Zappa MandA

The Fundamentals of Strategic Logic and Integration for Merger and Acquisition Projects
A comprehensive introduction for practitioners to assess merger and acquisition activity from an acquiring firm perspective motives, synergy realization, integration planning.
Marco Zappa
Master Thesis in the course of study
Management, Economics and Technology
Submitted to the
Swiss Federal Institute of Technology ETH Zurich Department MTEC Prof. Dr. G. Von Krogh Strategic Management and Innovation Kreuzplatz 5 8032 Zrich Switzerland
In collaboration with
METTLER TOLEDO AG Analytical Sonnenbergstrasse 74 8603 Schwerzenbach Switzerland
Master Thesis D-MTEC, ETHZ
Marco Zappa
Author: Marco Zappa Dipl. Ing. ETH Product and Marketing Manager METTLER TOLEDO AG Analytical
Date of submission: August 17, 2008
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Table of content
Introduction .............................................................................................................6 1.1 Motivation .........................................................................................................8 1.2 Objectives, perspective and limitations of this work...........................................8 1.2.1 Objectives .............................................................................................8 1.2.2 Perspective ...........................................................................................9 1.2.3 Limitations.............................................................................................9 1.3 Content description...........................................................................................9 Classification of mergers and acquisitions .........................................................11 2.1 The merger .....................................................................................................11 2.2 The acquisition................................................................................................12 2.3 Classification according to companies relatedness ........................................12 2.4 Other classifications........................................................................................13 2.5 Merger and acquisition as used throughout this work ....................................14 Post-M&A firm performance studies....................................................................15 3.1 Motivation to consider performance studies ....................................................15 3.2 How is post-M&A firm performance measured? ..............................................15 3.3 What is failure and success? ..........................................................................16 3.4 Factors with and without relationship to post-M&A performance .....................16 3.4.1 Positive or negative relationship to performance .................................16 3.4.2 No significant relatedness to performance or conflicting evidence.......19 3.5 M&A performance...........................................................................................20 3.6 Diversification .................................................................................................21 3.7 Degree of integration ......................................................................................23 3.8 Criticism on performance study methodology..................................................23 3.9 Conclusion......................................................................................................25 Motives for merger and acquisition activity ........................................................27 4.1 Exploitation (synergy motives) ........................................................................28 4.1.1 What is synergy? ...............................................................................28 4.1.2 Classification of synergies ...................................................................29 4.1.3 Cost synergies (rationalization)..........................................................30 4.1.4 Revenue synergies..............................................................................31 4.1.5 Synergies from intangibles ..................................................................31 4.2 Exploration......................................................................................................32 4.3 Preservation and survival................................................................................33 4.4 Managers self-interest and prestige ...............................................................34 4.5 Finance motives..............................................................................................35 4.6 Conclusion......................................................................................................36
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Post-M&A integration and transformation...........................................................37 5.1 What is an adequate level of integration? .......................................................38 5.2 What are the difficulties and dangers during integration?................................40 5.2.1 Under- and overintegration..................................................................40 5.2.2 Post-merger management of positive and negative synergies.............41 5.2.3 Speed of integration ............................................................................41 5.2.4 Communication to internal and external stakeholders .........................42 5.2.5 Cultural fit and anticipation of culture dissonance................................43 5.3 Conclusion......................................................................................................43 National and organizational culture and culture clashes ...................................44 6.1 What is culture in the M&A context? ...............................................................44 6.2 Which forms of acculturation exist?.................................................................44 6.3 Are cultural stereotypes a real assist or just convenience? .............................45 6.4 Can culture be measured? ............................................................................45 6.5 What is the result of perceived culture dissonance?........................................47 6.6 How can one understand culture dissonance?................................................48 6.7 What can be learned for practice to anticipate culture dissonance? ................49 6.7.1 Avoid insurmountable integration problems.........................................49 6.7.2 Be aware of potential cultural dissonance ...........................................50 6.8 Conclusion......................................................................................................51 Success factors, reasons for failure and risks....................................................52 7.1 Financial overextension and price premium ....................................................52 7.2 Realization of synergies..................................................................................54 7.3 Negative synergies .........................................................................................55 7.4 An example on the difficulties of synergy assessment and realization ............56 7.5 Strategic logic .................................................................................................57 7.6 Interview studies .............................................................................................58 Alternatives to mergers and acquisitions............................................................60 Reasoning of M&A activity in an early project phase .........................................63 9.1 The acquiring companys strategy...................................................................63 9.2 M&A motives...................................................................................................63 9.3 Strategic fit between target and acquiring firm ................................................63 9.4 Sources of synergies and price premium ........................................................64 9.5 Integration, transformation and culture............................................................65 9.6 Costs and negative synergies .........................................................................65 9.7 Competitions reaction ....................................................................................66 9.8 Alternative business collaborations .................................................................66
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10 Conclusion.............................................................................................................69 Acknowledgement.......................................................................................................72 Literature .....................................................................................................................73
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Introduction
Mergers and Acquisitions (M&As) are strategically planned transactions between two or more companies in which the target and the acquiring firm jointly create a new entity to gain competitive advantage in the market place. The motives and objectives for M&A activity are various. Competitive advantage could arise from synergies due to economies of scale, an increase in market share, better access to a customer base, ownership of distribution channels and access to knowledge and technology to mention just a few. In other words, mergers and acquisitions allow the purchase of assets that would be difficult, risky, time-consuming or even impossible to obtain by other alternative business collaborations or organic growth. While strategic logic for M&A projects seems to be straightforward, however, most empirical studies reveal that a majority of M&A projects fails to reach their objectives (Datta; Chatterjee) as shown in Fig. 1.1:
Fig. 1.1: M&A failure analysis from consulting companies and research studies (Picot).
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These findings raise a paradox: Why do managers continue to transact M&A deals on such a massive scale in both number and monetary terms (Fig. 1.2 and Fig. 1.3), when there is little economic justification for M&As?
Fig. 1.2: Merger and acquisition waves in U.S. industry from 1898 to 2000 (Ghauri).
Fig. 1.3: Number of M&A deals related to U.S. firms from 1895 to 2001 (Picot).
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1.1
Motivation
The present work is conceptualized around the set of questions raised above. The work is motivated by the recent necessity of the authors employer to obtain a comprehensive introduction to the field of mergers and acquisitions that is of practical relevance in the employers current economic context. The Strategic Business Unit (SBU) MatChar (Materials Characterization) of
METTLER TOLEDO AG faces a worldwide consolidation phase in the field of Thermal Analysis and neighboring analytical lab techniques. Competitors mergers and acquisitions and the limited organic growth potential due to harsh competition make it necessary to consider M&A as a feasible mechanism for growth and protection. However, beside financial analysis a systematic assessment concept and the corresponding knowledge required in a pre-M&A phase are largely missing. Considering the fact that an M&A deal can be one of the biggest decisions a company or business unit ever makes, missing fundamentals for a proper decision put a high risk to the acquiring company. Many managers however do not have adequate time and knowledge to carefully evaluate merger and acquisition projects. Such time pressure increases the chance of rushing headless into unqualified decisions of poorly planned M&As, leaving important areas of uncertainty unresolved and resulting in the widely reported disappointing outcomes.
