Organization for Success
Why not a parallel, non-legal merger agreement? Such a framework would look past the deal, to ensure that the new business thrives. Using everyday language, it would express the new partners’ growing vision for the business. It would state clearly the expectations of value each brings to the new business. It would explain how they will work together to develop, extract and expand that value. It would become the touchstone for shared purpose and trust, going forward.
xxxWhat subjects might it cover? Each agreement would be uniquely different, reflecting the distinctive issues facing the new company. Still, the places where we can create value and competitive advantage remain the same across companies, industries, and business cycles. Any agreement would highlight shared potential and plans to exploit it in such areas as:
•Achieving efficiencies in spending and use of financial and non-financial assets
•Acquiring, satisfying, retaining and building share among chosen customers
•Generating product and service offerings that meet those customers' needs for, e.g., functionality, quality, and ease of use, and reinforce their experience of value
•Delivering products and services to those customers just the way they want them
•Communicating with customers and prospects, to position what the new business is and what it does, sell its products and services, explain how to access and use them, and acquire information about those customers, their attitudes and behaviors
•Gathering and distributing knowledge and information to feed decision-making
•Recruiting, placing and retaining the people needed to achieve the strategic goals of the business, and helping them perform at the peak of their capacities
•Ensuring access to financial resources, by those likely able to achieve agreed standards of performance within the strategic priorities of the business
These subjects spell out where the new business will focus and how. To these, the leaders drafting an agreement could add certain basic principles stating the values and behaviors they agree to live by. These principles will partly come from the hearts and minds of the new partners. They should also reflect what the new business will need to achieve the success they are looking for. They might set out how they will implement the merger, enabling employees and customers to know what to expect from the start.
xxxFinally, the agreement could specify the basis for resolving major open questions such as how to choose the combined leadership team, how to rationalize the two work forces, and where to locate key activities.
xxxTiming matters here. Discussions on such an agreement would parallel the legal talks, for a draft to be ready by a similar deadline. Still, it should remain work-in-progress, until more leaders from both companies can strengthen it. In seeking such agreement, major issues may surface that were less visible in initial talks. In the extreme, such a process could derail the merger. Still, only when both parties have compatible value expectations is a merger likely to succeed.
xxxWhen the merger does formally close, the work of building the shared vision should be well underway. If so, the new partners will be off to a running start.
3) Merging
From the day a merger goes public, pressure on the leaders intensifies. Many sources of value are in play; some may head out the door. Issues once on hold now clamor for attention. Urgent calls to decide come thick and fast, yet the cost of a wrong move can be punitive. Clarity and focus are at a premium.
xxxStill, cultural differences and the lack of certainty may actually slow response times. Every day, new leaders get announced, while selections of others are in process. These leaders must develop new forums for decision-making, with new ground rules for how to work together. Agreed operating procedures may be missing or in conflict, until the two 'legacy' approaches get reconciled. The natural human tendency to 'wait until the dust settles' often prevails.
xxxNever is it more vital for leaders to be clear on what matters and communicate that clarity. To do so, these executives must revisit their vision and the types of value they first sought from the merger. They must set explicit performance targets to track progress on each and focus everyone on achieving them. They must secure or lock in any sources of value made uncertain by the merger.
xxxThink of these types of value in two categories. Some may be present at the outset of a merger, but will need extra effort to retain, e.g.:
Employees: Mergers can unsettle the best contributors of both companies far more than we expect. Naturally, unsettled people seek out and respond to alternatives, but why can even the brightest and best feel unsettled? Partly, this occurs when the rules of 'how to get ahead' are no longer as attractive or clear. Also, a merger may spur the departure of key mentors or 'godfathers'. Other upsetting changes can affect compensation, job scope, co-workers, performance demands, or the prospects for upward mobility. Prior loyalties were all to a prior company. No one owes anything to the new firm. Naturally, headhunters know all this, and come knocking.
Customers: Customer loyalty, too, may wane. At first, if ties to the former business are strong, many give the merged firm a chance to perform. Such customers stay until they have explicit reasons to change. Contracts or other retention tools can also bind more footloose customers. Soon, however, a merger puts all relationships back in play. Where customers see an advantage, a merger can be an excuse to switch or demand better terms.
Stakeholder Goodwill: Most businesses utterly rely on their reputation among their many audiences for the license to act in areas of common concern. Trust in the company and belief in its competence, prospects, and ethical standards permits the growth in good will that allows it to function. Once a company merges with another, however, communities, investors, lenders, unions, regulators, and the press all may question their faith. Some test the relationship or even withdraw their support.
xxx'Will the new business close its site in our town?' 'Will our loan quality suffer?' 'Will the company continue to emphasize quality growth?' 'Will they treat our members fairly?' 'Can we trust them to do right by the environment?' 'Will they keep us informed of their plans?' Few inherited relationships will be immune from the doubts that a merger will raise.
xxxWhat do employees, customers and stakeholder goodwill share in common? All three represent relationships of value based on trust and mutual respect. Each can be powerful in creating value, but untended, render a merger vulnerable to rapid value erosion. Retaining this value becomes a top priority.
xxxFirst, this means uncovering the true value at stake. For example, many companies now regularly measure the expected lifetime value of key customer relationships, and can report the cost of losing such a customer. What fewer consider is the value of the relationship to the customers. Why did they choose us? Why do they stay with us? What could cause them to switch? We need to appraise any relationship of value by asking such questions.
