Adding Cultural Fit to Your Diligence Checklist: Culture due diligence helps buyers spot likely people problems at a target and determine whether potential clashes might sink the deal.

CEO Ron Oberlander of Canadian newsprint producer Abitibi-Price Ltd. knew that a consolidation of firms in that highly fragmented industry was inevitable. He also acknowledged that most mergers and acquisitions, no matter how good the synergies look on paper, produce disappointing results as managers grapple with the difficult work of turning two previously independent organizations into one. With several potential partners at hand, Oberlander wanted a realistic assessment of the various cultural challenges before making a decision which firms to merge with or acquire. For those firms that passed his company’s strategic and financial filters, Oberlander wanted to use cultural fit as a criterion in moving forward with a deal. Oberlander is among an increasing number of executives planning an acquisition who are thinking about cultural issues during the “pre-combination phase” when the deal is being conceived and negotiated. A simple reason accounts for this advance planning. Executives who have lived through the pain of clashing cultures in botched acquisitions or disappointing mergers don’t want to repeat the experience as they plan future deals. These leaders are not necessarily looking for cultural clones of their organizations. Instead, they want a realistic assessment of the likelihood of culture clash and a head start on minimizing its debilitating impact on corporate combinations. As a result, they have instructed their analytical people to check out such factors as corporate values, organization structure, operating and decisionmaking apparatus, reward systems, and other people-related matters. Operating in a corporate culture is a lot like breathing. You don’t notice your breathing, you just do it. You may be aware of your breathing now, because its been raised to your attention. If someone were to approach you from behind, cup their hands firmly around your mouth and nostrils, and threaten your ability to breathe, then you would certainly pay attention to breathing. The same holds true for culture in a merger or acquisition. People don’t regularly notice their corporate culture, but when thrust into a combination, employees become aware of how their ways of doing things differ from those of the other side. When they feel threatened by a combination often because they see themselves on the weaker side employees not only spot differences but also feel a sense of vulnerability and fear over losing their accustomed ways of doing business. In many combinations, culture clash is an afterthought. Early in the process, executives downplay the importance of culture with off-handed comments like “we are the same kind of people,” “we are all bankers, so there is no culture clash,” or “the more I look, the more I see how similar we are.” With 20/20 hindsight, these same executives bemoan their inattention to differences in culture and values that set so many combinations on the wrong course. Studies conducted of combinations in a variety of countries find that senior executives rate “underestimating the importance and difficulty of combining cultures” as a major oversight in integration efforts. In a British study of 40 acquisitions, for example, all companies conducted a detailed financial and legal audit of their intended target. Yet none made any attempt to audit the target’s human resources to assess the talent they were acquiring or to identify cultural norms. In a country where acquirers on average pay a 40% premium over pre-bid stock market value, British executives cited “culture compatibility” as being significantly more important than the purchase price in determining merger outcomes. A survey of French and German managers involved in acquisitions found that technical issues were less important in producing conflicts in work relationships than differences between the two countries in planning, managerial authority, commitment, monitoring, and teamwork. More than 50% of the sample reported that cultural differences gave rise to tensions. But they also indicated that such differences were not regarded as important by senior executives. In the United States, a study of 100 failed acquisitions found differences in management styles and practices between the partners to be the major problem in 85% of the cases. Culture does matter as previously separate organizations join forces in a merger or acquisition. Additionally, culture has a bottom-line impact on corporate financial performance. A Harvard Business School study found that firms that “actively managed” their corporate cultures realized a 682% increase in revenue compared with a 166% increase for firms that did not manage culture. Net income increased 756% for the firms that attended to culture versus just 1% for those that did not. Also, stock prices soared 901% for firms that actively managed their cultures, while those that did not realized only a 74% rise in stock price. What exactly is corporate culture? Some writers describe culture as the “glue” that holds people and processes together in an organization. Scholars have listed components of corporate culture, including values, interpersonal practices, and business practices. Perhaps the best definition of corporate culture is the simplest: how we do things around here. Do we make decisions quickly or slowly? Do we promote from within or go outside of the organization to find new talent? Do we reward seniority and playing by