How the Successful Acquirer Keys On Market Power The best m&a due diligence probes the qualities of a target that provide sustained competitive advantage to the buyer.

The most successful acquisitions are created by a corporate team that executes a well-conceived, dynamic due diligence process that goes beyond merely defining matters of fact. Instead, the process is directed at developing a specific, carefully focused, and dynamic business plan that is implemented to generate sustained competitive advantage for the combined company. The complete and most productive due diligence project actually begins with the earliest steps in the acquisition process. Selecting a merger partner means rejecting other candidates, putting a premium on choosing the right business that will achieve the aims of obtaining long-range competitive advantage. There are great rewards for the correct choice and negative results for the wrong selection. This opportunity cost represents the highest degree of risk in the entire m&a process but it can be controlled through a disciplined and systematic approach that requires: Clearly defining the objective of the acquisition; Identifying the “Universe of the Possible,” from which the right target will emerge; and * Conducting a thorough analysis concentrated on determining the competitive benefits provided by each candidate in the “universe.” When due diligence at this stage is properly conceived and executed, there is no such thing as an unsuccessful search. The process generates a useful analysis of the acquirer’s available market and always yields beneficial insights into its own operations and market position, major ingredients for mustering the strengths needed to sustain competitive advantage. Through the information provided by an exhaustive search, it is possible to know the real opportunity costs in a business development project with some certainty. No amount of work in the later stages of the m&a process corrects for an inappropriate target selection, but thorough up-front diligence produces an informed selection at reduced risk. Most important, a well-begun process generates positive excitement as it unfolds. The best and brightest possibilities are knowledgeably selected and systematically built upon. This creates a constructive process that engenders great enthusiasm because it should land a complimentary business that will do the most for sustaining competitive advantage in a continually evolving marketplace. Only after the in-depth strategic homework has been completed is the stage set for other members of the due diligence team to enter. Attorneys, accountants, environmental impact professionals, etc., all have defined roles to play and generally carry out their responsibilities well. However, their traditional emphasis on gathering legal and financial facts, despite its great importance as a device for checking and verifying key information, does little to develop the successful, value-creating transaction. That rests with the ability of the strategic members of the due diligence team to infuse the acquisition with a vision that goes beyond a cold set of facts. Narrow adherence to the Sergeant Joe Friday approach to investigation would lead the combining companies astray. Asking for “the facts, ma’am, just the facts” limits their ability to imbue an acquisition with vitality. Too often, even the most important facts are bound in a neat book, stored away, and forgotten. Yet, preoccupation with just the facts can prevent the merger partners from developing the fuller conceptualization of why they are coming together and how their combination can generate competitive advantage for both sides. Synergy is a concept that exemplifies the demarcation. To the fact-bound, results are expressed in purely quantitative and measurable terms. To the visionaries, synergy is a synchronized combination of actions linking every organ in the system. It is a cooperative process of yielding, without resistance, to applied energy, which in the case of acquisitions is derived from the strength of vision embodied in a business plan. Real synergy is the glue that creates the improved, more competitive organization and cannot be imposed by directive from the top. An empowered due diligence team charged with gathering facts and weaving them into a vision is structured carefully so it can deliver maximum impact. Its responsibilities are to develop key success factors and establish the framework for a positively charged evolutionary process. Vision develops as the team identifies specific dynamic forces driving the transaction and leverages them. The resulting business plan energizes and controls the process of combining two businesses. If the due diligence team’s work goes well, it can yield to the transition team, which is empowered to put the companies together so the vision can be articulated and executed. Dynamic Due Diligence One of the principal areas that merits inquiry in a process that goes beyond the straight facts is people. Solid due diligence goes beyond numbers and inventories of skill sets into the attitudes, cultures, and other personal attributes that are the real shapers and drivers of vision. This exercise produces not only the grist for a viable postmerger integration and checks out the target’s work force but reviews the relationship of the acquirer to its employees. Operating companies often do a better job of evaluating one person considered for a new hire or for advancement than they do in sizing up five or 10 key people with their full complement of staff and support systems. Even cursory employment interviews are not conducted. Hidden agendas go undiscovered and a lot of valuable information falls through the cracks. Take the starkly dramatic case that I experienced after a front-office meeting with the owners of a company who spoke glowingly of a “family atmosphere” and the strength of employee loyalty. I had a few minutes on my hands, so I poured myself a cup of coffee and sat at an outside picnic table which was also occupied by a number of employees. They were speaking rather loudly