Why Do M&As Fail?
Snapping up rivals or merging with powerful competitors to create mega-companies that dominate markets has long been a strategy for business growth, and nothing excites financial markets more than news of large deals.
But there is a catch: Most mergers fail. In fact, McKinsey estimates that around 70% of mergers do not achieve their expected “revenue synergies.” Where are they going wrong?
It is not hard to find examples of unsuccessful mergers. Who can forget the infamous $164 billion AOL and Time Warner team-up in 2000? The plan was to combine the world’s leading “old” and “new” media companies and create the dominant supplier of print, broadcasting and online content. But it did not work out that way. For starters, the two companies were wildly different and there was no real integration plan. Then, shortly after the deal was concluded, the dot-com bubble burst. Within just five years, the newly merged entity saw 97% of its shareholder value wiped out.
Daimler Benz’s $37 billion merger with Chrysler to create Daimler Chrysler in 1998 is also considered an expensive disaster. While the logic behind the deal made sense—create a trans-Atlantic automotive giant—the management of both companies mainly focused on the idea that combining the two entities meant doubling revenues, but ignored the possibility that they might also be multiplying problems.
For starters, Chrysler was not a high-end car manufacturer like Daimler Benz, so anticipated production synergies were overblown. The timing of the deal also worked against them: Both the United States and Europe were hit by a recession, so sales dropped. Added to that, Daimler wanted to control the direction of the new company, and Chrysler’s management resisted. By 2007, Daimler Benz sold Chrysler for a mere $7 billion.
More recently, the department store chain Nordstrom announced a near-$200 million write-down last November following its acquisition of online shopping service Trunk Club—equal to about half of what Nordstrom had paid for the company just two years earlier. The deal was meant to jump-start Nordstrom’s online presence, but the strategy never took off. Perhaps they should have seen a red flag in the fact that, shortly before the acquisition, Trunk Club had started opening physical stores because its own online strategy was not working.
Robin Booker, director at M&A advisory firm Morphose, said mergers often fail because people neglect to research the company or ask themselves why they want to buy it in the first place. “Many companies get so carried away with the idea that buying a smaller rival is the quickest way to grow the business and expand that they fail to consider the downsides,” he said. “However, an acquisition usually means that you have two businesses rather than one, and both are competing for management time. Trying to integrate them so that they pull in the same direction can be a nightmare, and this is often where mergers go very wrong.”
Emma Shipp, head of the corporate team at law firm Shakespeare Martineau, said that mergers tend to face the same problems that have always beset transactions: Boards get so carried away with the excitement of the merger or acquisition that they forget about day-to-day operations.
Moreover, companies do not consider whether customers will still want to buy goods and services from the new entity. According to McKinsey, few boards appreciate that the average merging company loses 2% to 5% of its combined customers. “If a company that rates ethical business as a key tenet is taken over by a bigger company that has a reputation for being aggressive, are customers really going to stay loyal to the new brand? Not necessarily,” Shipp said.
Such culture clashes and differences in business approaches are often cited when mergers fail to deliver. “More M&A deals fail because of unresolved cultural issues than anything else,” said Annabel Jones, human resources director at ADP, a data processing firm that has helped companies integrate human resources and payroll systems post-merger. “Merging two businesses comes down to culture—it’s about bringing together two different groups of people. All the strategy, consolidation and efficiency gains you hope to achieve will only work if the people voluntarily and enthusiastically become one.”
Val Jonas, CEO at risk management software firm Risk Decisions, believes that the most underestimated challenge in making an M&A successful is that of integration and ensuring cultural fit. “The deal may make perfect sense on paper, but people may not behave in a logical manner,” she said. “Organizations also underestimate how long it takes to bring two companies together. Things that might seem trivial could turn out to be time-consuming and costly, and also distract staff from core business activities.”
Experts agree that the “softer issues” around M&As, like employee satisfaction, retention and corporate culture, tend to be the ones that either make or break a deal. Many also point out that risks that were previously not considered at all can become massively important.
For example, reputation issues increasingly have an impact on the value of a company and whether it should be considered a suitable target for an acquirer, according to David Imison, partner at reputation and privacy consultancy Schillings. Key among these considerations are ethical practices, labor violations, tax treatment and cyberattacks.
“If a target company has been hacked, then the value of any deal is just going to go down,” Imison said. “Reputational and legal/regulatory issues surrounding a data hack or cyberattack could lead to substantial long-tail liabilities because the full extent of the breach may take years to completely detect and evaluate, so companies that are subject to these kinds of incidents can see their price and value slashed.”
Recent events clearly prove this. Yahoo’s revelation that it has been the victim of two massive hacks that affected 1.5 billion user accounts led its potential acquirer, telecom company Verizon, to demand a hefty price concession ahead of the deal—even threatening court action if the transaction was not repriced. Verizon originally demanded a $1 billion price concession for the initially disclosed hack of 500,000 accounts alone. A second hack of another one billion accounts, revealed last September, only further exacerbated the situation.
