In the calm following the acquisition storm of the 1990s, dealmakers have found themselves with time to reflect. Disappointing results proxied by findings that more than three-fourths of mergers and acquisitions fail to produce anticipated results have led executives to wonder: “Did we overpay? Were potential company synergies real or imagined?” Few familiar with the m&a world believe that a buyer consciously pays more for a company than it’s worth. Furthermore, an extensive business case usually justifies the union. So, what’s the rub? Why do so many m&a deals fail to realize the forecast results? The same surveys reporting the high failure rate have traced it to flawed or incomplete integration including, despite nearly two decades of coping with the problem, the botching of the part dealing with people, process, and culture. Unfortunately, the strategy for addressing “people issues” still means little more in practice than a few teambuilding exercises before the process is turned over to accounting and administrative staffs while the CEO and his or her team move on to stalk the next deal. At a critical juncture for leadership, integration may turn into little more than rationalizing the chart of accounts and sharing common e-mail systems. Furthermore, when organizational culture is considered at all, it’s often in the context of “cultural fit.” But congruence in the respective cultures of the buyer and seller before the deal takes place is less important, we argue, than seeing to it that a strategic, proactive approach to human capital occurs during the integration phase. In other words, the culture of the merged organizations can be actively shaped to achieve the desired synergies and create a new organization that incorporates and maximizes the strengths of each partner. Successful integration of two or more companies begins prior to pre-closing due diligence, as soon as two organizations come into contact and begin to “sniff out” each other’s culture. Integration should be driven by a combination of strategic, financial, and operational factors, as well as the dynamics of the existing cultures. Early on, the cross-company team should address how the desired results will be achieved and who will achieve them, not just how much revenue will be tallied when the deal is completed. Considering people issues in due diligence and integration, therefore, is not a “touchy-feely” undertaking but a vital step in determining whether the new organization’s performance will prove out the case for the transaction. Only when this is done correctly does the much-desired synergy that drives the buyer and seller to join forces actually occur. When the buyer considers the prospect of change, it may be tempting for it to see itself as impervious. After all, it’s the dealmakers who are calling the shots and the target organization that should prepare to accommodate the values, technology, and structure of its new owner. But we believe that in a successful integration, the buyer also acknowledges and plans for cultural change in its own organization. After all, it’s a rare marriage that occurs without requiring some change on behalf of both partners. Designing the New Organization What is culture? The simplest definitions refer to the “way things are done around here,” which may include everything from shared values to a company’s business practices. Cultural change should occur in all of the companies involved and begin as soon as the deal is considered, rather than when due diligence is completed. From that point, it can be actively shaped to improve the prospects of integration success and, ultimately, the bottom line. While it’s never as easy as it looks, we recommend five somewhat simplified steps to help the m&a transition team direct integration success. First, in order for people to effectively manage and embrace the changes associated with m&a integration, the goals and priorities need to be well articulated. Although goal setting is seemingly simple, many dealmakers neglect to build a business case that blends financial results with operational and people-focused measures. Communicating to targets in language that all parties understand can require a surprising level of effort, especially if inadequate recognition is given to the reality that a brand new culture is going to emerge. Ultimate success will depend on the people who do the work and how they do it. So identifying the right skills coupled with active recruitment in both organizations, and decisive placement of key personnel, must be done early and quickly. The next step in effectively managing culture change includes a complex interaction of tactics that: * Establish a rewarding environment in which the m&a benefits are clear, and *Hold people accountable for cooperation and new ways of working. Appropriate resources and organizational structure that support the business case are needed to bind the two companies into one well-oiled machine. The emerging organization must be supported by consistent leadership – the key predictor in terms of successful cultural integration. Step 1: Communicate to Targets in Meaningful Terms From the first meeting, strong opinions about the prognosis of the relationship will begin to form on both sides. For example, on the first day of a recent due diligence we noted a casual conversation between a member of the due diligence team and a truck driver at the target company. The manager commented that the company’s fleet size could be reduced by implementing a computerized routing system to replace the current will-call system. The driver scoffed, claiming that a new system couldn’t possibly reduce off-route deliveries as dramatically as the manager outlined. After the conversation, the driver gathered his co-workers and relayed his experience, adding his opinion