Avoiding the IT Integration Blues

When dealmakers are trying to knit together a transaction, managing all the details can seem like death by a thousand cuts. But experts insist that deal principals must look beyond financial and other models when evaluating deals and include information technology (IT) on their short list of concerns. This may sound obvious, given the central role an organization’s computer system plays in supporting the business. But experts say that IT issues often are neglected in the rush to close deals and that IT fizzles have contributed to high-profile merger failures. “We have typically found that most companies don’t pay enough attention to the IT structure when making acquisitions,” says Joseph McConville, an IT consultant at PricewaterhouseCoopers. In a typical deal situation, people understandably tend to be focused on the acquisition itself. “Most participants pay more attention to the corporate and financial aspects of the deal, as do shareholders. In doing so, they often overlook the opportunity to realize benefits they could gain in IT and other operational parts of the business,” says Akiba Stern, a Partner at Shaw Pittman. One reason for overlooking IT is suggested by John Alexander, the former CIO of insurer Unum Corp. “M&A is a heavily personality-driven activity. It is the personality of the CEO and the investment bankers that make deal happen. IT isn’t often critical to their evaluations. But once the deal is inked, it becomes essential to its execution.” Another reason systems integration gets overlooked is that few people in most organizations understand its intricacies despite the fact that IT is usually the foundation that allows the business to operate. Cap Gemini consultant Peter Greis says that this lack of attention can have far-ranging consequences because the penalties for overlooking IT integration can be damaging to the synergies the deal was designed to create. In all, it seems strange that dealmakers don’t concentrate on information technology. After all, “IT is the enabler of most of the synergies and is often the highest-cost item to reconcile in a merger,” says Mark Walsh, an IT specialist at Deloitte. IT integration gone wrong There are numerous examples of deals that bungled systems integration. Some of the more notable ones include: USA Waste Inc.’s $20 billion acquisition of Waste Management Corp. in 1998 provides a good example of how not to integrate systems. Neither company had an IT system that could service the combined organization. The year after the deal was completed, the entire senior management team was fired, and planned efficiencies were accomplished 18 months to two years later than planned. The merger of insurance providers Connecticut General Corp. and Insurance Co. of North America to create CIGNA Corp. was another deal plagued by integration problems. “The two home offices were never combined in a single location. Information systems stayed separate for years and the expected results from the deal never materialized,” says Alexander, now a Principal at Claridge Strategies Group in Tampa, Fla. Petroleum giant BP PLC’s $48 billion merger with rival Amoco Inc. in 1998 encountered problems because of the companies’ different philosophies on outsourcing. Integration went slowly until dominant partner BP decided to impose its own philosophy on the combined entity. In some cases, the need for quick integration trumps the desire for the latest technology. According to Greis, when Dow Chemical Co. acquired Union Carbide Corp., Dow chose to “dumb down” its SAP R3 system in order to blend it with Union Carbide’s earlier-generation R2 system. Citing a similar case is Bill Swanton, a Vice President at AMR Research, an industry and market analysis firm specializing in enterprise applications and related technologies. Fleet Bank Corp. converted BankBoston Corp.’s ATM system to the technical standard it used despite the fact that BankBoston’s system was more modern, he notes. Even if these decisions sound counterintuitive, they are the strategic choices that IT talent, both in-house and consultants, must make and make quickly to ensure that IT contributes to, rather than detracts from, the deal’s synergies. One bright note is that if it’s done right, IT integration can go beyond supporting the organization and can create new value that will improve the transaction’s metrics. Checklist for IT integration success Before looking at specific recommendations about how to integrate IT, it’s worthwhile to keep in mind a few general principles. According to Alexander, merging companies must ask what the strategy of each business is and what the strategy of the combined organization will be and then make sure that the technology is aligned with that strategy. He suggests that it’s vital to look at whether the companies’ cultures are compatible and whether the IT departments that are to be combined have shared approaches to technology platforms, outsourcing, and other issues. Bring the CIO in early A key factor to successful systems integration is to make sure that the company’s senior executive in charge of IT – usually the CIO or CTO – is included in deal discussions early. However, dealmakers say this often doesn’t happen for a number of reasons. Senior managers often want to maintain secrecy about the deal until it is announced, so they tend to limit the number of people who know negotiations are going on. There is also constant pressure to get the transaction structured and completed quickly. “Often a deal starts with two CEOs and perhaps a few m&a consultants meeting somewhere off-site. These individuals aren’t usually well versed to spot potential IT sticking points in the transaction,” Alexander says. He adds that because the percentage of CEOs who understand what is going on in the technology field is “woefully small,” it can be vital to have someone who is technology savvy in the room. However, even if the CEOs and bankers working on the deal are taking IT issues into account, in some cases merely including the CIO in the loop isn’t enough. “If the CIO has little experience in m&a, he may not have the relevant experience to contribute much to deal discussions,” says Lynne Ellyn, CIO at DTE Energy Co. In some cases, she notes, even the CIO has mainly internal-looking responsibilities and could use help in assessing IT integration risks. A possible solution in this situation would be to use consultants, but experts warn that it’s essential to get advice from experienced