Establishing Strategic Guideposts for Corporate Buyers In the 21st Century

Strategic planners are working with corporate clients to frame acquisition programs that meet the challenges of the modern business environment. The focus is on buying and integrating businesses that help keep in step with constant change while simultaneously enhancing shareholder value. M&A: Some concerns have been raised about whether companies are getting too big to manage, partially as a result of mega-acquisitions or serial acquisitions. Do you see this as a problem? When does a company become too big or when does size begin to adversely affect performance? Sirower: I don’t think we have any empirical evidence that shows that size is necessarily a bad thing. Some of the largest and most successful companies in the world, like General Electric, continue to prosper with their acquisition programs. Then there are several large companies with long track records of successful acquisitions, but they do a transaction that deviates from the types of deals that have made them successful, and they significantly disappoint investors. And, small organizations, of course, go out of business regularly. I know of no evidence that suggests that just because you are big that means you are going to have trouble or that size should necessarily be the defining issue when considering acquisitions. Schmidt: I don’t think there is a natural law that predicts diminishing returns to scale. The fact is that the larger companies tend to do more complex transactions. If two large companies are combining their businesses and organizations, the deal is naturally going to be complex. If they are not in the same industry, if it is a cross-border deal, if the synergies involved are a real “stretch,” then the risks associated with size are compounded. That said, you can find examples where large, complex transactions have worked. In the banking industry, Citigroup seems to be doing reasonably well after a large acquisition, although Bank of America has perhaps not fared quite as well. Again, success depends on the circumstances. No general rule about the size of a deal applies to all situations. Bogush: Size in and of itself is not a red line. However, the larger the transaction, the more the relative complexity increases. And when complexity increases, it impacts your ability to either realize or create value. A second piece that is more functional is the whole concept of span of control. As you double your size you have to make accommodations for creating a span of control that now can deal with this significant increase in size. And there is the issue of cultural assimilation. These are all things that they need to be wary of in terms of whether they have a plan or at least some strategy for dealing with them, so that they can actually achieve the value that was projected, and is the basis or the reason for doing the deal in the first place. M&A: What are some of the signs that a company is becoming more complex and perhaps needs an out-of-the-box approach to managing? Bogush: Complexity tends to revolve around revenue drivers. You may be acquiring customers, or market share, or technical talent. These are all things that are harder to execute around than in more of a consolidation deal where there are redundancies and you are looking to put infrastructure together. The first things that I look at in terms of the value drivers are why are you doing the deal and where the value resides. Then you start looking at the complexity from that point of view. Sirower: Some strategies are more difficult to pull off than others are. One of the hardest strategies to make work is cross-selling, although we hear it all the time in financial services. A lot depends on what exactly you are trying to cross-sell and how you plan to do it. Say two big banks are trying to get together. There are likely to exist different sets of algorithms that each bank uses for getting customer data through the best sales channel at the most effective time to generate sales. These differences may also be tied to different technologies and systems. You have to get the sales forces hooked up to that new technology and a new way of transferring new algorithms to things that the sales force does day to day. So depending on the level of cross-selling and the degree of integration of the two banks, it is possible to introduce very different strategies and resulting levels of complexity. Schmidt: Traditional parameters for looking at organizational complexity can be applied in mergers and acquisitions. They involve the number of markets, such as geographic markets or product markets, the number of channels of distribution, the amount of consistency in the systems infrastructure, and many other factors. With these parameters, you can assess whether a company is getting to the point where it ought to think about whether it is already too large to pull off the next merger or acquisition successfully. If it’s a company that has made a series of acquisitions, you need to look at their track record over time. In most cases, they tend to start out with smaller deals. Eventually they get to the point where size really matters. When they do the post-mortem on the latest deal and find out that they didn’t achieve anywhere near the benefits that they had expected, assuming the quality of the dealmaking was comparable to earlier deals, that’s perhaps the time to reconsider doing the next deal, because it just may be that the management resources and capabilities of the