that the new prospective owners knew nothing about the operation and were obviously going to screw things up. “Looks like we’ll need to plan for some people change-outs here,” the buy-side manager remarked as he rejoined his team. Diligence was only in its first day, but the lack of “buy-in” already was undermining the acquirer’s plans to improve operational efficiency. The integration strategy and the way that it is communicated is step one in shaping the culture of the two organizations. People need to understand what they need to do and why, so communication is one of the most critical priorities in terms of the success of most large-scale change initiatives. People in an acquired company are naturally in an unsettled state and are more open to change earlier in the integration period than they are likely to be at any other time in the transition. But they must be told what specific changes are expected of them in terms they can understand. The transformation from strategy to organizational behavior occurs only when employee actions are tied back to the business case. In the trucking example above, earnings projections will be dependent on more than the additional revenues from the target. Without effective operational interventions to improve truck routing efficiencies, better management of the drivers, and targeted improvements to customer service, the financial projections that were based on reducing the cost per mile by 50% won’t be realized and the return on investment will be reduced from targeted levels by 16% to 20%. So, how does management ensure that people “get it?” Besides communicating “early and often,” tailor the method to the specific information and audience. Broad goals and high-level strategy are more accurately dispersed through mass communications such as newsletters and management communiques, while the “translation to behavior” will occur largely through more individualized approaches. This takes time, just when the management time is in the shortest supply. But at the end of the day, making personal communication a priority will pay big dividends. Step 2: Invest in the Best Talent Once the goals are understood, management must identify the skills and experience that will be essential in the new organization. Again, it’s important to keep in mind that this applies to the acquirer as well as the target. For example, will an acquisition cause a dramatic increase in the size or complexity of the organization? Or, will a merger result in a shift in products or services? These factors need to be considered in determining the skill sets against which the old and new employees will be measured. In particular, conducting an audit of managerial talent early in the process is a vital part of due diligence. When it is clear what performance is expected for the new organization, assess the team. Is the bench strength at the target sufficient for the needs of the new company? Can the acquiring managers truly handle additional size or complexity? Figure out who the key players are going to be during due diligence, and take the necessary steps to recruit them from both firms, making certain that you retain the skills you need on both sides. One reason to intervene early is that attempts to recruit key managers at the target may fail no matter how vigorously they are pursued. A regional vice president who is one of three peers in a smaller company may dislike being one of 30 field executives in a larger firm. Greater pay and enhanced benefits may not make up for lost autonomy or other attractive cultural aspects of the old post. Assess in advance the effect on integration if key managers leave. What is the strength of those who will remain? Are further recruiting expenses needed to preserve the acquired earnings? In the case of a large wholesale energy distributor, the failure to recognize cultural differences and act to stabilize a vital employee group nearly resulted in bankruptcy. The buyer had multiple wholesale offices while the target consisted of a stand-alone wholesale operation with several power plants, each with a substantially different sales method. The executive charged with integration of wholesale operations, however, disliked the new company’s business model – focusing on small-volume customers and hiring sales people from outside of the industry. Bypassing the CEO’s mandate, the VP in charge simply ignored the new offices. Following his lead, the support staff was unresponsive and unsupportive of the new employees. Eighteen months later, the acquired sales force of 12 was down to three, and a $2.5 million profit stream had been reduced to $500,000. Because the $120 million deal had been priced at a multiple of eight times earnings, the failed integration resulted in the loss of $16 million in enterprise value (i.e., 8 times the lost $2 million in recurring earnings), nearly 10% of the purchase price. Admittedly, thinning management ranks may be as important as retaining key performers, and that should be handled early. But if the managerial ranks are incomplete, it’s important to develop a recruitment strategy and to establishing a method for staffing decisions before integration. Step 3: Reward the Right Behavior An acquired company is going to change, but a common integration error made by buyers is to deny the issue, primarily out of the desire to minimize disruption among target employees. “We love what you guys do and aren’t going to be making any changes; things will be as they’ve always been,” is a common promise. But change is inevitable and it’s important that communications are frank, to set expectations and build trust. Target employees expect change and will be most approachable during the early weeks of integration. They know that with new management, changing expectations about performance are likely