advisers. “A little know-how can be a dangerous thing,” McConville states. “It pays to hire a consultant who knows the space well.” Alexander agrees, adding, “You want to have an adviser with the clout to say, Don’t send me your associate development manager, I need to talk to the CIO.'” He adds that in his experience a less experienced consultant sometimes sees a particular circumstance but can’t put it in its most useful context. Scheduling and prioritizing An important aspect of systems integration is setting up a process for melding the functions that must be operative on Day One and then prioritizing what needs to be combined at later stages of the integration. Walsh suggests that companies do simulations of what will occur on the different deadlines of the combination. “You can be a leader by doing pre-integration tests as you approach Day One and subsequent integration.” He recommends that clients do readiness reviews within the business and run systems and processes that can test the IT functions to be integrated to get an idea of what will occur on Day One and afterward. It’s important to understand the cost of time and to move quickly to start the IT integration, notes Swanton. “It’s often a critical aspect of unlocking the business synergies that the deal is supposed to create.” And planning is vital so that the integrators don’t rush willy-nilly into the integration. “It’s a mistake to try and do everything at once,” Greis says. “You want to separate out Day One items, Day Sixty items, and other points in a timeline that could stretch as far as two years.” One major acquirer in the technology industry immediately puts target companies on its primary system, but only for the core functions. This helps to quickly integrate the company into the parent. Other ancillary functions, which differ from deal to deal but can include marketing and product development, are integrated more slowly, sometimes as late as a few years after the transaction. An approach to setting up the schedules for IT integration is to remove complexity from the system at the fastest possible pace, but with the understanding that everything isn’t a Day One project, Greis says. Another useful tool to aid integration is to have a strategy in place to counteract or, at least, compensate for the fact that after Day One comes and goes, senior management tends to pay less attention to integration issues. “The CEO and CFO tend to pack up and move on after Day One, and this can mean that it becomes hard to get the resources needed to see that that other deadlines are met,” Walsh says. In large organizations, he adds, it becomes important to prioritize and rationalize assets after Day One because IT staff have their “regular jobs” to do in addition to performing integration-related tasks. Since both m&a and IT projects tend to be scheduled aggressively, he recommends putting common tracking and rating systems in place to prioritize both companies’ ongoing IT projects and the resources allotted to meeting the integration deadlines. Avoiding integration land mines DTE Energy’s Ellyn, who oversaw the 2001 merger of her company’s primary unit, Detroit Edison Co., with Michigan Consolidated Gas Co., says that a potential trap for executives tasked with IT integration is taking at face value the optimistic projections presented by m&a consultants. “We were told that when we acquired Michigan Consolidated we could get $25 million in IT cost savings because according to the bankers’ calculations, that’s what the redundancies in the systems came out to,” she says. She found, however, that the people working up the economic models had never been responsible for executing a large-scale IT integration. “They didn’t understand the level of nuance or difficulty that we faced in an integration.” She describes the investment bankers’ simplistic analysis of the deal. “They saw that we had a PeopleSoft system and Michigan Consolidated had a PeopleSoft system so they figured we would just be able to combine the two.” Despite the fact the systems had the same brand name, she adds, Detroit Edison’s system had 70% of its code customized while Michigan Consolidated was only 40% customized. As tidy and simple a process as IT integration might seem to the people putting together the financial parts of the deal, it is rarely that simple, she adds. “Many companies have such a patchwork quilt of software and interfaces that the integration is like blending software shanty towns’ and is rarely as quick or as simple as projections suggest.” Another challenge in the process can be meeting aggressive schedules for IT cost reduction. The pressure to produce quick integrations at a low cost can lead to overly optimistic scheduling. Similarly, it can be tough for senior management to get an accurate appraisal of the cost and a realistic timetable for the integration. “One of the biggest determinants of successful IT integration is how quickly you can get the systems working together, so there’s a lot of pressure for IT managers to be overly optimistic about the cost and speed of the project,” says Frank Dybeck, a Principal at Communication Network Architects Inc. in Washington, D.C. Added headaches in carve-outs In case some of the observations and anecdotes about the difficulty of IT integration listed so far haven’t sounded daunting enough, many experts point to a type of deal where IT snafus are more common than in plain-vanilla mergers: carve-outs. “I’m seeing a huge trend in m&a where companies are buying or selling pieces of businesses that are embedded in larger units,” Deloitte’s Walsh says. It’s often harder to do IT integration when you’re pulling apart a piece of a business than when you’re integrating huge enterprises, he says. Many of the problems with carve-outs stem from the fact that the seller is unloading the unit because it isn’t core to the business. As a result, keeping systems in place to manage the transition is a low priority. It’s common for the seller to provide short-term transitional services to the spun-off unit for six to 12 months. While the spun-off unit relies on this partnership to meet Day One targets, the relationship can be fraught with problems for the newly independent company, not the least of which is that the former owner was probably not paying much attention to its former unit to begin with. Despite the contractual obligations, the spun-off company may find that its former parent isn’t able to provide a high level of IT support now that the former sub is on