“The news of an earlier major hack to one billion Yahoo accounts increases the pressure on both Verizon’s board to negotiate a lower price and on Yahoo’s board to finalize a sale,” said John Colley, a professor of practice at Warwick Business School in the United Kingdom and an expert on mega-mergers. “Verizon will have to demonstrate to shareholders that major concessions have been achieved as Yahoo is clearly worth less now than when the $4.8 billion deal was struck in July.”
Potential deals can also be derailed by supply chain risks, including unfair practices, use of slave and child labor, or incidences of fraud or corruption. Tim Vine, European head of trade credit at Dun & Bradstreet, said that M&As will come crashing down and fail if a supplier is found to be committing fraud or illegal activity, or if a company it has merged with is actually on the verge of bankruptcy. It is essential, therefore, that businesses use their compliance teams to make all the necessary regulatory checks. “Businesses must make sure their compliance teams have the tools and support needed to protect the organization and drive business growth, such as data analysis tools and real-time reporting,” he said.
More commonly, an inability of existing suppliers to meet the demands of a much larger client can be the biggest and most immediate risk of all. “Some suppliers may already be maxed out in terms of capacity and have no efficiencies available to them,” said Jeremy Smith, director at 4C Associates, a procurement consultancy. Furthermore, he warned, suppliers and customers may have contract terms that simply allow them to walk away and take their business elsewhere, which can create a major headache for the newly merged company.
Smith advises that organizations ask if they have full transparency of their supply chain or even know whether such risks exist. “Look below the first tier of the supply chain as, in our experience, the risks usually sit at the second or third tiers,” he said.
Building a Better Strategy
Not all deals are calamitous, however, and the desire to use mergers and acquisitions as a way to quickly enter a market remains strong. But companies need to dig deeper into the business rationale for following this strategy, and functions like risk management must question the figures and motives behind any planned deal, and encourage executives to be sure of the business case.
There are steps that companies can take to avoid some of the common pitfalls that prevent M&A transactions from succeeding. Prior to any merger and through the integration process, organizations should benchmark to assess function-specific performance gaps, risks and potential synergies, said Philip King, senior director for global business services at The Hackett Group. Benchmarking can identify redundancies, promote standardization of processes and economies of scale, and provide the foundation for delivering more efficient services to the new entity.
King also recommended that organizations set up a program management office that reports to the board to oversee the integration process, ensure that the benefits of the merger are realized, and keep everyone working toward the same goals. This includes keeping a close watch on budget, developing a tracking model to monitor performance against expectations, reporting integration milestones, and highlighting the most important metrics that support the overall integration strategy. King suggested that organizations develop an M&A “playbook” that provides a set of guidelines, templates, checklists and frameworks to better plan and manage integration.
“Post-merger, the new entity must be able to provide customers with high-quality, competitive products and services from the outset,” King said. “Achieving this requires delving into the detail of the two companies and preparing to bring processes into alignment. Synergies, best practices and economies of scale need to be identified quickly.”
Organizations should also consider developing an enterprise performance management (EPM) system to coordinate performance management processes so that the merged entity can be up and running as soon as possible. This means integrating technologies, particularly to enable financial reporting. “Companies that consistently reach merger integration objectives absorb the acquired company’s EPM processes into their own,” King said. “Within the first 100 days of closing the deal, budgeting, forecasting and reporting of the acquired company will need to be woven into the acquiring company’s EPM system.”
Barriers to merger integration success frequently revolve around people issues. According to King, the most prevalent ones include leaders not supporting the changes triggered by the merger; disengaged stakeholders who have not been adequately informed about the changes; cultural differences between the two companies; lack of clarity on project goals and priorities; and the simple failure to answer workers’ fundamental question: “What’s in it for me?”
Successful companies proactively anticipate and address these issues by creating activities that embed the new processes and systems into employees’ day-to-day routines, King said. This includes assessing whether workers have the skills to support the changes and, if not, providing the necessary training to enable them to do so. It is critical to engage with the workforce so that employees are aware of what is happening and how they fit into the new organization and its strategy.
Other experts have similar recommendations. Jonas, for example, believes that companies need to use scenario-planning and stress-testing to prepare for changes in the market or economy that could impact the bottom line of any deal. “A merger might make sense in current market conditions, but what happens if these conditions change, for example, with reduced access to finance, the emergence of competitors, or new legislation? The future could suddenly look bleak if the merged entity is no longer a strategic fit in the new environment,” she said.
Risk Management’s Role
Risk management also has a key role to play in ensuring that the merger delivers on its stated objectives. Risk management facilitates success by keeping sight of the objectives based on the established business case, Jonas said. She believes that risk management’s aim should be to “maintain an understanding of what could go wrong, evaluate the consequences and identify actions to manage the significant risks,” while also watching for any opportunities that may arise in support of the overall objectives.
“Risk management supports change to ensure integration is swift and logical,” she said. “Ultimately, there must be a cost benefit. At every stage, risk managers should ask themselves whether the cost is greater than the value that will be delivered.”
Awareness of the pitfalls will sow the seeds of a good merger, and experts believe that a structured, planned approach to delivery will reap benefits. “Approaching the M&A through measured risk-taking, within a properly planned change program, has the capacity to massively improve the chances of a successful outcome,” Jonas said.