and I couldn’t help overhearing what they were saying. Everyone there had resumes out and was actively seeking other jobs. The “family” was breaking up right under the noses of the somewhat smug, ill-informed ownership. The lesson for the transition team is that people are more likely to buy into a system that they had a hand in shaping than one that is imposed on them. As a result, the transition team should actively involve as many people as practicable. These people know the strengths and weaknesses of the two companies, and with the right encouragement can pick up on the dynamic forces while rooting out the dysfunctions and surfacing the hidden agendas. Their input can help engineer the compensation systems and personnel policies that lead to achievement of quantifiable objectives punctuating the business plan. Many real assets and synergistic opportunities are hidden. For example, several years ago we represented a potential seller that drew the interest of a small public company because it was impressed by the way our client dominated a geographic market. On further examination, the buyer found that the target’s experience and ability could be replicated in all of the locations it served and that the results would return value that was worth more than the purchase price. Clearly, a successful acquisition begins with a finely focused objective which is expressed as a measurable process rather than as a set of stagnant facts. Acquiring companies is not a gambler’s game based primarily on hopes. The definition of what constitutes facts can be enlarged and altered depending on their source. A “mystery shopper” may produce a completely different set of facts and insights than a private detective conducting a discreet inquiry. The market prospects of the target as viewed by customers, suppliers, and employees produce valuable insights, although the perspectives may vary. But all available sources must be tapped. Few industries are as fortunate as food manufacturers and wholesalers or health care products firms which can avail themselves of widely known data from professional research specialists, although similar information may be on hand for other industries and can be obtained by the acquirer willing to gather and understand it. Don’t overlook the potential for background checks of key people at the target because it may lead to better understanding of their motivations, interests, and capabilities. An effective due diligence blends the talents of different kinds of people and allows for assignment of different primary tasks. Some find the critter, others forage for facts, and still others work to combine specific functions. Collectively, the team must assume the responsibility for synchronizing the studies and recommendations. Properly conceived due diligence, to reiterate, is the process of developing a clearly written business plan, based on facts and specific points of leverage, to create sustainable competitive advantage. Dynamic Points of Leverage Because synergy is not a matter of fact, an effective business plan focuses on quantifiable actions that serve customer needs. The due diligence team then must bring into a functioning system the combined effective actions of two companies and many individuals. The major objective is more effective, powerful, and aggressive customer service measured in terms of what the customers really care about. That goal can be accomplished by focusing on the performance characteristics that directly impact customers. The process starts by identifying dynamic points of leverage, which is the first step in synchronizing actions that can be combined in a self-sustaining business plan. Mere presence in an industry is not a leverageable point. A leadership position in the industry may be leverageable. An entrenched position in that industry certainly is. Demonstrated management skills evidenced by survival of the firm in the face of adversity and a track record of accomplishment are highly leverageable. Distribution strength, graduating technical expertise, and a loyal customer base can be leveraged into a sustained competitive advantage. Valuable employee skills and unique processes are potentially leverageable. Performance characteristics often are expressed as ratios because ratios approximate relations between things or actions rendered in numbers, quantity, degree, rate, percentages, or proportions. They are expressions of relative values. Collectively, they constitute the dynamic points of leverage. In some cases, they are the performance characteristics of specific industries that should be analyzed by the due diligence team, i.e., barrels per hour in brewing, tons of steel or concrete produced in those industries, billable hours in professional services, barrels of proven reserves in oil, bed utilization in health care facilities, etc. But the opportunities for the thoughtful to create points of leverage based on the specifics of the merging companies and its industry are unlimited. Some possibilities for identifying points of leverage and developing instruments that can be used to apply them within the business plan include: Financial Formula for Calculating Return on Assets Per Employee This can create a method of evaluating productivity of the work force, especially in industries where such efficiencies are vital. The right formula will help measure prospective improvements and how productivity is responding to company initiatives. One food company which acts as a major industry consolidator and is an active acquirer uses an ROA formula as a primary organizing tool. Employee compensation is based on the formula which provides a powerful incentive for workers to perform well. Growth in sales and profitability have been dramatic. Economic Value-Added Formulas An economic value-added formula is a tool to measure real profitability. It is powerful because it takes into account the total original cost of capital and equipment plus working capital, cash inventories, and receivables. In its simplest form, the formula starts with operating earnings and subtracts taxes and capital