the rules or do we value performance and risk-taking? Do we sweep mistakes under the rug or raise them up as learning opportunities? Do we communicate fully and openly or just on a need-to-know basis? One thing is for certain: Culture clash afflicts every corporate combination. It makes explicit what had been implicit. By their very nature, mergers and acquisitions produce a “we versus they” relationship, and there is a natural tendency for people to exaggerate the differences, as opposed to similarities, between the two companies. What is noted first are differences in the ways the companies do business perhaps their relative emphasis on manufacturing versus marketing, or their predominantly financial versus technical orientation. Then differences in how the companies are organized such as centralization versus decentralization modes or differing styles of management and control are discerned. Finally, people ascribe these differences to competing values and philosophies, and often view their company as superior and the other as backward, bureaucratic, or just plain bad. Culture clash follows some predictable stages. First, as people notice differences in how the other side approaches work, they come to revalue their own ways of doing things, e.g., “We have a major product review each month, they have a quarterly review.” Next, people begin to evaluate differences between the companies; they come to view their way as superior and the other as inferior, e.g., “Monthly reviews are essential in today’s rapidly changing business environment; quarterly reviews are insufficient for keeping all parties informed and acting quickly when changes are required.” Then, people begin to attack the other side and defend their own, e.g., “Quarterly reviews are just one more sign of how loosey-goosey and poorly managed their company is; we know what it takes to run an effective organization.” Of course, people from the other side are going through the same stages, e.g., “Monthly reviews are just one more sign of how bureaucratic and poorly managed their company is; we know what it takes to run an effective organization.” Eventually, one side “wins” as its way is adopted in the combined organization, leaving the other side feeling like losers. Ironically, a fair amount of diversity in approaching work aids mergers by sparking productive debate and discussion of desired norms in the combined organization. When left unmanaged, however, the clash of cultures pulls sides apart rather than joins them together. Task forces made up of employees from the partner organizations to study and recommend combination options presumably to garner the best thinking from both sides degenerate into dysfunctional groups producing decisions by default rather than by discussion. In cases where one side dominates the action, decisions perpetuating its ways get forced on the other side. When there is more balance in the perceived power between the sides, the decisionmaking process is like horse-trading you can get the information technology architecture, but we are going to keep our human resources policies. Either way, the low-quality results defeat the rationale for taking the time to use task forces, miss the opportunity for truly productive thinking, and leave a work force that is cynical about the ongoing prospects of the combined enterprise. Benefits of Cultural Due Diligence The objective of cultural due diligence is not to eliminate culture clash in a combination. That could never happen. Neither is the purpose of cultural due diligence to find a perfect fit between to-be-integrated organizations. In reality, a moderate degree of cultural distinctiveness is beneficial to productive combination. If it were possible to find two organizations with completely identical cultures and values guiding their behaviors, the combined organization would, at best, be no better than the sum of the parts. While too wide a gap in underlying values and ways of approaching work is unhealthy, the best mergers and acquisitions occur when a fair amount of culture clash prompts positive debate about what is best for the combined organization. Ideally, this debate includes consideration of cultural norms that may not be present in either organization separately but which may be desirable for the combined company. The fundamental benefit of cultural due diligence is to prepare executives for the demands of joining together previously separate organizations. Cultural distinctiveness may not be a “deal killer” but leadership should be ready to acknowledge culture clash (not deny or ignore it) and to manage its perverse potential to pull merger partners apart rather than bond them together. Cultural due diligence aids eventual merger and acquisition success in various ways. Spotlight on Culture Cultural due diligence raises awareness of and sensitivity to the cultural issues in a combination. In essence, broadening due diligence beyond its traditional financial focus puts culture “into play.” It prompts acquirer and target company representatives to initiate early discussions and negotiations with queries and viewpoints about how the potential partners go about their respective businesses. Target Selection Cultural due diligence enhances the process of selecting a merger partner or acquisition target. Just as Ron Oberlander sought, executives can complement financial and strategic criteria with cultural data as candidates are being assessed. This cautions an acquiring company about buying a target with strongly different ways of doing things and prevents the trauma of an inevitably