organization have reached their limit. Unless some new learning or significant new capability is developed, further complexity is going to lead to disappointing results. Sirower: That’s a great point. There are ways to anticipate the complexity that you are about to deal with. Perhaps the most crucial early step is to clarify the most attractive opportunity space for the client where acquisitions might play a role. After the opportunity space has been defined, the question is whether the client can learn from deals it has done in the past. These learnings can be used to aggressively sort the opportunity space for the options most likely to be valuable to the client. Self-due-diligence takes significant discipline and isn’t always easy, but it may turn out to be an important eye opener in screening the best growth options and avoiding those that are likely to be disappointments. M&A: There seems to be a pause in the deal flow, which may result from some of the things we are talking about, such as economic conditions, the stock market, tightness in the capital markets, or a combination. How do you see this affecting future m&a activity, as far as the types of deals or sizes of the deals being done are concerned? Schmidt: If you look at the 1999 and 2000 data, the size of a deal has gone down by about 20% on average. There were many transactions in high tech and other industries that enjoyed very high valuations prior to the stock market correction. In these cases, you are probably going to see fewer deals and smaller deals. But in some of the industries where consolidation has been lagging, in utilities, for example, you will see the deal flow start to pick up. Bogush: As recently as six months ago and over the prior two years a lot of deals were certainly driven by the inflated currency that acquirers were using to do deals, especially in high tech. The point is if someone inflated my currency by a factor of 10, I had better go spend it before someone deflates it by a factor of 10. It was a case of going out there and striking while the iron was hot. Over at least the next six to 12 months, people are going to really start looking more at the feasibility of the deal. A lot of the operating companies that we are working with are looking at transactions in more concrete terms. They want to know if they can get their arms around it and they are looking at it from an operational span-of-control perspective, with the question, “What makes us think we can pull it off?” Usually they have a pretty good answer. That’s different than just asking, “What makes us think we can put company A and company B together, redefine how that service is delivered into the market place, and start capturing market share?” Sirower: We are still looking at an environment where thousands of companies have market caps that they could not have imagined just five years ago. And we are still looking at the extensive use of stock as currency, which is a complete reversal from what we saw 10 years ago, when almost all big deals were done with cash. That is going to continue. Every CEO around the world who has currency to spend is considering how best to use it for acquisitions. You can do good deals with that currency, whether it is inflated or not, or you can do bad deals. But make no mistake, in this market, companies with attractive market values will continue to look for ways to use it to shape their destiny and the landscape of their industries. Schmidt: I agree, but it has to have some effect because the currency for funding deals is simply not as valuable as it was three months ago. M&A: What do you see ahead in restructuring? What are some of the key criteria going to be for keeping or shedding a business? Sirower: While we have lived through the biggest merger wave in history and are still seeing an incredible amount of deal flow relative to what we would have expected five or six years ago, we are also living through the biggest IPO, divestment, and spin-off wave in history as well. That includes everything from PepsiCo spinning off its restaurants a few years ago to businesses being forced by the antitrust authorities to get rid of pieces so their deals can go through. Some restructuring is inevitable because of mergers. One often hears that mergers are going to result in fewer companies, but it is clear that as companies focus where they can best add value in their portfolio, the result will be more companies and thus more competitors. Something that is going to drive a lot of restructuring is that deals that made economic sense before the Internet and other technology developments don’t necessarily make sense anymore. The Internet breaks down the old barriers of asymmetries of information. Now buyers and sellers have a lot of information about each other that they didn’t have before, and many of the advantages that you might get from owning certain businesses are gone. You’ve got to build that into your valuations of current and prospective businesses. When previously proprietary information is now readily available, some past acquisitions may now be good candidates for divestment. Schmidt: Competition authorities in the U.S., Europe, and elsewhere are doing more serious questioning about the merits of deals from the consumer perspective. That probably will lead to additional divestitures and spin-offs as a condition of getting the necessary approvals. There is also an economic argument here. Large acquisition premiums are being paid to complete deals because, essentially, companies are paying for