1.2
1.2.1
Objectives, perspective and limitations of this work

Objectives
Metz in his studies argues:

Es ist keineswegs bertrieben, von einer nicht mehr berschaubaren Zahl von Verffentlichungen aus betriebs- und volkswirtschaftlicher, juristischer sowie vereinzelt aus sozio- und psychologischer Sicht zu sprechen.
Indeed, research on M&A consists of two distinct categories: the empirical performance literature and the post-merger integration and culture literature. While these two very extensive areas of research dominate the whole M&A literature, they are highly specialized focusing mostly on very distinct subjects. As a consequence they provide little guidance for managers due to their very fragment-like research questions.
Master Thesis D-MTEC, ETHZ Marco Zappa
Interestingly, there is even very little literature on strategic concerns of mergers and acquisitions not to mention a comprehensive (but still trustworthy) introduction for practitioners. As a consequence, the overall objective of this work is to: Provide a comprehensive introduction to subjects being relevant in an early stage of a merger and acquisition project (before due diligence) to increase the likelihood of M&A success. Allow an informed decision on strategic logic and integration matters of merger and acquisition projects and to sensitize to the profound interdependence of these to subjects. Introduce the prerequisites for a systematic assessment and more objective comparison of potential target firms. Evaluate alternative business collaborations. Be a guide for practitioners enabling them to cope with the many difficulties attached to M&A projects and to build awareness of common pitfalls.
1.2.2
Perspective
The addressed readers of this work are managers of acquiring firms and consultants that need to evaluate, advice on, decide on and conduct merger and acquisition projects.
1.2.3
Limitations
Although the following matters find their reflection in this work it is not a guide on how to: Conduct a due diligence Define and review a companys strategy Perform a market or company analysis
1.3
Content description
The first step towards the objectives defined above is to present various definitions and categorizations of mergers and acquisitions emphasizing the multifaceted and complex nature of such undertakings (refer to chapter 2). On this basis, the most often reported findings of empirical post-M&A firm performance studies are reviewed to gain insight into why certain M&A projects fail and others
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succeed and to discover universally valid performance-enhancing key success factors that do not depend on the specific characteristics of an M&A project (refer to chapter 3). From the results of these performance studies and the critical review of their methodology, a broader set of motives and objectives for mergers and acquisition activity emerges and is discussed in the light of multiple motive M&As. In particular, an extensive overview on the manifold classical strategic motives like synergy is presented and illustrated with a few examples. While considering a number of motives that receive far less attention also irrational and illegitimate motives find their reflection (refer to chapter 4). Once this basic framework is established, various integration and transformation concerns are discussed like the adequate level of target firm integration, generic scenarios and the parameters determining the level of integration. In particular, it is illustrated how M&A projects can be compromised to reach their objectives, if postmerger management fails to realize positive synergies and does not foresee negative synergies. Beside strategic considerations of the integration and transformation period, determining national and corporate cultural fit between target and acquiring firm, results of cultural dissonance and means of anticipation for culture clashes and are deduce d from a group of surveys (refer to chapters 5 and 6). From all these areas under discussion, success factors, reasons for failure and risks of an M&A project are figured out (refer to chapter 7). As an addition, feasible alternative business collaborations are contrasted with mergers and acquisitions in terms of strategic motives and objectives to be realized (refer to chapter 8). As a summary, a guide to reason M&A activity in an early project phase is developed. Without credible answers to these basic questions, acquirers are on their way to losing the acquisition game from the beginning even before the due diligence or even the integration starts to happen (refer to chapter 9).
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Classification of mergers and acquisitions
Merger and acquisition, or M&A is a field of study in which the definitions often vary in different publications. The traditional framework how to distinguish between mergers and acquisitions is the perspective on the legal independence of the business entities (Fig. 2.1):
Fig. 2.1: Types of collaboration between business entities categorized by effect on legal independence (Metzenthin).
2.1
The merger
A merger is a combination of assets of two previously separate firms into a single new legal entity. All involved companies lose their legal independence as all their assets become the pieces of a new firm. A merger may be characterized by an equal rank of
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the involved firms with respect to their sizes, resources and power. In this context, the phrase merger of equals is frequently used to refer to the equality of the formerly independent companies. However, even when theoretically and officially mergers are supposed to be between equal partners, most result in one partner dominating the other (Ghauri). Terming the combination a merger rather than an acquisition thus can be done purely for political or marketing reasons. The number of real mergers in M&As is either way almost vanishingly small. Less than 3% of cross border M&As by number are mergers (Ghauri).
2.2
The acquisition
Acquisition (or takeover) usually refers to a purchase of a smaller firm or a part of a firm by a larger one. In an acquisition, the control of assets is transferred from one company to another. The acquired firm (target) loses its legal independence, while the acquiring firm is not affected in that respect. Acquisitions can be subdivided into full absorption or a subsidiary status within a corporate group depending on the level of organizational integration of the acquired firm (refer to chapter 5.1). Sometimes, however, a smaller firm acquires management control of a larger or longer established company and keeps its name for the combined firm. This is known as a reverse takeover.
2.3
Classification according to companies relatedness
While the traditional distinction between mergers and acquisitions is mainly based on their differences in legal structure there exist many other ways how to categorize M&As. One is to group M&As into four categories with respect to the companies relatedness (Ghauri): Horizontal: takes place where the two combining companies produce similar products in the same industry and/or are competitors. Vertical: occur when two firms, each working at different stages in the production of the same good (value chain), combine (e.g. buyer-seller, client-supplier). Conglomerate: takes place when the two combining firms operate in unrelated businesses (unrelated diversification).
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Concentric: occurs where two combining firms are in the same industry (related diversification), but they have no customer or supplier relationship (e.g. a merger between a bank and a leasing company).
2.4
Other classifications
Depending on the perspective on M&As other criteria for classification are discussed in the literature. These perspectives are reflected in the field of M&A performance studies (refer to chapter 3) to conclude on the key success factors for mergers and acquisitions projects. Here, list of some alternative classifications is given (Metzenthin; Ghauri): Management cooperation perspective: M&As can be friendly or hostile. In the former case, the companies cooperate in negotiations, finally agree to the transaction and ensure that the deal is beneficial to both parties. In the latter case, the acquiring company purchases the majority of outstanding shares of a company in the open market while the takeover target is unwilling to be bought or the target's board has no prior knowledge of the offer. Stock market perspective: Accretive mergers are those in which an acquiring company's earnings per share (EPS) increase and/or in which a company with a high price to earnings ratio (P/E) acquires one with a low P/E. Dilutive mergers are the opposite of above, whereby a company's EPS decreases. The company will be one with a low P/E acquiring one with a high P/E. Financing perspective: Stock-financed versus cash-financed (self-finance or borrowed)
Fig. 2.2: Types of collaboration categorized on the basis of involved capital investments (Metzenthin).