to follow. So, now that you have people’s attention, how do you motivate them to achieve the new organizational goals? First and foremost, people want to know, “What’s in it for me?” After all, people ultimately don’t work for institutions, they work for themselves or their immediate peer group. Most people need to understand how the plan you’re asking them to execute will improve their lot in life – by increasing the flow of resources like dollars, equipment, access, or time to them. Communication of rewards needs to start at the top, and needs to make explicit what the implications are for the entire organization, the departments or business units, and the individual. Behavior can be rewarded in many ways – from the subtlety of what gets a nod from the boss to more explicit compensation strategies. This is the time to use all the human resources tools at the organization’s disposal to align action with objectives via job descriptions, training programs, performance evaluations, and compensation, all focused on a carefully defined set of competencies. The point at which performance expectations for the integration are set is not the time for participative management, deep delegation, or any other motif that puts responsibility in the hands of those who may have hidden agendas or may have opposed the deal in the first place. One of leadership’s key responsibilities will be to link strategy to rewards and then hold people accountable. A case in point involved a propane gas retailer with just over 100 locations in the Midwest that acquired a much larger company with more than 400 operations across the country. The buyer believed the new operations should focus on higher margins and a better quality of earnings rather than volume. However, it retained a bulky, complicated management bonus program that rewarded sales and other operational initiatives such as employee training hours completed, scheduled maintenance record keeping, and regulatory compliance documentation – all important, but only indirectly related to earnings. The better quality of earnings never materialized. The problem actually ran deeper than the failure to change the compensation strategy. Believing that they were far leaner and marketing-focused, the buyer wanted to re-focus local operations on margin rather than volume, as part of a cultural change process. But after merging the two home offices, they failed to recognize that an entirely new culture had formed, and because of the dramatic increase in size, the new culture was sharply different than just the combination of the two former cultures. An entirely new way of doing things was going largely unmanaged. Merely stamping the buyer’s brands on the target was not effective integration. If it had its eyes open, management could have taken an active role in creating the new culture with deliberate, well-planned interventions that would have worked toward the goal of higher margins. Actually changing the way business is done so that it’s consistent with expectations can be difficult even when the mandate is clear. In the merger of two package express companies, for example, the CEO of the combined organization announced that much more authority and accountability would be delegated to the local managers. Training and recruitment were initiated to upgrade the quality of management at the local level. A politically powerful executive, however, was promoted to a position that gave him power over fully half of the field operations. His own opinion, which he kept to himself, was that the old dictatorial, top-down way of doing business was fine with him. The cultural change process lagged considerably in his part of the country, and because his promotion was made at a time when the new initiatives were being announced, the credibility of the whole management team was called into question by employees. The CEO should have determined that this guy wasn’t signing on and fired him at the outset. People will generally fall into one of three camps: * “Early adopters,” who embrace change and are ready to accept the new vision; * “Tentative watchers,” with a wait-and-see attitude, who, with a little coaching, can be brought on board; and * “Potential resistors,” the fearful or openly antagonistic, who won’t or can’t go there. Those in authority have the right and the obligation to determine whom in both companies buys into new ways of doing things. Those who don’t should be humanely, but swiftly, separated from the organization; those who do should be vigorously recruited. People in the organization also need to understand the risks of maintaining the status quo. Treating performers and non-performers the same way sends a signal that the contributions of the doers don’t matter and undermines the enthusiasm of those who are ready to get on board. Step 4: Design the New Foundation With expectations clear and the right people in place, the merging companies face the architectural challenge of combining two or more enterprises. Organization of the business in terms of functions, processes, and systems will go a long way toward shaping the culture of the evolving organization. Furthermore, supplying resources that fit the new organizational priorities signals where the firm is headed. Organization structure may be based on function – i.e., people with similar skill sets grouped together – markets, geography, product lines or services, processes, or some combination of them. Regardless of the basis, it should tie back to the business case. The reality is that at many organizations, the structure is usually nothing more than a product of how it has evolved over time. Like an amoeba gone mad, the business has divided and subdivided to meet a host of quirky, short-term demands with no “thought” to the design of an enduring organization. An “organic” structure may work well for a company doing business as usual. But simply acquiring a new business and cramming it into an existing framework risks a very poor fit. Unfortunately, there’s a common tendency to ignore the structure of the acquired entity or even rush to dismantle it with some degree of hostility. Teams charged with the integration are anxious to “get back to normal” and get the job behind them. There’s no time to study the structural details of the target during due diligence or as integration begins, so they sprint to get the company folded in as quickly as possible. Consider the merger of two companies intending to capitalize on a range of products that each offers to a common customer base. Management will need to determine how to blend, recreate, or disband design teams, sales channels, and administrative functions with a clear view of the structural landscape that is free from historical prejudices. It’s easy for senior managers with the upper hand to favor their own people or products to the detriment of the anticipated synergies, only to find later that they have killed some of the products that go over best with customers. Building the organizational foundation must involve careful analysis to understand which processes can be centralized and where a made-to-order approach is best. Take the building supply company that via growth and acquisition expanded to more than 250 outlet stores. Interviews across the company conveyed a clear understanding of the company’s vision: to offer customers “the right product, at the right time, at the right price.” Implementation of a standardized inventory management system was critical to keeping costs down, while leveraging the company’s increasing bulk. At the same time, regional differences and variability in customer needs also meant that marketing and pricing strategies needed to be considered on nearly a store-by-store basis. While everyone understood the overall goal, trying to shoehorn each outlet into the same strategy met with employee resistance. Furthermore, the company’s aggressive growth had begun to tax its central resources. Business processes, and in some cases the personnel who managed them, didn’t always meet the level of sophistication required to support the expansion. Key changes in financial management, human resources, and information technology were needed to sustain the acquisition objectives. Management’s failure to address these organizational design issues with effective integration interventions resulted in a shortfall of over $20 million in expected earnings improvements in the first two years following a major acquisition, for which analysts later claimed the buyer grossly overpaid. Step 5: Reinforce With Consistent Leadership A coherent strategy, a motivated team, and the right structure will only go so far if leadership doesn’t stay in the game. In the $120 million acquisition of a propane distributor, the business case for the deal was to inherit the earnings of the acquired company and realize consolidation benefits during the integration phase. Senior executives on both sides of the deal believed that the cultures and business practices of both companies were so similar that integration would be a snap. The CEO of the acquiring company, however, disappeared entirely after the road show for the secondary stock offering that was to finance the deal. During the road show itself, the CEO proudly described the integration his powerful management team would implement. But after returning to the home office, he turned the whole process over to a senior management team that was given no clear, quantifiable goals and had little understanding of the m&a metrics. “Handling it” meant shoving the acquired organization into the current systems as unceremoniously as possible. While the president of the target was put in charge of performance, he had no control over the hostile managers responsible for implementation. The result: The earnings failed to materialize and most of the key managers at the target were gone within 18 months. Securities analysts concluded that the buyer had “overpaid” for the acquisition, and four years later the company was in the hands of turnaround specialists who were preparing a Chapter 11 filing. Integration may not be as sexy as the hunt, but it is the stage most vital to making the deal work. This is not the time for the CEO to vanish; strong leadership is an absolute requirement. During periods of intense change, people want and need to turn to a strong leader. The CEO should set firm and quantifiable expectations and then communicate them in a language that everyone can understand. Assuming that the basic business case for an acquisition is sound, the key to realizing expected earnings is a proactive integration strategy that emphasizes “culture by design.” Worrying too much about pre-acquisition issues of “cultural fit” leads to an overemphasis on “softer” considerations, such as team-building and bonding. The result may be organization-wide denial that change is taking place throughout the company. Neither of the old cultures will survive intact, in any event, so the new company must have enough insight to understand how results are going to be achieved and who is going to do what to achieve them. Once this is understood, the new culture can be envisioned and the vision can become reality, with the right interventions led by senior management. Bonding exercises and merged e-mail systems won’t be enough to get it done. Toni E. Lesowitz, Ph.D., is President of Lesowitz Group, a Chicago-based consulting firm specializing in organization design and development. Thomas E. Knauff is Managing Principal of Jordan, Knauff & Co., a Chicago-based investment and merchant banking firm. Copyright 2003 Thomson Media Inc. All Rights Reserved.