doomed corporate marriage. When multiple candidates are being considered, cultural criteria make the selection process more sophisticated and more likely to result in a compatible candidate. Head Start on Integration Cultural due diligence helps anticipate the demands of integration. Even if cultural due diligence is not used to make a “go/no go” decision, the process foretells issues that could arise later, while integration is underway. The acquirer can determine which aspects of a target’s cultures its practices, people, or projects are most dear to acquired employees. Decisions can be made to retain a degree of cultural autonomy in the target or to approach the work of fully assimilating the acquired culture. Cultural “End State” Cultural due diligence helps determine the cultural “end state” of an acquisition. By considering cultural characteristics early on, the acquirer’s executives can be prepared to articulate a cultural “end state” for the combined organization. Will one side dominate or will cultural characteristics be blended from both organizations? This last benefit is quite important to eventual financial success. One of the worst things acquirers can do is to “talk merger” but “act acquisition.” When the buyer intends to do things its way, it is better to say so from the outset rather than to pretend otherwise. Talking merger (i.e., “this is a merger of equals” or “we are partners in this together”) and then culturally dominating the other side will erode whatever credibility the buyer has in the eyes of acquired staff. It is much more difficult to rebuild credibility after losing it than to maintain a track record of credible communications. Stating the hard truth may alienate some target personnel early on, but over the long haul they can be brought on board by highlighting the merits of the buyer’s ways of doing things. Sending culturally inconsistent messages hastens the departure of key talent that the acquirer may have wanted as part of the acquisition. Conducting Cultural Due Diligence A small, but growing, number of firms are formalizing cultural due diligence as part of their merger and acquisition process. These tend to be companies that are experienced in the m&a game and have learned the hard way that ignoring or denying cultural issues early in a deal turns a corporate marriage sour and makes the honeymoon hellish. Approaches to conducting cultural due diligence fall into four general categories: *Integrating cultural criteria in the earliest of merger discussions. *Staffing and preparing due diligence teams with an eye toward cultural criteria. * Adding cultural criteria to due diligence data collection. * Using formal tools to assess culture fit. Discussing Culture Early Smart acquirers put culture on the table at the earliest planning and negotiating sessions. That can be as early as when the acquisition strategies and selection criteria are being developed within the acquiring company so that the in-house conclusions will be prominent in initial cross-company discussions. The value-creating acquisition of Benham Capital Management Group by Twentieth Century Advisors began with a screening process that integrated human and cultural issues with strategic and operational criteria. Both firms meshed along operational lines in offering only no-load mutual funds and treating small shareholders well. But, as one senior executive recalled, an exchange of corporate values statements during due diligence was part of the information indicating that cultural compatibility existed as well: “Their Guiding Principles’ and our Statement of Beliefs’ were very similar. Both companies stated honesty’ as a fundamental belief, and you don’t too often see that both stated and acted out in the financial services industry.” Increasingly, potential partners are exchanging corporate philosophy statement and values documents along with balance sheets and organizational charts as companies explore possible mergers or acquisitions. These are tangible sources for determining what matters in how people in the organizations approach their work. Of course, statements of corporate values or guiding principles are trivialized in some organizations. They are regarded as “motherhood” statements or the CEO’s fad-du-jour. How the values statements themselves are regarded tells a lot about the culture of an acquisition candidate. At American Century, the new name of the combined Twentieth Century and Benham mutual fund groups, the importance of cultural fit was extended into the integration planning process. A high-level executive task force was charged with defining values for the new company. It commissioned focus groups to explore what employees valued about their prior companies, what they did not value, and what they believed should be carried forward in the combined company. The task force used this employee input, along with their CEOs’ vision and values statements, to define a desired culture for the combined organization. If a merger or acquisition candidate has no statement of corporate values or philosophy or challenges the importance of culture in making a deal work this is a telling sign that integration problems may be down the road. If you feel like you are “talking different languages” with a target early on in negotiations, then you are going to feel that way as the deal is formulated and consummated. Financial and strategic fit will not offset a cultural mismatch. Remember that the huge failure rate for mergers is frequently due to the exodus of key personnel who are turned off by culture clash. I have worked