xxxIt is not enough that we see the value; others must know we do, also. Too often, mergers leave key employees in the dark, enduring months of uncertainty. Lacking assurance, they test their options, often right out the door. We can criticize careless employers, who let star performers doubt their value. In mergers, though, to convey to all major relationships how much we value them takes a huge time investment. Just being essential does not make this easy.
xxxLast, we must ensure that the relationship continues, while we focus on the merger. This calls us to understand why the relationship has worked and how best to keep it. Suppose our new partner enjoys the goodwill of a key regulator, due to personal ties with one of its people. What if that person is now retiring? Can a new contact keep the relationship whole? Can we persuade the employee to stay, at least through the transition? Instead, could we offer more concrete assurances to the regulator, to replace this reliance on personal ties?
xxxRetention of existing values may be Job One, in the Merging process. If so, Job Two is building new types of value, often from the ground up. This is where we develop the potential value we envisioned, which goes beyond 'A plus B'.
xxxTo develop a stream of new value from the merger requires new colleagues to begin fusing the strengths of each founding company into something greater. Specifically, they must define and exploit the revenue expanding and cost reducing opportunities the merger enables. As few mergers are successful unless they drive bottom line growth, how do we accelerate this important work?
xxxMeanwhile, every part of the business will also require some integration work. Some of this will be essential and some a major distraction. Mergers have the potential to engage everyone in an endless swamp of organization change. Thus, an urgent task is to define a few key principles to apply in choosing the true priorities and making them work:
xxxLead off with profit opportunities. Initiatives that drive bottom-line growth give high performers an immediate purpose and a target to shoot at. Such projects raise morale and quell the confusion that mergers stir up. Projects that focus on internal restructuring just raise anxieties and drain organizational energy
xxxAmong profit opportunities, stress those that add value to customers or undercut competitors. Most of us know that companies looking outward defeat those that look inward ? especially during a merger. The goal of winning customers from competitors reminds new colleagues of what they have in common, and dampens internal rivalry. It re-positions the merger as bringing benefits to customers, too, not just more turmoil and uncertainty
xxxFocus on the important few, with potential for early wins. Many employees key to the new company's success will watch, at first, from the sidelines. If they see a 'swamp' of long-term 'change' projects, many go on waiting. Consider, instead, the impact of a few core initiatives offering large, visible, rapid progress. Their early results will show the value of ‘getting on board’, and helping build the new company. Perceptions of success will multiply. When the next round of projects gets underway, many more will sign up
xxxTie all process changes to business improvements. Mergers raise a large dilemma. To succeed, we rely on the discipline of our most outcomes-driven people. At the same time, they find the new firm’s lack of fixed processes, structures and procedures slows them down. Nor do these ‘drivers’ tolerate the time it takes to strengthen a process or create a new one. They avoid projects aimed at improving teamwork, building a new culture, or other ‘soft goals’. One solution is to give all projects a primary business focus, but subtly use each as a vehicle to create new ways for new colleagues to work together. Managed skillfully, the process work appears secondary, simply a means to an end
xxxRigorously define success and track it. Mergers all begin with hard-edged goals. Too often, we lose sight of them amid post-merger upheaval, or fail to state them in finite, measurable terms. When we say "Increased market share", we may really seek "A 10 percentage point rise in our share of the business of our profitable customers". By "improved shareholder returns", we may actually mean "raising our ROE by 400 basis points".
xxxTo manage our progress, we will also need a mix of both short and long measures. We may not find meaningful customer satisfaction data until a year later. Until then, we may need to track customer activity weekly
xxxCommunicate with everyone whose support will matter. Putting it bluntly, we cannot communicate too often or too well during a merger. Focus, trust, and alignment with the goals of the merger are all at stake. This means speaking with customers, employees, suppliers, indeed all affected parties. We must tell them what we know for sure and what remains unknown. We must explain what the new firm's goals are and how each can contribute. We must tell them how and when their feedback will make a difference. We must exploit every formal and informal channel, and speak with a consistent voice. Communication must come from the top, and from leaders at every level. It must also flow the other way, inviting employees and customers to offer up their concerns and ideas. Even so, we will not likely communicate enough
xxxGo on merging. When is a merger truly complete? It can only be when two organizations have become one. The old seams are invisible. As this can take years, by then it will not matter. There is no need ever to declare victory
xxxKeep expanding what you mean by success. No matter the skill we bring to Assessing and Negotiating, not all of the upside potential will be apparent from the start. Some of the potential will only emerge as people who are new to each other, and the new mix of capabilities they offer, come together. The moment the full achievement of the merger's early goals is in sight, we should define new, greater horizons to conquer
LAST WORDS:
In the end, we merge to fulfill our search for value. The job of assessing, negotiating, and merging two businesses can be so intensive, and the distractions so common, that we risk forgetting that simple idea.
xxxThe mergers we now call successful are the work of a few people who never lost that focus, and the many they enlisted. Together, they unearthed the real value and its potential for growth. Together, they secured whatever value was initially at risk. Together, they are still driving on, to find more.
xxxThe moral is clear. Company A can build a lifetime of happiness with Company B. It just helps if they remember what they first saw in each other, and keep on working, every day, to make that dream come true.
If you have any comments or questions for Morrey Ewing, he may be reached at: morrey@sympatico.ca
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