its own. Beyond the parent’s possible lack of concern and unfamiliarity with providing the transitional IT services, Walsh cautions that integrators pay particular attention to service-level exit agreements. He has seen deals, he notes, where the carved-out unit didn’t understand the penalties it faced if it was unable to operate its IT system independently of the former owner after the contract expired. “You don’t want to be in a situation where the unit has to make a tough decision, if it’s not ready to exit, of whether to pay penalties to retain services or become independent.” He advocates focusing on the service-level agreements while negotiating the deal and being familiar with the scope of the agreements that are put in place. In helping to protect the spun-off unit, Walsh recommends structuring the service-level agreements so that they can be exited in pieces rather than all at once. “If there are 100 types of services, you may be able to exit some after two months. Others may take 10 months. But at least you get the cost relief from the ones you can shed during the process.” Contracts and licensing If dealmakers don’t have IT at the center of their concerns as they rush to close deals, this inattention can leave them oblivious to opportunities to maximize savings during the run-up to inking the pact. “Before closing takes place, you have leverage to do a number of things, which if you don’t do, you lose the opportunity,” says Shaw Pittman attorney Stern. For example, when companies merge, Stern notes, suppliers and vendors want to retain the business of the combined entity. As a result, executives can play them against each other to achieve the best terms and considerations for their services. The ability to run this kind of auction often disappears once the deal closes, he says. Dealmakers often don’t focus on these details because they’re concentrating on getting the deal done, he cautions. Their attention to post-Day One IT issues and other operational impacts is secondary, at best, he adds. Stern urges integrators to pay attention pre-closing to licensing rights and obligations that will be affected by the consolidation. “You have the opportunity to make a number of parties play your game if you pay attention to these issues early.” Also, he suggests that the CIO and legal counsel think about the legal aspects of the integration process and review licensing agreements, exclusivity pacts, and competition issues for the business units to be merged. Legal counsel can be helpful because many CIOs are inwardly focused, he notes. As a result, they may not be proactive in making external agreements line up to support the consolidation. “Often, if you look at these aspects of the deal, you can unlock hidden values that may not have been structured into the deal’s pricing,” he says. Know what you’re buying M.R. Rangaswami, co-founder of Sand Hill Group, a Palo Alto, Calif.-based firm that provides investments and advice to emerging enterprise technology companies, echoes the sentiment that merging companies should pay more attention to systems issues. IT due diligence can be a daunting task, and it’s usually not done in sufficient depth, he notes. “You can’t just send out a team of three guys,” he says. “It’s a common problem that you often don’t know exactly what IT assets you’re buying.” IT evaluation should be an important part of due diligence, and tire-kickers should ask deep questions and be given the time to get the answers, he asserts. Experts stress that knowing what you’re buying is essential to a smooth integration. There are software packages available for helping prospective buyers get a handle on a potential target’s IT assets. BDNA, for one, markets a product that allows buyers to get a spreadsheet-like view of a target’s information technology assets. It allows IT organizations to provide integrated information about their assets with accuracy and clarity much more quickly than they could with traditional methods of data collection. “If you have a strong set of documents, you’re in way better shape to understand the deal’s impact,” says Greis. He adds that this sort of best practice should be used whether a deal is looming or not. It’s even a plus for the target, he suggests, because having a clear picture of its assets can make the difference between whether the acquirer’s or the target’s IT system is the surviving one. SOA to the rescue Despite the blunders that can occur during IT integration, experts say there is hope that these onerous tasks will become easier in the next five years or so. Service-oriented architecture (SOA) and other technical advances are likely to make the chore of knitting together the systems of two organizations easier. Service-oriented architecture is essentially a collection of services that communicate with each other. The communication can involve either simple data passing, or two or more services coordinating some activity. Some means of connecting services to each other is required. “We’re seeing a movement toward a more component-based framework that will make it easier for systems to talk to each other across platforms,” McConville says. He foresees a three-to-five-year window before SOA software is widely adopted. When it arrives, it will make it easier to map IT inventories and will increase usability across platforms. But during, and even after, the roll-out of this technology, dealmakers will be well advised to give information technology a higher place on their due diligence agendas and integration checklists. Top 8 Rules for Avoiding IT Blunders * Conduct a comprehensive inventory of IT contracts * Determine in a timely manner the appropriate disposition of assets, and which assets will be required during the transition period and thereafter (including obtaining appropriate assignments, transfers, licenses and services splits) * Understand license scope and permitted affiliate use * Anticipate how consolidation may create strategic sourcing initiatives * Ascertain that there is an exit strategy and establish appropriate service levels, with respect to transition service agreements * Obtain all consents necessary to legally provide transition services before closing * Recognize the operational impacts of being unable to use licensed assets out of scope and organize to overcome those impacts * Hire counsel with IT knowledge and experience – Akiba Stern, Shaw Pittman Copyright 2004 Thomson Media Inc. All Rights Reserved. http://www.thomsonmedia.com http://www.majournal.com