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Market perspective: Both partners focus onto the same or different target customers, distribution channels, technologies, products and services. Motives perspective: Similarity M&A versus complementary M&A Geographic perspective: Domestic versus cross-border M&As Technology perspective: Technology oriented enterprises versus non-technology firms Strategic perspective: Diversification (cross-industry, focus decreasing) versus concentration (focus increasing) Integration perspective: Degree of loss of control or degree of integration of the target firm
2.5
Merger and acquisition as used throughout this work
The various perspectives on the field of M&A emphasize how multifaceted and complex such an undertaking is. Since most of the perspectives given above will find their discussion throughout this work the terms merger and acquisition are not assigned to a specific type of deal. In fact, the term merger and acquisition or M&A is generally used for a project where two firms (the target and the acquiring company) combine to one legal entity or one or several parts of a firm (target) change their belonging to the entity of the acquiring firm. However, merger and acquisition is clearly set apart from collaborations as alliance, co-operation or joint venture (refer to chapter 8).
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Post-M&A firm performance studies
The most often researched and reported findings of post-M&A firm performance studies are described here focusing on those being of strategic importance in a pre-M&A stage. A critical review on performance studies methodology is given and other sources of evidence are discussed.
3.1
Motivation to consider performance studies
The surveys on acquiring firms post-M&A performance build the vast majority of all research studies beside those focusing on M&A integration matters (Paine). Thus, one could assume that performance studies provide, first, insight into why certain M&A projects fail and others succeed and, second, present universally valid performanceenhancing key success factors that do not depend on the specific characteristics of an M&A project.
3.2
How is post-M&A firm performance measured?
In the literature manifold ways can be found how an acquiring firms post-M&A performance is measured relative to its pre-M&A performance: Turnover and profit growth Relative firm value Short- and long-term stock price (event study methodology) Abnormal stock return (difference between actual returns and the previously expected returns) Present value of the post-M&A incremental cash flows In most studies the underlying assumption about what constitutes a legitimate M&A can be summarized as follows: Shareholder wealth creation is the goal of the firm and thus the acquiring firm will only engage in M&A where it will increase economic value for acquiring shareholders (Hitt). In other words, it is assumed that any manager engaging in an M&A which may provide neutral or negative returns is transacting an illegitimate deal.
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For a more complete understanding of different types of performance studies and their characteristics (data collection, time horizon considered, statistical evaluation, relative performance vs. absolute performance methodology, definition of failure and success etc.) refer to the corresponding literature. Beside the many performance studies also a large number of reviews can be found of which those by Sirower and Agrawal are the most complete and most recent.
3.3
What is failure and success?
Failure has been understood in terms as extreme as resale, liquidation or divestment, or as conservative as failing to reach certain projected growth or profit in benchmarking. As a result, the definition of failure and success depends on the performance measures applied and thus is exceedingly broad and almost a peculiarity of every single performance study.
3.4
Factors with and without relationship to post-M&A performance
This work distinguishes between factors having a positive/negative impact and factors having no significant or a highly controversial impact on a firms performance. Since there is mostly no agreement on the extent of positive or negative impact no concrete figures are given here. The findings on the factors M&A activity, Diversification and Degree of Integration have biggest significance for the validation of potential firms to be acquired and thus are discussed in more detail subsequently to the list below.
3.4.1
Factors for which a majority of empirical studies found a positive or negative relationship to performance of the acquiring firm:
1. M&A activity (e.g. Dyer) Most studies report, on average, a negative long-run performance following M&A deals (see a more detailed discussion subsequent to this list). 2. Acquisition premium (e.g. Epstein) The level of the acquisition premium (price paid) has a strong negative effect on performance across most measures of shareholder performance. The higher the
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premium is, the larger the subsequent loss. Alberts and Varaiya (in Datta) conclude that post-acquisition gains to most bidding firms were not adequate to cover the premiums paid to acquire the targets. Epstein reports that even if the price paid is not public, acquiring companies experience a decrease in stock price when the market is anxious that the bidder will overpay for growth opportunities of the acquired firm. 3. Multiple bidders (e.g. Datta; Goergen) The presence of multiple bidders has a negative impact on short- and long-term acquiring firm performance. As a result, bidding firms should avoid getting involved in tender offers. The vast majority of worldwide M&As are single-bidder auctions (more than 72%). The increased competitiveness in such cases tends to drive up acquisition premiums. 4. Means of payment (e.g. Loughran; Goergen) An all-cash offer for acquisitions results in better performance than an all-equity or a combination of cash and equity. The fact the takeover will be paid with equity might signal to the market that the bidding managers believe that their firms shares are overpriced or already expect a subsequent long-term underperformance of the combined firms. 5. Percentage of the target firm shares acquired (e.g. Sirower) Majority holdings in the target firm correlate positively with the acquiring firms long-term performance. 6. Managerial ownership (e.g. Goergen) The fraction of managerial ownership (e.g. through equity stakes) in the acquiring firm is found to be strongly significant for long-term performance. This suggests that managers are more likely to undertake value-destroying M&A deals, if they do not own equity in their firm. 7. Type of takeover (e.g. Loughran; Goergen) In comparison to friendly M&A offers, hostile bids trigger large positive abnormal returns for the target shareholders but significant, negative returns for the bidder.
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The overwhelming proportion of M&As are friendly. In 1999, there were only 30 hostile takeovers out of 17000 friendly M&As. 8. Industry phase A study by Krger evaluating 30000 firms over 15 years reports successful M&A deals in almost 60 per cent of the cases across various industries in their opening phase (ffnungsphase) and accumulation phase (Kumluationsphase) of his model (Fig. 3.1). In the subsequent focusing phase (Fokussierungsphase) the success rate diminishes to 30 per cent and even less in the balance phase (Balancephase). The reason for this decline in success rate is seen in the decreasing realizable synergy potential due to the raising price premiums paid for target firms and, when the industry matures, the value chains that are already substantially optimized in the later phases of the model.
Fig. 3.1: Success rate of M&As as a function of the degree of consolidation (Krger).