the intangible assets in the business. That is where one plus one equals three or four. So if you are acquiring a company, you need to understand the intangibles in its businesses and their growth potential. Otherwise, you are not going to achieve the improved performance that you need to offset the acquisition premium. This argument may lead to greater scrutiny of intangible asset potential on the part of CFOs. They will look at the portfolio of assets the target company has and highlight those that will or won’t allow them to capture the synergies needed to achieve financial success. Bogush: It goes to value creation as it relates to the premium. Say, there was a going-in strategy that said if we put these two things together and we execute around this strategy we will create value and then justify the premium on the deal. It may a good idea and a plausible idea, but it may be translating into value in terms of execution. As that relates to divestitures, I think we haven’t really seen anything yet. I think that toward the end of 2001 and into 2002 and 2003, we are going to see a wave of divestitures as companies look to refocus in on core businesses and reevaluate the strategy that drove an acquisition two years ago. They may find that it wasn’t as easy as they thought or that for some reason they miscalculated. Sirower: Divestments are an important part of the process of going back and reassessing what has worked and what hasn’t worked. They are also an important part of the up-front work on building an acquisition strategy itself. You can recoup a lot of the acquisition premium by identifying the pieces you don’t really want and holding an auction for them early on. In a strong market, the best time to do asset dispositions and find the best buyers at the best prices is right around at the time that you do the acquisition. It is an important part of early postmerger integration. Bogush: In the 1980s the basic premise was that the parts were greater than the sum. The idea was that if you buy the entire thing and break it down, you will have more value in the parts. With the strategic wave that started in the 1990s, it was just the opposite – the whole was greater than the sum of the parts. Now, I think you will get a revectoring around what is closer to reality. Schmidt: Sometimes when we talk about divestitures, the implication is that we are talking about whole businesses. But as a natural part of combining asset bases, companies involved in mergers and acquisitions are going to shed redundant or non-strategic assets. For example, in the big oil industry mergers, the resulting companies have only so much money to invest in wildcat exploration. When you put the prospects of the two companies together, you get a different rank ordering on what the best prospects are. The things at the bottom of the list are going to fall off, but at the same time, they might be very attractive to another buyer. M&A: Consolidation and scale have been big drivers over the last decade. How does it stand now? Industry by industry, or market by market, is a lot of consolidation still to be done or is it kind of falling by the wayside? Sirower: There is a tremendous amount of consolidation still to be done. There are some industries that have had several megamergers and still are not very concentrated. Look at pharmaceuticals, even after the Pfizer/Warner-Lambert and Glaxo/SmithKline deals. Each of those large combinations has barely 7% of the market. The next one down, Merck, has just over 4%. The average market share is probably 2% or less from there. So pharma is a big but still very fragmented industry. It’s the same thing with specialty chemicals. There are more than 200 specialty chemical companies with revenues greater than $500 million, so there is plenty of consolidation due there. In addition, there are a lot of sub-industries in which it is clear that the increased scale resulting from consolidation would yield significant cost reductions. We still have many tier one auto suppliers with large captive component manufacturing operating in high-cost locations. If some of these pieces were consolidated and moved to more favorable cost locations, a lot of value could be created and many of these tier ones would be rid of businesses where they weren’t competitive. You can bet that smart LBO firms are thinking about this sort of thing. Bogush: Mergers and acquisitions are vehicles for growing a business. The best balance is between organic growth and some growth from m&a. But a lot of industries have reached the limits of organic growth. Their investors still have expectations for growth, so mergers and acquisitions become an important component of the long-term growth strategy. There are many industries where the top players are doing well, at least for the time being. But when you work down into the mid-tier companies and the smaller companies, there is lots of room for further consolidation. M&A: What are companies principally using mergers and acquisitions for right now? What are some of the primary strategic purposes that come to the surface? Sirower: Well, scale is always going to be a big issue in some businesses. In pharma, R&D is going to be an issue where scale remains important as new advances in areas like biotechnology require ever larger investments. A lot of the small biotech players are going out of business or being acquired because they can’t afford the continued investment to stay in the game. Another driver is geography. A company may have a product that its distribution