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Why Mergers Fail and How to Prevent It

by Susan Cartwright

Executive Summary
Mergers and acquisitions (M&A) are increasing in frequency, yet at least half fail to meet financial expectations. The United States and the United Kingdom continue to dominate M&A activity. As the number of crossborder deals increases, however, many other national players are entering the field, further highlighting the issue of cultural compatibility. Financial and strategic factors alone are insufficient to explain the high rate of failure; greater account needs to be taken of human factors. The successful management of integrating people and their organizational cultures is the key to achieving desired M&A outcomes.

Introduction
The incidence of M&A has continued to increase significantly during the last decade, both domestically and internationally. The sectors most affected by M&A activity have been service- and knowledge-based industries such as banking, insurance, pharmaceuticals, and leisure. Although M&A is a popular means of increasing or protecting market share, the strategy does not always deliver what is expected in terms of increased profitability or economies of scale. While the motives for merger can variously be described as practical, psychological, or opportunist, the objective of all related M&A is to achieve synergy, or what is commonly referred to as the 2 + 2 = 5 effect. However, as many organizations learn to their cost, the mere recognition of potential synergy is no guarantee that the combination will actually realize that potential.

Merger Failure Rates


The burning question remainswhy do so many mergers fail to live up to stockholder expectations? In the short term, many seemingly successful acquisitions look good, but disappointing productivity levels are often masked by one-time cost savings, asset disposals, or astute tax maneuvers that inflate balance-sheet figures during the first few years. Merger gains are notoriously difficult to assess. There are problems in selecting appropriate indices to make any assessment, as well as difficulties in deciding on a suitable measurement period. Typically, the criteria selected by analysts are: profit-to-earning ratios; stock-price fluctuations; managerial assessments.

Irrespective of the evaluation method selected, the evidence on M&A performance is consistent in suggesting that a high proportion of M&As are financially unsuccessful. US sources place merger failure rates as high as 80%, with evidence indicating that around half of mergers fail to meet financial expectations. A much-cited McKinsey study presents evidence that most organizations would have received a better return on their investment if they had merely banked their money instead of buying another company. Consequently, many commentators have concluded that the true beneficiaries from M&A activity are those who sell their shares when deals are announced, and the marriage brokersthe bankers, lawyers, and accountantswho arrange, advise, and execute the deals.

Traditional Reasons for Merger Failure


M&A is still regarded by many decision makers as an exclusively rational, financial, and strategic activity, and not as a human collaboration. Financial and strategic considerations, along with price and availability,
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therefore dominate target selection, overriding the soft issues such as people and cultural fit. Explanations of merger failure or underperformance tend to focus on reexamining the factors that prompted the initial selection decision, for example: payment of an overinflated price for the acquired company; poor strategic fit; failure to achieve potential economies of scale because of financial mismanagement or incompetence; sudden and unpredicted changes in market conditions.

This ground has been well trodden, yet the rate of merger, acquisition, and joint-venture success has improved little. Clearly these factors may contribute to disappointing M&A outcomes, but this conventional wisdom only partly explains what goes wrong in M&A management.

The Forgotten Factor in M&A


The false distinction that has developed between hard and soft merger issues has been extremely unhelpful in extending our understanding of merger failure, as it separates the impact of the merger on the individual from its financial impact on the organization. Successful M&A outcomes are linked closely to the extent to which management is able to integrate members of organizations and their cultures, and sensitively address and minimize individuals concerns. Because they represent sudden and major change, mergers generate considerable uncertainty and feelings of powerlessness. This can lead to reduced morale, job and career dissatisfaction, and employee stress. Rather than increased profitability, mergers have become associated with a range of negative behavioral outcomes such as: acts of sabotage and petty theft; increased staff turnover, with rates as high as 60% reported; increased sickness and absenteeism.

Ironically, this occurs at the very time when organizations need and expect greater employee loyalty, flexibility, cooperation, and productivity.

People Factors Associated with M&A Failure


Studies like the one conducted by the Chartered Management Institute in the UK have identified a variety of people factors associated with unsuccessful M&A. These include: underestimating the difficulties of merging two cultures; underestimating the problem of skills transfer; demotivation of employees; departure of key people; expenditure of too much energy on doing the deal at the expense of postmerger planning; lack of clear responsibilities, leading to postmerger conflicts; too narrow a focus on internal issues to the neglect of the customers and the external environment; insufficient research about the merger partner or acquired organization.