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3.4.2
Factors for which no significant relatedness to the acquiring firms performance or heavy conflicting evidence is found:
1. Stock market behavior at announcement (e.g. Goergen) There is little consensus about the announcement effects for the bidding firms. About half of the studies report small value-destructive effects for the acquirers shareholders (Sirower) whereas the other half finds zero or small positive abnormal returns. Considering that the average target is much smaller than the average acquirer, the combined net economic gain or loss at the announcement is expected to be rather small. However, the literature findings for target firms returns are much more consistent. Goergen et al. in their extensive empirical study across various industries find large announcement effects of 9% for target firms, but the cumulative abnormal return that includes the price run-up over the two-week period prior to the event rises to 20%. 2. Acquisition experience According to Straub the number of acquisitions in the years prior to the relevant acquisition is not significantly related to performance while Duncan identifies a companys previous acquisition experience as a factor for success. Selden et al. (in Sirower) on the other hand find that most companies outperforming the S&P500 have low M&A activity, and if, rather small firms are acquired. 3. Diversification (e.g. King) Strategic relatedness does not generally outperform strategic unrelated M&As (see a more detailed discussion subsequent to this list). 4. Size of merging firms There is lacking evidence on the correlation between the relative size of the merging firms and long-term performance. Some researchers have suggested that small mergers (mergers where the two firms are very different in size) tend to produce higher performance than larger mergers (mergers where the two firms are similar in size). They attribute these performance differences to the ease of combining operations. With smaller mergers the integration of the new entity is
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more easily controlled and the disruption to the organization as a whole is minimized. With a large merger, the integration problems are multiplied and disruption can occur throughout the whole organization. On the other hand, those researchers neglect the fact that a small merger often provides also less significant gains to the large organization. However, as Lubatkin and Seth point out, the few studies that have examined this size issue have found that larger mergers, on average, tend to be more successful than smaller ones. 5. Degree of integration The post-merger integration level (i.e. fully integrated versus not or partially integrated) has no relationship with a firms performance (see a more detailed discussion subsequent to this list). Many other factors exist being reported in a smaller number of studies, as for example the pre-merger book-to-market ratio (e.g. Rau and Vermaelen in Megginson), the premerger financial performance (e.g. Kruse), the net cash held by the target and growth potential of target as central factors influencing long-term firm performance of the merged firms.
3.5
M&A performance
Success and failure with M&A deals has been studied in the vast majority of all surveys in terms of narrow measures as given in chapter 3.2 leading to the claims that most M&As fail. Acquiring firms loose, on average, 10 per cent of stock value in a five years period as found by Dyer in his study across various industries. Only about 35% of acquisitions are met with positive stock market return. According to a KPMG study (2000), 83% of recent deals failed to deliver shareholder value and 53% actually destroyed value. Also Porter (in Datta), based on an analysis of acquisitions made by 33 Fortune-500 firms, concludes that acquisitions have been largely unsuccessful when one considers that over half were subsequently divested. When gains to targets and bidders are combined, most acquisitions are wealth creating. Although Seth et al. (in Ghauri) find that positive total gains occur in 74% of the acquisitions they estimate in their review that total gains are only 7.6% of the preacquisition value of the combined firm. From a macroeconomic point of view one can
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argue that acquisitions transfer resources from less to more productive sectors of the economy. However, bidders have only minimal or no incentives at all to be a participant in such transactions (Datta). Ghauri claims that more than 50% of the mergers so far have led to a decrease in share value of the bidder firm and another 25% have shown no significant increase. Ghauri reports that targets realize the majority of the gains, while acquirers appear to experience positive effects on shareholder value only in about onethird of M&As and gain nothing on average. In summary, the aggregate evidence from the performance literature is toward negative performance for acquiring firms in M&A deals. Results indicate that while the target firms shareholders gain significantly from M&As, those of the bidding firm do not. Moreover, historical evidence documents that the returns to acquirers have gotten progressively worse, on average, for acquisitions occurring in the 1960s, 70s, 80s and 90s, respectively (Sirower). As a conclusion one is tempted to claim that the M&A activity itself inherently is a reason for under-performance or failure of M&A deals. Clearly this negative evidence raises serious doubts over the massive and still increasing size and number of M&A deals over the last 40 years (refer to chapter 3.8).
3.6
Diversification
There is considerable disagreement in the literature about whether strategically related acquisitions are more beneficial than strategically unrelated acquisitions. However, most publications suggest from a theoretical point of view that corporate focus is the primary determinant of long-term M&A performance. Continuing to focus on the acquiring firms core business should help to maintain its strengths and to minimize the risks associated with acquiring a business in an industry of which the firm may have only limited knowledge. However, many studies document that relatedness (focus-preserving or focus-increasing, FPI mergers) had a marginal positive effect on long-term performance. On the other hand, unrelatedness (focus-decreasing, FD mergers) is often reported to result in significantly negative long-term performance (e.g. Megginson; Duncan). To classify corporate diversification Megginson uses the Herfindahl Index (HI), which describes the merger-related degree of change in corporate focus (Megginson). He finds that every 10% reduction in focus results in a 9% loss in stockholder wealth, a 4% discount in firm value, and a more than 1% decline in operating performance. These
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results suggest that companies should not attempt to do what investors can do better themselves, i.e. creating a diversified portfolio. However, several authors have found no significant effect of relatedness on performance. Some researchers even have found that acquiring firms making conglomerate (i.e. unrelated) acquisitions outperform those making non-conglomerate acquisitions (Sirower; Kruse; review in Megginson). They report advantages of unrelated M&A to be improved cash management, more efficient allocation of investment capital and reduced cost of debt capital. In summary, although a majority of studies have found overperformance of related M&A deals, the evidence is very vague. Boutellier reminds that the decision for relatedness or unrelatedness is very dependent on the industry within which the firms operate. This matter of fact is visualized by Palich et al. (Fig. 3.2):
Fig. 3.2: Performance versus degree of diversification: (a) the linear model; (b) the inverted-U model; (c) the intermediate model (Palich).
An excellent summary on various studies (with conflicting findings) regarding diversification and relatedness can be found in Sirower and Agrawal.
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3.7
Degree of integration
The finding that the degree of integration of the acquired into the acquiring firm is a particularly interesting result because performance gains presumably should be driven by some type of synergy realization through integration. On the other hand, the level of integration is assumed to be related to the number of integration difficulties limiting the realization of the synergy potential. As a result one could conclude that the advantages of a full or moderate integration are diminished by the disadvantages such integration creates.