system simply cannot get exposed in a particular geographic area. By doing an acquisition, the acquirer may suddenly open up another geographic area where it can perhaps become the best player. On the other hand, we are going to see large deals done around the world to preserve regional power bases, just like what is happening right now in banking. There is also technology. A lot of companies may not be doing pure outright acquisitions, but they will take minority positions in companies to make sure that they don’t miss out on the changing technologies. We see this regularly in pharma and telecom, among other industries. Bogush: I would add the people equation or the intellectual capital represented by a good employee or a good group of employees or a good division. That is the ability to acquire 1,000 incredibly talented people at one time. If you were trying to acquire those 1,000 people on a onesy/twosy basis, your prospects would be much more limited. The acquisition allows you to ramp up and capture that intellectual capital that resides in the people of the acquired organization. Schmidt: There is another aspect to the same idea. In the more mature industries you have a demographic imbalance because a lot of employees are approaching retirement. In fact, the average age of the workers in some mature industries is 48 or 49 – and every new year, the average goes up a year. These companies have to compete for new talent in the same labor markets with the technological and strong brand image companies that have a lot of pizzazz. Some are finding it very difficult to compete given the image of their own industry and perhaps the image of their own company. So when you combine companies in a merger or acquisition – and I have seen this in the oil industry, as an example – some of the pressure around “Grey 2K” suddenly goes away. As you consolidate organizations and operations, you need fewer people. This provides an opportunity to reshape the demographic profile of the company – to give you something more competitive over a longer period of time. It doesn’t take the problem away, but it buys you some time. M&A: How are you working with clients on shareholder value today? Are you using any new tools or approaches in determining how an acquisition or any other type of corporate development initiative impacts shareholder value? Sirower: When we begin a corporate strategy project that may involve an acquisition, we make sure that the client understands the trajectory of performance that is already built into their current share price and what it might signal to investors if the client were to do a particular acquisition. We talked earlier about how most companies have market values today they couldn’t have dreamed about five years ago. This rise in value is clearly not all accounted for by current performance; it is the expectation of future profitable growth. CEOs need to understand this before they announce new strategic thrusts like a major acquisition. Paying large premiums for deals that don’t make sense will continue to be upsetting to investors. The result might be a loss in shareholder value greater than the premium paid because investor confidence is lost in the future growth value of the underlying businesses. One of the ways that we assess acquisition premiums, aside from just a percentage or the dollar amount, is something we call the P/E multiple of synergies. Suppose you think that you can take $100 million of costs out annually for a given deal. How many times that $100 million are you actually paying? What is the P/E multiple you are willing to assign to those synergies? We then compare that to other deals that were done in the industry and determine whether they were successful or unsuccessful deals. You can actually get a good picture based on many other experiences of what is a sensible P/E for those synergies in a particular industry. Schmidt: We look at it from a somewhat different perspective. Companies earn off of three classes of assets – tangible, intangible, and financial. Most traditional accounting measures and economic profit measures like EVA are oriented to the tangible assets. But, when you look at correlations between classes of assets and past earnings, or predict future earnings, you find the highest correlations are associated with the intangible assets. Intangible assets are made up of human capital, the structural capital (or organizational capabilities in the business), the intellectual property, the brand value, and everything that drives brand equity in the business. Understanding the sources of value in those intangible asset value streams and measuring the earnings coming off the intangible assets is a new frontier in shareholder value management. When you are paying a large premium for an acquisition over the target company’s market price, which includes in it an embedded expectation about future growth, that premium is going to have to be recovered largely on the basis of how effectively you manage the combined intangible assets of the new company. So factoring this economic calculus into due diligence, factoring it into pricing deals, and building it into integration planning represent another pathway toward improving shareholder value in mergers and acquisitions. Bogush: About a-year-and-a-half ago KPMG did a study on shareholder value, looking at about 750 of the largest deals between 1996 and 1998. In every single one of those deals, the number one or number two reason for doing the deal was to improve shareholder value. So