Differences between Mergers and Acquisitions


In terms of employee response, whether the transaction is described as a merger or an acquisition, the event will trigger uncertainty and fears of job losses. However, there are important differences. In an acquisition, power is substantially assumed by the new parent. Change is usually swift and often brutal as the acquirer imposes its own control systems and financial restraints. Parties to a merger are likely to be more evenly matched in terms of size, and the power and cultural dynamics of the combination are more ambiguous. Integration is a more drawn-out process. This has implications for the individual. During an acquisition there is often more overt conflict and resistance, and a sense of powerlessness. In mergers, however, because of the prolonged period between
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the initial announcement and actual integration, uncertainty and anxiety continue for a much longer time as the organization remains in a state of limbo.

Cultural Compatibility
The process of merger is often likened to marriage. In the same way that clashes of personality and misunderstanding lead to difficulties in personal relationships, differences in organizational cultures, communication problems, and mistaken assumptions lead to conflicts in organizational partnerships. Mergers are rarely a marriage of equals, and its still the case that most acquirers or dominant merger partners pursue a strategy of cultural absorption; the acquired company or smaller merger partner is expected to assimilate and adopt the culture of the other. Whether the outcome is successful depends on the willingness of organizational members to surrender their own culture, and at the same time perceive that the other culture is attractive and therefore worth adopting. Cultural similarity may make absorption easier than when the two cultures are very different, yet the process of due diligence rarely extends to evaluating the degree of cultural fit. Furthermore, few organizations bother to try to understand the cultural values and strengths of the acquiring workforce or their merger partners in order to inform and guide the way in which they should go about introducing change.

Making It Happen
Making a good organizational marriage currently seems to be a matter of chance and luck. This needs to change so that there is a greater awareness of the people issues involved, and consequently a more informed integration strategy. Some basic guidelines for more effective management include: extension of the due diligence process to incorporate issues of cultural fit; greater involvement of human resource professionals; the conducting of culture audits before the introduction of change management initiatives; increased communication and involvement of employees at all levels in the integration process; the introduction of mechanisms to monitor employee stress levels; fair and objective reselection processes and role allocation; providing management with the skills and training to sensitively handle M&A issues such as insecurity and job loss; creating a superordinate goal which will unify work efforts.

Case Study
Paul Hodder was involved as director of human resource management in the formation of Aon Risk Services, a merger of four rather different retail-insurance-broking and risk-management companies. A major theme of their integration process was the formation of a series of task groups to review and identify best practice. Another part involved an organization-wide training program to provide individuals with life skills to help them initiate and cope with change, to improve teamwork, and to develop support networks. Enthusiasm for the program provided several hundred change champions to lead change projects and assume support and mentoring roles. Good communication of early wins and successes has reassured organizational members that the changes are working and are beneficial.

Conclusion
Despite thorough pre-merger procedures, mergers continue to fall far short of financial expectations. The single biggest cause of this failure rate is poor integration following the acquisition. The identification of the target company, the subsequent and often drawn-out negotiations, and attending to the myriad of financial, technical, and legal details are all exhausting activities. Once the target company has been acquired, little energy or motivation is left to plan and implement the integration of the people and cultures following the merger. It seems nonsensical to waste all the resources and energy that have gone into the merger through
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inadequate planning of the integration stage of the process, yet all too often organizations do just that. Without a properly planned integration process or its effective implementation, mergers will not be able to achieve the full potential of the acquisition.

More Info
Books:
Cartwright, Susan, and Cary L. Cooper. Managing Mergers, Acquisitions and Strategic Alliances. 2nd ed. Woburn, MA: Butterworth-Heinemann, 1996. Cooper, Cary L., and Alan Gregory (eds). Advances in Mergers and Acquisitions. Vol. 1. New York: JAI Press, 2000. Stahl, Gunter, and Mark E. Mendenhall (eds). Mergers and Acquisitions. Stanford, CA: Stanford University Press, 2005.

See Also
Thinkers John D. Rockefeller

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