3.8
Criticism on performance study methodology
Empirical performance studies have almost exclusively concentrated on whether M&A projects create abnormal shareholder value or profitability for the acquiring and the target company and whether strategically related acquisitions are more beneficial than strategically unrelated acquisitions. The overall conclusion from hundreds of studies is that most M&A fail. The vast majority of studies on M&A performance in the last 40 years show failure rates for acquirers of between 40% and 85% with an average of approximately 2/3 on a wide variety of measures (Angwin). Despite considerable research effort being devoted to assess M&A performance the findings of strategic importance in a pre-M&A stage are mainly vague or inconsistent. That fact is troubling since first, no significant success factors for M&A deals that drive the returns can be extracted and second, a reasoning of the findings in these studies seems to be inappropriate in the view of such lacking evidence:
[] M&As influence on post-acquisition firm performance remains inconclusive. [] the existing empirical post-acquisition performance studies have not recognized any prerequisites that would be useful in forecasting post-acquisition performance. (Straub)
These findings raise a paradox: Why do managers continue to transact M&A deals on such a massive scale in both number and monetary terms, when there is little economic justification for M&As from the bidding shareholders point of view? This difference between action (the continued pursuit of mergers) and performance (the low rate of successful mergers) are caused by:
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Managers being overly optimistic, continuing to make estimation errors in valuing target firms, thinking that they have learned from past merger mistakes and that the next merger will be successful (while in fact they continue to make the same merger mistakes). Past empirical studies being inaccurate because of data collection, time-periods covered, statistical errors or aggregation of different deal structures (e.g. size of merger, cross-industry comparison etc.). Angwin states that too often M&A projects are considered as a whole homogeneous entity not taking into account project-specific characteristics. For example, if one accepts that acquisitions are often a search for a unique asset embedded in a firm, then returns from that asset will vary as the size of the unique element varies as a proportion of the total company. It is desirable that research in future differentiates among different types of M&As so that similarities and differences among deals are clearly understood. This could lead to a much more specific set of findings with much less contradictory findings and thus substantial practical value. Managers pursuing goals other than shareholder wealth maximization and, thus, empirical research is using an inaccurate measure of performance (e.g. Angwin). Some researchers raise the fundamental issue of whether the financial markets are always best placed to value the actions of management. For instance, a CEO embedded in an industrial context may be more of an expert on how firms should be run and necessary investment decisions which should be made (such as M&A) than financial analysts and shareholders eventually far away from that context. The CEO may take actions which may not result in positive shareholder returns in the short run but could be of vital importance to the long-term success of the firm. Evaluation of long-term changes in stock price must be done with care since merger strategies often require years of integration efforts before potential benefits are reflected in stock price. And, changes in stock price often tells little about the M&A and its motives but more about the company overall and the economic context. If the existence of multiple merger motives and motives other than share holder wealth creation is correct, then past merger studies that attempt to measure
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merger success by examining single financial indicators of performance (most commonly profitability and share value) tend to undervalue the achievement of other goals and may fail to provide an accurate picture of M&A success. Thus, the results from performance studies may be biased since many deals are being assessed on motives which were never the main intention of management. To test performance M&As should at least be judged in terms of what management primarily attended to achieve with the deal and whether the deal was superior to possible alternatives (refer to chapters 8 and 9.8). A number of researchers have suggested that the proper way to measure strategic performance is against a firms set of key success factors. These factors may include financial indicators but as well as other quantitative and qualitative objectives. By using key success factors as the measure of merger performance, managers can get a better idea of the benefits attained from the merger, not just a measure of whether shareholder value has changed.
3.9
Conclusion
A broader set of motivation for M&A deals (refer to chapter 4) may explain why so many deals appear to perform poorly in performance studies and may explain also why so many M&A deals continue to take place. Although the suggestion of multiple motives for M&A deals other than share holder wealth creation or profitability increase is not new, traditional performance studies as discussed so far prevail also nowadays. One reason might be that researchers face substantial resistance when studying the real M&A motives since management hardly will officially report motivations other than the traditional and most legitimate intention of improving financial performance of the firm. Less acceptable motives will be downplayed or even neglected. Metz in his studies remarks:
Ursprnglich war geplant, an Fallbeispielen zu analysieren, wie Unternehmungen Synergieeffekte planen, messen und kontrollieren und wie sie diese in ihren Entscheidungen bercksichtigen. Die Vertraulichkeit der Informationen verhinderte jedoch, den Kreis der Beispiele zu weit zu ziehen.
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The sheer difficulties in obtaining data from managers and honest answers on their true motives and thoughts tend to overcomplicate empirical M&A studies since researchers must rely on relatively small samples and unknown data quality. In the light of these difficulties it seems much more convenient to rate a firms M&A performance through easy access to performance measures allowing for quantitative and statistical evaluation. Even if the true motives for M&A deals would be taken into account one can assume that still a large portion of M&A transactions remain unsuccessful since the main motive for M&As remains the traditional value creation resulting from synergies (refer to chapter 4.1).
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Motives for merger and acquisition activity
Categorization of mergers and acquisitions according to the managements motives is fairly generic since motives can have manifold facets, overlapping each other or even belong to several categories. While it is attractive to categorize M&A deals into single motives research studies show that this would be an oversimplification. A survey from Angwin in 2000 involving CEOs of 100 domestic acquirers in the UK about their motivations for carrying out a specific M&A transaction reveals up to seven reasons in some instances, 45% gave three or more reasons and 71% of CEOs gave two or more reasons. Angwin in his survey groups motives into four categories: Exploitation of the target through synergies to increase acquirer value with a high degree of certainty (classical motivation) Exploration of new territories of latent value and for future opportunities with low certainty of improving returns to the acquirer but with a big potential Preservation (stasis) attempting to defend the acquirers competitive situation through control of potential new competitors Survival attempting to prevent the acquirers end through being acquired itself
The payoffs for these different types of motives are different. From exploitation deals there should be reasonable certainty about value created. Exploration deals may have the potential for much greater returns than exploitation deals as well as much higher risk about whether those returns will be achieved and how far into the future. For preservation deals the acquirer may not receive any direct benefit, with neutral or even mildly negative returns but the negative threat of severe future change maybe reduced. Survival deals are not so much about increasing value as to survive potential takeover threat or current demise of the firm. For preservation and survival type deals, value creation maybe an inappropriate way of viewing performance. Instead worse off test should be applied answering the questions would the acquirer be substantially worse off if it did not transact a particular acquisition?
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4.1
Exploitation (synergy motives)
Synergy motives are widely seen as the most frequently mentioned motives when managers argue for an M&A project (Schweiger). Synergies are accepted as a legitimate reason for such undertakings since their realization appears to directly correlate with the enhancement of economic performance of a firm.
4.1.1
What is synergy?
A target firm has an intrinsic value that is based on what a firm is worth as a stand-alone entity. This value is typically based on the expected stream of cash flows it can produce as a going concern. If an acquirer pays more than this value (price premium), value is likely to be destroyed. However, a buyer can utilize the acquisition to improve cash flows of either the target, itself or both such that value still can be created. This concept is known as synergy realization. Kuhn in his publication gives a few examples of synergy realization, however, not without closing his illustration with an ironic undertone:
Schnell etablierte sich die Unterscheidung zwischen Kosten- und Umsatzsynergien. Im ersten Fall sinken die Ausgaben des neuen Unternehmens, weil es etwa Skaleneffekte im Einkauf erzielt, nur noch ein Rechenzentrum bentigt oder im idealen Fall Manager und Mitarbeiter die besten Geschftspraktiken der jeweils anderen Seite bernehmen. Im zweiten Fall erzielt die fusionierte Firma hhere Umstze, weil der Vertrieb den Kunden aus der kombinierten Produktpalette attraktive neue Angebote zusammenstellen kann, nun die kritische Masse vorhanden ist, um neue Mrkte zu erschliessen, oder sich Strken in verschiedenen Vertriebskanlen ergnzen eigentlich kein allzu ambitioniertes Ziel.
In other words, synergy is the increase in performance of the combined firm above what the two firms are already expected to accomplish as independent firms through gains in competitive advantage. Thus, the synergy hypothesis proposes that M&As take place when the value of the combined firm is greater than the sum of the values of the individual firms. The relationship between price, synergy and value is illustrated in Fig. 4.1.