we basically went out and asked whether the deal did or didn’t improve value. The results were astounding because in only 17% of the cases the deal actually improved shareholder value. We found that it most cases, the acquirer had a fundamentally good strategy but that the planning and execution fell short. We then asked why they had not accounted for the execution and found there was an overreliance on the financial model that drove the deal in the first place and not a good sense of the practical implications of making the deal work. Consequently, over the last year or even a little longer we have been moving much further upstream in terms of working with clients to assess some of the practical impacts on value creation – the concept that one plus one equals something more than two – and factoring in the complexity of the deal. We try to identify all of those factors that either point favorably to your ability to pull it off and create value or that would inhibit you from creating value. Sirower: It is true that a bad postmerger integration can ruin a good deal. But it is just as true that a good postmerger integration can’t save a bad deal. One of the big pieces of folklore around unsuccessful acquisitions that emerged in the 1980s and has blossomed in the 1990s and beyond is that the financials looked fine on paper but we didn’t manage the integration right. Or we didn’t manage the cultures right. In fact, a lot of strategies that sound good are not strategies at all, so the price paid for a deal had no economic foundation and the transaction was doomed from the beginning. Bad management will only make it worse. CEOs, bankers, and a lot of consultants are expert at making good vision statements. But they seldom actually show how or why you will be a better competitor because of the deal, or how you serve your customers better, or why your employees will find the company a better place to work. It is just missing. I keep hearing that word “cross-selling,” but without any support for how the new company can actually sell more product or better product or fill its distribution channel better than either player could have done without doing that deal. Or whether it would have been better to negotiate a less risky commercial agreement or joint venture that could have for all practical purposes accomplished the same thing as a full acquisition. We know that at the heart of shareholder value issues is whether there is a real strategy in place well before you actually talk about valuation and postmerger integration. We can spend a lot of time moving fast and integrating things but actually waste significant time and money if the senior team does not have a clear strategy in the first place. Schmidt: Strategy indeed is an absolutely essential ingredient in a successful outcome. But I would argue that once you have done a deal, and hopefully a good deal, virtually everything else pales in comparison to getting the people issues right. I mean not only employee communications and the structuring of new employment arrangements, but all of the organizational, cultural, process, and other issues that go into building a competitive organization. Unfortunately, that whole area tends to get too little attention. Sirower: But if you don’t have a clear strategy that impacts the economics of the business that can be communicated to the organization, you can do a lot of restructuring and maneuvering people around for no good reason. You can create a lot of damage by doing postmerger integration for an acquisition that does not build on capabilities or make the combined company a better competitor. We find that many companies that have been using acquisitions to grow have been successful in part by building their postmerger integration strategies not just around one deal but around how they position themselves for other acquisitions going forward. Successful companies do more than just integrate deals in isolation, they actually create an organization that can accommodate other transactions. Bogush: I have seen more and more companies getting serious with the process. Some of that has to do with the publicity that GE gets in terms of how it carries a deal from the very beginning and brings it to fruition. The company calls that its “pathfinder process,” which involves an early agreement of the financial and the strategic people about what they hope the acquisition will end up being, inserting reality early on, having a process that can drive it forward, and also having some sort of closed-loop feedback. The more acquisitive companies are getting more and more serious about creating a core competency around what I will call business integration. It involves not just one deal but what the company is going to do for 10 years. This is a building block type of strategy. M&A: How about the external alternatives to m&a? Coke and P&G just announced a huge joint venture. Do you think we will see more of these alliances or other growth alternatives as opposed to m&a? Schmidt: The research doesn’t make a clear case that alliances and joint ventures are necessarily more successful than mergers and acquisitions. Sirower: But they carry much lower up-front investments that are a lot less risky. Schmidt: That is the key point. They are less risky and they provide greater flexibility. In certain circumstances, such as in entering new markets or pioneering new technologies, the chances of success may be higher through an alliance than through an acquisition. I think we’ll probably see more alliances and we