with several firms to increase cultural sensitivity in the early stages of their merger and acquisition programs. In some cases, this occurs through presentations and workshops with m&a specialists, corporate generalists, and operations managers to raise their awareness of cultural dynamics in a deal and to enhance their approaches to due diligence and subsequent integration. In other cases, more experience-based approaches are taken, like simulating the acquisition scouting and integration processes before actually going through them. And, in still other cases, I work closely with and coach the leaders of the m&a process on an ongoing basis during the selection and integration of targets. This counsel helps them keep an eye on cultural matters and prepares them for anticipating and managing the issues that will arise down the road. Focusing Due Diligence Teams In most corporate combinations, true “diligence” needs to be put back into due diligence. The effectiveness of the due diligence team hinges on the balance between what it wants to see versus the rigor it uses in questioning what it sees. Typically, the financial people who dominate due diligence teams get a sense of the partner they want and build a case for a combination going forward. Alternatively, it is important to get people on the team who will probe deeply and thoroughly enough to work backward and identify faulty assumptions and what might hinder eventual success. Broadening the membership of the team enhances organizational due diligence. Membership can be expanded to include both staff professionals from areas like human resources and information technology and operating managers who will be working with new partners if the combination is carried out. A functional specialist provides a breadth of analysis that simply cannot be conducted by a corporate generalist. Operations managers have a particularly important role on due diligence teams; they are the ones who are going to have to work with the partner’s people to make the combination a success. Middle managers can find many reasons why a deal that looks good on paper would crash on takeoff. In addition to reviewing operational issues, they can also assess the chemistry between themselves and their counterparts. If the chemistry is not there early on, it is not likely to be developed later. Differing viewpoints and preferences for how to conduct business are not in and of themselves reasons to negate a deal, but incongruent values, genuine distrust, and outright animosity should be noted as “red flags.” Of course, this assessment works both ways target candidates appreciate dealing face-to-face with executives whom they may ultimately be working with or reporting to. Some organizations place up to 20 people on their due diligence teams. This may be bulky up front, in terms of scheduling logistics and organizing findings, but it pays off when a showstopper gets unearthed. One organization convenes duplicate diligence teams to assess candidates and overcome the “deal fever” the overwhelming desire to get the deal closed fast that frequently afflicts due diligence. Knowing that a poor partner can exact a huge financial toll and can be a tremendous burden on management time and energy, this company only goes forward with combinations that pass muster with both teams. Due diligence is also a time to size up the breadth and depth of managerial talent in the potential partner. A study of large combinations found that 65% of successful acquirers reported managerial talent to be the single most important instrument for creating value in a deal. Smart buyers not only evaluate current executives but also look closely at managers within the target organization who are not yet in leadership positions. To ensure that all involved have a shared understanding of what culture is and how to assess it during due diligence, a few organizations have initiated programs to educate due diligence team members on cultural matters. Lucent Technologies Inc. recently assigned veteran human resources professional Ellen Walton the full-time responsibility of enhancing the firm’s acquisition process. As part of her job, she delivers educational presentations on cultural dynamics in mergers and acquisitions to executives considering acquisitions and team members conducting due diligence. The presentations clarify what culture is, how it relates to eventual financial performance of an acquisition, and how it can be assessed during due diligence. Adding Cultural Criteria to Data Collection Some organizations are adding specific cultural criteria to the checklists of due diligence teams everything from how decisions are made to how successes are rewarded and failures treated. Catholic Healthcare West (CHW) has grown into a network of hospitals, ancillary facilities, and home-care and physicians organizations in California, Arizona, and Nevada through an aggressive acquisition program. Between 1994 and 1998, CHW expanded from 20 to 48 hospitals, from $1.7 billion to $4.3 billion in revenue, and from 16,000 to 48,000 employees. CHW requires cultural due diligence as part of its candidate screening and has an explicit protocol for assessing cultural dynamics during due diligence. It begins with a review of documents to determine cultural and values congruence with potential targets. Among the documents reviewed are executive compensation materials, employee handbooks, and employee survey results. CHW also solicits third-party information on a candidate’s culture from external consultants, customers, professors who have studied the