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The figure illustrates that value can be created when the price paid for a target is below its stand-alone value. When the price exceeds the stand alone value, synergies must be captured for value to be realized. When the price exceeds all synergies, there is no chance that value can be created.
Fig. 4.1: The relationship between price, synergy and value (Schweiger).
4.1.2
Classification of synergies
Dyer proposes the following classification of synergies: Modular synergy: if firms manage their resources independently but their final outcomes combine to potential synergy realization (e.g. common usage of distribution channels) Sequential synergy: if one firm completes its activities first and transfers the outcome to the partner firm (e.g. after-sales offering) Reciprocal synergy: if firms jointly work together in activities and mutually share resources along the value chain (e.g. common R&D activities)
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Other authors divide synergy according to the types cost, revenue and intangibles (Angwin; Weber; Schweiger; Ghauri; Cullinan): 4.1.3 Cost synergies (rationalization)
Reducing costs is one clear way to increase cash flows and has been the most common form of synergy. If synergies are expected to come from cost savings for price and/or cost structure competitiveness, they must emerge from eliminating duplication due to similarities between the firms. Synergistic benefits from potential duplicated resources can come as fixed or variable cost synergies: Economies of scale i.e. increasing volume of production/sales reduces costs per unit Economies of scope i.e. spreading or shearing resources across more business activities Examples: sharing of products/services, marketing/advertising and brand development efforts Bargaining power along the value chain i.e. increasing power over suppliers (purchasing efficiency) and distributors to reduce transaction costs Elimination of redundant functions i.e. reduction of overlapping work force (administration, overhead, corporate staff like finance, IT, human resources etc.) and rationalization of processes (production facilities, distribution/sales, warehousing, servicing etc.) Control over value chain i.e. vertical integration Such moves are made to increase value added into the business, to gain control over more aspects of the business (supply, distribution) and to reduce transaction costs in the value chain. Examples: Lower variable costs of raw material through control over raw materials, lower overall costs through improved product development and manufacturing interfaces. Flexibility of capacity i.e. using excess capacity of one firm to fill the other firms excess demand (improved agility).
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4.1.4
Revenue synergies
Typically, revenue synergies are associated with complementary (i.e. non-overlapping) activities resulting in higher volume and revenue sales: New customer base i.e. increase sales coverage or acquire new distribution network or new sales channel that can result, for example, in more profitable or loyal customers. Cross-selling of products or services through complementary sales organizations or distribution channels that serve different geographic regions, customer groups or technologies (increased sales productivity by selling more volume with the same number of sales people). Broadening a companys products and services portfolio to provide needed bundling or a more complete/full offering. Internationalization i.e. increase sales volume and market share through geographic extension and access to new customers M&As are means to expand internationally more rapidly or they make it possible to enter new markets using the distribution network and the specific knowledge of local partners. Thanks to the contributions of these partners, the foreign company is offered a geographic presence, less effort and time has to be put into learning how to succeed in very different local environments (Garrette). Internationalization can also foster a companys responsiveness by moving production processes, distribution, warehousing, and after-sales activities closer to customers. This can result in increased competitiveness by being better able to serve customers with needs for broader geographic coverage.
4.1.5
Synergies from intangibles
This type of synergy results from the acquisition of immaterial goods or goods that hardly can be acquired in the market: Access to brands, reputation and intellectual property Example: increase appeal to more and better distributors, suppliers and employees.
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Access to human resources i.e. people, knowledge, experience, skills, brainpower (talent-based M&A). Access to technology and the attached knowledge, innovation and product development efforts i.e. create new business opportunities or enhance a firms core business. Knowledge often cannot be acquired in the market as it is bundled with other assets. Due to the asymmetric information regarding knowledge and technology the valuation of this asset is extremely difficult however important as it is very often the key reason for an acquisition. Access to superior managerial practices, business models and operational excellence (e.g. quality control system, delivery concepts, after-sales service). The reverse is victim infusion (Ghauri): a firm can infuse the victim with better management, organization skills, or superior marketing.
4.2
Exploration
There are motives other than synergy realization which receive far less attention: Greenfield entry As new markets and knowledge emerge there will always be a need to engage in these areas. By definition there will be significant uncertainty since acquirers cannot know the future. They can form views about whether the potential of an M&A deal maybe high, but in new unfamiliar areas (geographic, technological etc.) the information available maybe extremely unreliable or difficult to interpret. There are huge question marks over the potential, how the market may evolve or whether a market will actually emerge at all. In conventional terms such M&A deals might likely to be a failure but the deal could be significant in influencing market development and placing the acquirer in a privileged position for future strategic moves. Not to participate in an emerging area may also have a cost of being late or even excluded from participation.
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Learning prologue i.e. sequential M&A to learn about a sector as a prologue to a later larger M&A deal (e.g. a common practice amongst Japanese firms in cross-border M&As) (Ghauri).
4.3
Preservation and survival
This type of synergy results from the elimination of competitors from a market and to gain a more dominant position in an industry: Affecting competitive dynamics M&A deals can be used as a weapon to harm the actions of competitor firms. Here performance is less about the contribution of the target firm to the new parent, but more in terms of the damage done to the competitor and prevention of unpleasant challenges in an industry (e.g. Angwin; Ghauri). Example: avoid price war or affect a competitors pricing ability in mutual markets through acquiring in a competitors main market. A similar motivation is to prevent a private firm from becoming more tradable and so available to competitors as often seen in the pharmaceutical, biotechnology and IT industry. Overcapacity reduction i.e. purchasing competitors and closing them down to gain market share or critical mass Pricing flexibility i.e. elimination of capacity from the market place allowing an acquirer to maintain or increase prices in the market thereby improving margins and cash flows. Innovation quenching (Angwin) The acquisition is intended to suppress rather than develop the competitive potential of the acquired firm (Ghauri). For instance, buying infant firms and closing them down prevents any possible takeoff of that firm which could change industry dynamics. An alternative to closure is to purchase infant firms so that the acquirer can control the rate of innovation leakage into an industry. Such acquisitions itself may not result in positive returns, but may be less damaging than allowing the firm to emerge.