costs. The remainder is the economic value-added. It can be an effective measure of the ability to create wealth. Percentage of Revenues and Profits From New Businesses New lines, products, and customers are signs of a healthy growing business. Chart the percentage of total revenues from these new ventures in past years as a portion of total revenue. Use this tool to benchmark the new product/customer forecast. Quantifying Lost Business Revenues Keep track of revenues lost from missed business opportunities, being beaten by competitors, new product fizzles, and other adverse developments. Diagram the impact in terms of both what value the company has lost in not succeeding and how existing operations have been penalized by the miscues. By getting a better handle on failure, the company can surface the problems that caused the misfires, address them in timely fashion, and establish goals more sharply. Customer Concerns Quantifying Customer Relationships Develop a matrix that includes average duration of customer relationships, the number of customers per employee, support expense per customer, and marketing expense per customer, among other data. This will identify the most profitable customers as well as those that may need special attention. The information can impact a wide range of operations, including new product development, value chain management, and delivery and production schedules. Customer Satisfaction Index This measurement invests the company with the discipline of constantly canvassing customers to get the ingredients for devising the index. Changes in the index demonstrate how well or how poorly the company is scoring with the customer base. While the index should be administered in-house, it’s a good idea to have the process checked by an outside marketing professional. Return on Assets and Profits Per Customer This is another measure of the profitability of individual customers which should lead to further decisionmaking by management on the future of the company. Charting Market Share Aggregate market share and its changes are easy. But a thorough measure includes key breakdowns such as share per asset, share per employee, and other reducible and controllable factors that provide critical information on productivity. Sales Calls Per Customer This would include the number of calls needed to close a sale. Are sales people spending too much time with the least profitable customers and not enough time with the best customers? Is the sales force as good as initially rated? What improvements can be made? Process Improvement Formula for Administrative Expense Per Employee The measure should embody a plan to reduce overhead and measurable attainable goals for the expense cuts. Measuring Cycle Time Improvements These trends should be charted historically and in terms of achieving goals from management initiatives aimed at improvements. Charting Achievement of Quality Goals An important discipline for the well-managed company. Ultimately, product/service quality is critical in customer relationships. Management Information Systems Quantify the capacity and availability of the systems on a per-employee basis. This not only will point up areas that may need upgrading (or downsizing, if overcapacity is found) but show, at least indirectly, who in the company is best and least informed about the business. Human Resources Leadership Motivation Index Identifying which employees in the work force are take-charge persons and allocating compensation accordingly. Employee Empowerment Index A tool for measuring how well the management is achieving top-to-bottom buy-in. Investment in Employees Assess the total outlay with a tool that measures training time and expense per employee and per capita cost of employee support programs other than training wages and direct benefits. Quantifying Management Capabilities Consider the breadth and depth of management know-how. The measure should include years of service, number of executives, and the educational levels they have achieved. Teamwork Synchronization The merger is not separable from the process used to join the businesses together. That notion broadens the concept of due diligence. The inquiry that we call due diligence begins at the acquiring company before the first contact with a target is made and extends through the postmerger transition, well after the deal has been closed and the facts are on file. The due diligence team has diverse roles, including joint goal-setting, conflict resolution, and sharing of information. Its key functions are to blend the resources of the two companies, mesh supply systems, and exert a credibility and an influence which directly impact customer service in a measurable way. Each team member’s role is interdependent. No individual is responsible only for his or her narrowly defined area or task. Members stay with the process from beginning to end and their goal is to broaden involvement through communication, coalition building, and education. Consider the analogy to an automobile transmission. It must deliver mechanical energy from the engine to the wheels. Various speeds and conditions require that several gears spin at different rates but gears moving at different speeds must be brought to the same speed by synchronizers before a shift is made. Customer service is where the “rubber meets the road,” and the team’s responsibility is to mesh myriad gears so the combined company can enjoy a smooth ride toward satisfying the customer without a hitch. Diligent and thorough fact-gathering provide the building blocks for a powerful business plan of combining companies. The due diligence process itself must be proactive and vigorous to instill the entire project with vitality. Once the dynamic points of leverage are in focus, the due diligence team works to synchronize these forces. An articulate business plan transmits that energy to all employees for the purpose of sustaining competitive advantage. The business plan that fosters a self-perpetuating process for leveraging strengths of the combining companies is a strategy that is likely to succeed.