organization, and others. The due diligence team conducts focus groups with a candidate’s board members, CEO, and senior management team members. The focus group attendees are asked to describe icons, heroes, and other symbols that represent their culture, as well as how change occurs within the organization. Tracking of organizational change gives CHW insight into the change-management capacity in a target and previews the steps the acquiring company may need to take to ensure that change is well managed during the integration process. For example, if due diligence has determined that a target’s leadership is lacking in change-management skills or operates in a manner strongly inconsistent with the acquiring company’s culture, CHW will replace the incumbent leadership with its own people. Importantly, CHW knows going into the deal that it must clean house and it acts swiftly, rather than wallowing around for months while a culture clash festers. Using Formal Tools Acting on his desire to conduct cultural due diligence, Abitibi-Price CEO Ron Oberlander asked two internal organization development consultants, Michael Leckie and Pascale Carrier, to propose a methodology for assessing the cultural fit between his firm and potential merger or acquisition candidates. They responded with a pre-combination cultural due diligence process based on a Merging Cultures Evaluation Index (MCEI) that analyzes several dimensions of corporate culture. Among them are concentration of power versus diffusion of power, innovation versus tradition, wide versus narrow flow of information, and consensus versus authoritative decisionmaking. The MCEI calls for individual members of the executive teams from Abitibi-Price and potential partners to complete a questionnaire assessing the cultural dimensions for their own firm and the other company. Individual scores are aggregated into team rankings and gaps are identified, first between the two sides’ self-assessments and then between both sides’ self-assessments and the evaluation of them made by the other side. The summary report displays mean scores for the two companies and the extent to which people within the companies agree on the particular dimension of their culture. Executives then prioritize the cultural dimensions expected to be most important to the transaction’s success and analyze the results accordingly. This process assumes friendly relations between the parties. In the case of a hostile or uncooperative situation, Abitibi-Price executives couple their own assessment of the candidate with input from third parties, such as industry analysts, former company executives, or academics and reporters with knowledge of the company. A similar tool has been developed by consultant Ron Ashkenas. His “Cultural Assessment Worksheet” lists 10 dimensions, including: * Innovation Using traditional and tested approaches versus looking for and experimenting with innovative ways of getting work done. * Communication style Formal versus informal. * Solutions sharing – Sharing of ideas originating in one department throughout the entire organization versus infrequent sharing with other departments in the company. nWork orientation – Emphasis on defined processes and roles versus simply getting measurable, bottom-line results. Members of the potential partners plot their cultures on a 1-to-5 scale. Mean averages are computed for each of the 10 dimensions and compared between the two organizations. A scoring key rates the potential partners’ cultures as “very similar,” “some cultural differences,” “significant cultural differences,” or “radically different cultures.” A Concluding Caveat Even though formal tools are being developed, cultural due diligence is not a science. The secrecy and limited access beyond senior management ranks that characterize the preliminary phases of a merger or acquisition interfere with the collection of cultural data. Thus, the efforts at cultural due diligence described here aim more to raise awareness and initiate dialogue on cultural dynamics than to provide a comprehensive assessment of the potential partners’ cultures. The intent is not to conduct a full-blown study of culture but to get executives and managers thinking and talking about the cultural implications of their integration efforts. Even limited cultural due diligence is helpful, as it alerts executives to cultural issues and opportunities and prompts them to consider sooner, rather than later, what actions are needed to manage culture clash in a merger or acquisition. Then they can dedicate the proper resources to reducing the unintended consequences of culture clash by, initially, respecting the pre-combination cultures of the partners and, subsequently, building the desired post-deal culture. SPOTLIGHT ON CULTURE In the past, culture clash has been something that managers have dealt with after the deal had been completed and the combining companies were preparing to integrate. Not anymore. Smart acquirers increasingly are trying to get a handle on potential culture problems before selecting a deal partner, because they recognize that financial and strategic fit alone do not guarantee a successful deal. More and more, acquirers aim to get a realistic assessment of the likelihood of culture clash and a head start on minimizing its debilitating impact on their deals. As a result, they have instructed their due diligence teams to check out a host of people-related matters at a potential target so that managers can get an early start on thinking and talking about the cultural implications of their integration efforts.