will see more spin-offs and IPOs as well. Companies are continually looking at their assets and the businesses they are in and how to optimize value. They will inevitably make changes over time to create a higher value proposition for their shareholders. Sirower: Commercial agreements, alliances, and joint ventures are alternatives to acquisitions but they are not necessarily mutually exclusive. Corporate development is all about clarifying and developing capabilities in your businesses and taking actions to add value or create value based on those capabilities. There is a whole range of corporate development options available ranging from simple commercial agreements to acquisitions. With acquisitions you are actually buying a complete set of assets plus paying a premium for them. I always tell clients not to limit their options to either buying this or that. Acquisitions have their role but so do various commercial agreements, alliances, and joint ventures where both companies share the risk of a new or expanded business. Bogush: Joint ventures and alliances will continue. In the short term, that has to do with the risk/reward component. The risk is lower, the reward is lower, and when you are in a position where you are limited in terms of the amount of risk you can take, it becomes a natural way to move if you have complimentary products. With the Coke and P&G venture, P&G brought in salty snacks to better position Coke against Pepsi and its Frito-Lay business. In the short term, probably more companies are exploring alliances. Whether they do it is another matter. The fundamental problem that I’ve seen with most joint ventures and alliances is that they seem to be all shades of gray. Consequently, when they start getting into the execution and try to make it work in the marketplace, they tend to be somewhat hamstrung in their ability to make things happen at the speed that they want things to happen. Sirower: Alliances may work if you can’t put two companies together for antitrust reasons. You can put pieces together through commercial arrangements, such as the code sharing agreements that airlines have. Two airlines don’t have to merge to code share and they may get a lot of the potential merger benefits from the agreement. So clearly there are cases where joint ventures and alliances are an option when you just simply couldn’t do the acquisition and may not even need to do it in the first place. Schmidt: There are also situations where alliances just don’t work. For example, in resource-based industries, particularly the vertically integrated ones, big alliances don’t produce the same kind of results as an outright acquisition. The reason you do an acquisition, in this case, is that you want control so that there is higher assurance of capturing potential synergies. M&A: The Internet has been regarded as a breakthrough in the way business is done. Where do you see the Internet playing out generally as a stimulus or a catalytic influence on m&a? Sirower: Before we think about the best opportunities for a client, we first have to understand how the business economics of an industry might be changing. It is clear that the Internet has had a major impact. Wherever you had information asymmetries between buyers and sellers, that was an advantage for some competitors. Now the landscape has changed. Businesses that may have been in your best opportunities space before aren’t in there anymore. They may be in somebody else’s space. The Internet has essentially broken the trade-off between richness and reach. It used to be very hard to get rich information out to a lot of people. Just imagine your typical newspaper ad. It goes out to a lot of people, but there is only so much information you can get in the ad. The next step is direct-mail. Well, you can get more information in it but it is very costly to send it to many people. You get the richest information out by going door to door. You can get out very, very rich detailed information but it is very expensive per delivery and you can’t bring it to too many people. That has all changed with the Internet. Now very rich, extremely detailed information is available to almost anybody who wants it. This has given rise to the whole B2C and B2B phenomena. Now there is a whole new set of potential partners and corporate development options that did not exist just a few years ago. Schmidt: In merger integration work, we’ve helped clients rationalize web sites and upgrade their Internet capabilities. Every company has 1,000 flowers-in-bloom – a lot of web sites and other duplicative stuff. So in and of themselves, they present an opportunity for rationalization. Mergers and acquisitions also provide an opportunity to look at ways to digitize the business. When a merger or acquisition comes, there is usually a readiness for change within an organization. In that environment, you can implement some things that had just been concepts before, put some resources behind them, and make things happen a lot easier. Another interesting aspect of the Internet in mergers and acquisitions is communications. Because the best communications are a combination of high-tech and high-touch approaches, you can use the Internet to help communicate frequently on important matters to employees in all worldwide locations. In some of the big mergers we’ve been involved with, Internet sites have been created to communicate what jobs people had, where those jobs were, what they were going to be paid, and if they had to be relocated what kind of assistance