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Competitor actions The actions of a competitor may induce a firm into engaging in M&A. It is known that when an industry begins to consolidate there is a rush of other firms to follow. The motive here is the fear of being taken over (M&A as a defense mechanism) or the fear of no suitable targets being left for an M&A deal. Customer / supplier pressure Powerful customers or suppliers can force firms making M&A deals. For instance, in the IT industry Nokia brought pressure on one of its suppliers to purchase a high tech firm as they wanted aspects of this technology integrated into the components they were sourcing, but they did not want to purchase the firm themselves. The supplier, wanting to keep its main client had no choice. It may not have benefited from the actual M&A but to lose Nokia as its primary customer would have been a far worse outcome. Political persuasion Governments can bring substantial pressure upon top management to act in a way which would further the national interest. For instance, in France there has repeatedly been pressure upon firms to merge rather than accept approaches from Italian, Spanish and Swiss firms. Gaining influence on 3rd party firms
4.4
Managers self-interest and prestige
All of the above motives for M&A assume rational managerial motivation based upon improving firm performance. However, not all motives can be considered rational from the business perspective: Agency motive (self-interest, greed motive) In the context of M&A the agency motive suggests that takeovers occur because they enhance the acquirer managements welfare at the expense of acquirer shareholders (e.g. Angwin; Brouthers). Hubris motive (prestige motive)
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The hubris hypothesis suggests that managers make mistakes in evaluating target firms (excess confidence) and engage in M&As even when there is no synergy potential or other legitimate motive (Berkovitch). Diversification of managements personal portfolio, managerial challenge, the increase of the firm size and prestige, the increase of the firms dependence on the management (empire building) and fashion (Ghauri) are manager motives summarized under the hubris hypothesis. The agency problem and hubris motive receive support from studies reporting that acquirer returns from M&A deals are positively related to the level of management ownership in the acquiring firm (Berkovitch; refer to chapter 3.4.1). Considering the increase in shareholder wealth as the primary reason for any M&A and taking into account that most M&As fail, Berkovitch jumps to the conclusion that many M&A deals are motivated by agency and hubris. However, the huge variety of motives different from shareholder wealth creation as the primary motivation for M&A puts some doubt on that straight conclusion. If all takeovers were motivated by synergy only, one would never observe negative gains. Here, Berkovitch does not take into account that there are many other issues except the motivation that decide upon M&A financial success.
4.5
Finance motives
The main motives cited in the finance literature: Improving stock market measures (classical motive referred as exploitation or synergy motive) Reducing cost of capital (e.g. through reducing firm risk by stabilizing earnings due to diversification or buying a listed company) Reduction of tax liabilities (e.g. through benefits achieved in cross-border M&As) Adjusting the debt profile of the company Accessing cash or other financial resources in the target company Generate cash flow from the break-up of the target firm (e.g. Megginson) Move capital to higher valued uses / Reinvestment of financial resources (e.g. firms with poor investment opportunities acquire firms with outstanding growth opportunities; Goergen), in the extreme case: Replace a business with a new one (respond to market failures)
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Asset stripping Speculative transactions driven by the intention to buy shares in companies solely to resell them at a profit in future.
4.6
Conclusion
The vast majority of M&A literature assumes that M&A deals must improve returns to shareholders. However, this ignores many other legitimate and illegitimate motives for M&A activities and ownership structures other than public companies. The broad set of motivations presented here now, first, allows a much more subtle assessment of postM&A firm performance while the lack thereof was criticized in the chapter Performance studies (refer to chapter 3), second, simplifies a sound review of strategic logic and reasoning for M&A activity and, third, opens a much broader view on upcoming integration and transformation difficulties like negative synergies and culture issues.
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Post-M&A integration and transformation
Independent of the underlying motives for an M&A project, during post-merger integration many different matters must be carefully blended such as for example different strategies, brands, product portfolios, production processes, knowledge and technology, pricing policy, support functions, sourcing and distribution partners, administrative policies and processes including the management of human resources, technical operations, marketing activities and customer relationships. Depending on the level of integration such a blending imposes many difficulties and pitfalls for synergy realization and for reaching other M&A objectives. The lacking awareness of those difficulties (fostering positive synergy realization and anticipating negative synergies) are seen as prominent reasons why M&A projects can be compromised to reach their goals, in particular when not considered at a very early stage in the M&A project (e.g. Datta; Haspeslagh). Mace and Montgomery already noted in 1964:
The values to be derived from an acquisition depend largely upon the skill with which the [] problems of integration are handled. Many potentially valuable acquired corporate assets have been lost by neglect and poor handling during the integration process.
As a consequence, besides recognizing the strategic logic that predicts value creation the processes through which the M&As objectives come to be realized must be taken into account and planned in detail. Management must find the appropriate integration practice (e.g. procedural, physical, and socio-cultural) given the motives and characteristics of the acquiring and acquired firms (Marks). They must decide how, at which level and to which degree acquiring and acquired organizations are to be integrated in the post-M&A period, should foresee the many difficulties and dangers in the integration process and must be prepared to anticipate culture issues. The already scarce and often overrated positive synergies should not be considerably impaired by negative synergies due to integration difficulties. Examples of such negative synergies might be alienated customers and demotivated sales organizations leading to low morale and high employee turnover.
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5.1
What is an adequate level of integration?
There are several possible generic scenarios how a company can be integrated in the post-M&A phase (Sirower; Duncan), although, hybrid and intermediate forms may exist: 1. The company is acquired as a stand-alone (total autonomy). 2. The company is acquired as stand-alone but with a change in strategy (e.g. restructuring followed by financial control). 3. The target company is to become part of the acquirers operations (e.g. centralization of key functions). 4. The target and acquirer are to be completely integrated (full integration). 5. The target takes over the acquirers existing business and the acquirer is integrated into the targets operations (reverse integration).
Schweiger suggests four measures that define intensity of integration: Consolidation: The extent to which the separate functions and activities of both an acquirer and a target firms are physically consolidated into one. Standardization: The extent to which the separate functions and activities of both firms are standardized and formalized, but not physically consolidated. Coordination: The extent to which functions and activities of both firms are coordinated. Intervention: The extent to which interventions are made in an acquired firm to turnaround, for example poor operating profit, regardless of any inherent sources of synergy.
Level of integration can be defined as the degree of post-acquisition change in an organizations strategic, technical, administrative, and cultural configuration. Level of integration is an important concept in acquisition management because, although high levels of integration theoretically enhance realization of interdependency-based synergistic potential, they may also result in realization of negative synergies as a consequence of increased coordination costs and potential for interorganizational conflicts (Pablo):
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A low level of integration is one in which technical and administrative changes are limited to the sharing of financial risk and resources and the standardization of basic management systems and processes to facilitate communication. Where a higher degree of autonomy is given to the target company it results in a lower level of complexity in the implementation process, as integration affects a lower number of employees and business units. A moderate level of integration includes increased modifications in the value chain as physical and knowledge-based resources are shared or exchanged. Fuller integration often results in a loss of power on the part of the target. As a consequence integration difficulties and cultural issues arise endangering the M&A integration success and, in the extreme, target employees are more likely to leave the company. The highest level of integration involves the extensive sharing of all types of resources (financial, physical, and human), generalized adoption of the acquiring organizations operating, control, and planning systems and procedures, and complete strategic, structural and cultural absorption of the acquired firm. What are the factors that determine the level of integration that is chosen in acquisition? a. The degree of integration is defined by the degree to which the realization of intended synergies depends on the sharing or exchange of critical resources. The strategic task, thus, requires that links are developed between the combining firms activities and that the organization should be appropriate to support those links. Based on these considerations management must decide whether the acquired firm is integrated, for example, at a corporate, divisional or business unit level (Pablo). b. From an acquirers perspective two key elements in the integration design decision are the perceived need to exert power and the ability to do so. The extent of the perceived need to use power will depend upon the degree to which the target has a vision of essential actions and outcomes in the acquisition that is compatible with the acquirers (Pablo). c. An acquirers degree of tolerance for cultural diversity should be a predictor of the level of integration that is chosen for an acquisition (Pablo).