their families could expect. So it becomes a very powerful communications device for bringing companies and their workforces together. Bogush: The Internet is an incredibly valuable tool. But I think that a lot of the companies are having a difficult time figuring out how to cash the check, so to speak, and actually realize some of the benefits that they foresee. In terms of being an enabler of m&a activity, as well as joint venture and alliance activity, there is no question that the Internet is one of the prime enablers. Whether it would actually drive the activity depends more on the fundamentals in play in a given situation. M&A: Are there any industries or markets where there has been a relatively light amount of m&a activity that are about to step up the pace of mergers and acquisitions? Conversely, are some m&a hot beds about to cool off? Sirower: When a lot of the Internet start-ups had their high-priced stock as currency, they were spending it on acquisitions. Once the currency goes away, so do the deals. There are a number of industries where we’ve seen over-investment, like the new-entrant telecom companies’ investments in networks and in biotech, where there has been tremendous investment in new generations of technologies. Some of these companies just can’t get the return on investment they need and are ripe to be acquired at low prices. So you are going to see a number of deals where there is this type of over-investment situation. The natural buyers are those companies that can utilize those assets and technologies and presumably get them at much better prices than they could have a year or two ago, and certainly less than what it would cost to build. Schmidt: There are some very fragmented industries still waiting for further consolidation. Take insurance as an example. There are lots of life insurance companies in the U.S., clearly more than we need in this kind of economic environment, and so there likely will be more consolidation there. The easing of the rules on bank ownership of insurance companies probably will also facilitate m&a activity. You could make a similar argument in other industries, as well. Bogush: As the tide goes out, so to speak, which it appears to be doing now, a lot of companies will be refocusing on this whole consolidation and scale aspect. In the last few months I noticed a lot of activity within the traditional automotive sector. Those companies are looking not only at consolidation and scale but to minimize or lessen their dependency on traditional business methods. There are companies that do 80% or 90% of their business with one of the Big Three or all of them. They are trying to determine how to take some of their technology and apply it to other areas, consumer goods for instance, such as washers and dryers and compressors. As the tide goes out and there is less money to spend, companies are perhaps taking the chance to retrench a little and rethink their positions in terms of how much they are dependent on a particular industry and the ups and downs of that particular industry. M&A: Do you ever reach a conclusion early, through due diligence or analysis or your knowledge of the client, that there is no way a target company is going to be properly integrated, no matter how compatible the two firms look on the surface? Sirower: The best companies figure that out early on. But why do there tend to be so many failures in postmerger integration and actually in the m&a process from the beginning? The only way that merger waves happen is when companies that haven’t been doing deals are now doing deals or companies that had been doing them are doing more and bigger deals. So by definition, merger waves are created by injecting inexperience into the market, a tremendous amount of inexperience. Most companies are reactor companies. But the most successful companies have transformed themselves from being reactors to single opportunities to what I call “always on” companies. They are ready to deal with opportunities proactively and recognize that different opportunities represent different strategies and different strategies require different integration methods and capabilities. So the best acquirers understand that when a particular opportunity comes their way, they know whether or not it fits strategically. They know the kinds of integration requirements that would have to be in place for the deal to truly create value. So there clearly are deals that come up where they quickly assess that they are unlikely able to integrate the target company successfully. Somebody else might be able to do it, but smart acquirers avoid deals with poor integration prospects. The best companies think about postmerger integration in their ongoing business development screening processes to weed out the least attractive opportunities from the very beginning. Bogush: Within the last six months to a year I have seen companies that tend to be acquisitive really look at creating the whole m&a process as a core competency. They are trying to take some of the emotion out of m&a up front. These projects have tended to be very emotional, almost a CEO-against-the-world type of attitude. Many executives want do a deal simply because they want to do it, and they are not going to be stopped from doing it. But as these companies grapple with the troubled aftermath – whether the deal shouldn’t have happened in the first place or whether they didn’t execute properly – a bit more common sense and reality are starting to sink in. They start looking at companies like GE and Cisco and other companies that seem to do it right more times than not. The successful companies say they have a process and they have extracted a lot of the emotion from it. They look at the financials, the people, the process, and the technology of the target as a total package. Then they go through some process that leads them to sit back and ask, “Can we really do this the way we think we can do it?” In the last 12 deals I was involved with, there were probably six in which the acquirers, because of a more enlightened and broader due diligence approach, sat back and concluded that the deal wasn’t going to work. Had they gone ahead with the deals, two years later they would have been struggling. The good news is that companies are starting to realize that. They are starting to take concrete steps to create the m&a process as a core competency, since they intend to be a growth-through-acquisition business. Schmidt: I have seen more and more companies examining some of the “softer” issues, applying them to their screening criteria and to due diligence, and looking at risks that are more subtle than paying too much to close a deal. Let’s say, for example, you’ve uncovered high turnover in a company you are planning to acquire. This could be a warning sign, particularly if you are doing the deal because you are trying to get access to the intellectual property that resides with the people in that target company. Or, you look at the change-in-control agreements during due diligence and, lo and behold, you find there are no double triggers. Key people may be gone as soon as you do the deal. As these examples illustrate, you don’t want to learn the hard way by doing the deal and then finding suddenly that much of the value is gone. Building those kinds of risks into target screening and into due diligence is key to a successful m&a outcome. M&A: How prominent is the realization by line executives, operating executives, or executive suite people that integration is critical? Sirower: Successful acquirers have made postmerger integration a much more structured activity. Gone are the days when it was fashionable to merely claim that the integration has to be done in the first 100 days and you have to move fast. That is actually pretty old news. It certainly isn’t the case that you only go after the 20% of things that get you a lot of value because in large, global integrations there may be 10,000 non-routine things that have to be managed. So you have to pay attention to many small projects. Now you must have a number of things in place right from the beginning. Most important is to treat postmerger integration as a discrete activity. You have to separate it from the day-to-day running of the businesses or else a tidal wave of distractions and excuses emerge. When deals go bad in postmerger integration, it is often because the integration effort gets mixed up with ongoing performance requirements of the individual companies. A state-of-the-art postmerger integration has its own structure, its own management principles, its own teams with charters for those teams and drives toward the creation of a real business plan for the combined enterprise. So when a deal actually closes, the new company is quickly up and running with tracking systems that enable pre-deal performance promises to be measured and rewarded. The time between announcement and closing is a critical window to really get that postmerger integration structure in place. Schmidt: We did a survey of large companies around the world that have been involved in mergers and acquisitions. We asked, among other things, about what was the single biggest obstacle to success in implementing the deal. The overwhelming response was lost business momentum following the closing. If you don’t have the approaches and the capabilities, the competencies, and the infrastructure in place to manage the integration process, you’ll end up with people who are trying to do their day jobs and manage the tidal wave of integration activity at the same time. You will damage the current results of the legacy companies, which already have a growth component built into their preacquisition share prices. And, you may be losing the opportunity to capture the expected synergies in the future. So the long-term economics of the deal also don’t work out. Bogush: We talked about what we refer to as critical success factors. Creating a discrete postmerger integration activity with its own structure and people and the resources to manage it. Balancing the needs of the day-to-day business with the needs of the integration. Linking the tactical execution to its strategic context. They are all critical. I see more and more companies trying to get those factors in front of the deals, such as when they are discussing potential targets. They are going through some analysis or metrics that actually allow them to start quantifying. When we talk about value, we talk about three aspects of value – preserving the value that you’ve acquired, realizing the value from consolidations, and creating value. The new approach is to take those components into consideration and not just accept the idea that somehow value will be preserved de facto because everybody wants to work for us and we are smart guys who can figure out how to create value. You are seeing the use of a lot more analytical tools to quantify some of the soft stuff in terms of people and to quantify their chances for creating value – pulling off the hat trick that truly drove the deal in the first place.