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5.2
What are the difficulties and dangers during integration?
Difficulties and dangers during the integration process are manifold and widely discussed not only in the M&A literature but generally in the transformation literature. Here the most often cited issues in the M&A context and those of major relevance for the pre-M&A phase are discussed. To foster a positive attitude in an often negatively charged environment success factors are presented instead of a list with frequent reasons for integration failure (no particular order): 1. Choice of appropriate level of integration 2. Post-merger management of projected positive and negative synergies 3. Speed of integration 4. Communication to internal and external stakeholders 5. Cultural fit and anticipation of culture dissonance 6. Experience with transition structures and transformation management (Reimus) 7. Avoidance of leadership vacuum (Duncan) 8. Choice of top management positions reflecting the values being applied in the merged firm and the true distribution of power between the former firms (Trauth). 9. All parts of the organization have the knowledge and resources, and give their commitment for the integration efforts (Epstein).
5.2.1
Under- and overintegration or the appropriate level of integration
An acquired firm must be aligned to a certain extent to the requirements of the acquiring company. The accomplishment of integration, however, requires that target-specific bases of critical resources and skills be kept intact. The organizational task therefore is the preservation of any unique characteristics of an acquired firm that are a source of key strategic capabilities. Pablo advises against fixing things that arent broken. However, under- or overintegration has been cited as one of the leading causes of M&A failure (Pablo). The realization of potential synergies can be short-circuited given an insufficient level of integration, but excessive integration (reconfiguration) can hinder the development of fruitful conditions (e.g. when executives depart, expertise is lost etc.). Management of the acquiring firm has the tendency to over-integrate the target firm, means to completely change the whole setup and the processes. These practices
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(besides demotivating the employees) can result in the loss of the firms success factors before the M&A deal (e.g. short decision processes, flexibility and agility in the market, personal partnership with customers, innovativeness) (Cliffe). Another common pitfall is that acquirers make organizational (e.g. cut workforce) or strategic changes to realize synergies while destroying, for example, the growth or source of innovation of the acquired firm by doing so.
5.2.2
Post-merger management of projected positive and negative synergies
Acquiring companies must view potential synergies in the light of realization problems:
When two previously sovereign organizations come together under a common corporate umbrella, the result is a hybrid organization in which value creation depends on the management of interdependencies through the facilitation of firm interactions and the development of mechanisms promoting stability. (Pablo)
Specifically, management should: Have an integration plan in considerable detail on how to implement the strategy (e.g. integration of sales force, distribution system, information systems, R&D processes, marketing efforts, reward and incentive systems). Examine how different issues impact the success of changes needed in the acquirer, the target, or both firms and the impact they can have on positive potential but also negative synergies (value leakage e.g. through reduction in cash flows and earning during integration period). Develop different integration scenarios leading to a series of realistic M&A evaluation.
5.2.3
Speed of integration
Angwin in his studies argues:

[] the first 100 days is when all the critical actions should be launched, as this is the outer limit of employee enthusiasm, customer tolerance and Wall Street patience.
Early wins to convince internal and external stakeholders keep the momentum of positive attitude while sustained uncertainty, not only amongst employees, is seen as one of the most corrosive elements of the soundness of post-acquisition integration.
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Faster integration may reduce the length of time to experience uncertainty as well as reduce the effects of the rumor mill. An organization, Angwin then argues, benefits from well planned and thus shorter integration periods in several ways: Spending less time in a sub-optimal condition Less costly readjustments and iterations Cuts time for competitors reactions to the new organization Favorable response of financial markets to quick wins
5.2.4
Communication to internal and external stakeholders
The preparation during the period leading up to the merger announcement is vital to success since it is critical to present the merger to key constituencies with confidence. During this period, the integration process is formulated and key decisions should be made in the areas of leadership, structure, and timeline. Unprofessional communication to employees, clients, shareholders, suppliers and the media fosters uncertainty, mistrust and rumors. Thus, it is necessary that the companies and their stakeholders involved understand the advantages associated with the merger. The communication should generate a culture where employees see the merger as enabling them to develop the business rather than inhibiting them from progress. Employees then can concentrate on reaching the objectives of the whole M&A project or the integration process in particular. Management must define the necessary changes that will bring a successful transaction. It is important to establish clarity in roles and responsibilities for those involved in the integration process, versus those in operating businesses. And, the final authority and responsibility should be communicated on all levels. Moreover, the achievements of the integration process and the current status (success, failures, shortcomings etc.) should be communicated to all employees in order not to loose their positive attitude, to encourage or to highlight serious deficits (Epstein). This chapter on communication passes into to the subject of culture dissonance since communication is an inherent part of culture and lacking or unprofessional communication shares the same set of human reactions to culture dissonance.
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5.2.5
Cultural fit and anticipation of culture dissonance
For Ansoff citing Machiavelli [] resistance to change is proportional to the degree of discontinuity in the culture and power structure introduced by the change. Resistance comprises cultural and social aspects, at both the individual and collective level. Culture dissonance, which might be real or just perceived, is a major risk for M&A integration success and thus is widely discussed in the literature and is treated in a separate but complementary chapter in this work (refer to chapter 6).
5.3
Conclusion
The M&A literature reports that insufficient planning for positive synergy realization and lacking anticipation of negative synergies are the elementary shortcomings in the M&A integration context. Cultural problems, disruption of employees, hierarchy changes and missing incentives for acquiring and acquired firm employees play a key role in these shortcomings. However, independent of the level of integration efforts to retain and encourage employees are of vital importance for reaching an M&As objectives:
[] mangers generally want a company that is fully staffed, with a general manager and all functional heads and, since it takes three to five years to develop a good operating team, they want assurance that these key people will stay on the job. (Paine)
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National and organizational culture and culture clashes
Numerous authors have discussed the potential troubles of culture dissonance (culture clashes) between merging organizations and report culture dissonance to be one major source of conflict that can undermine potential synergistic effects and endanger a whole M&A project. Duncan found that 65 per cent of those acquirers who had experienced serious problems with post-acquisition integration said that these difficulties had been due to cultural differences. Cultural fit is therefore a vital success factor for international and domestic M&As. The interesting point is that many studies show that culture is an important issue even when the firms come from the same country and the same industry (Ghauri). On the other hand, culture issues are worth to shed light into them since they can be used as almost uncontroversial alibi for anything that goes wrong with M&As (Sirower).
6.1
What is culture in the M&A context?
There exist various definitions of culture, but a classic definition is a shared set of norms, values, beliefs, and expectations which are translated into behaviors. A corporate culture includes this shared set but also implies incentive and reward systems, performance evaluation, chain of command, leadership styles, information and decision processes, operating procedures etc. (Veiga). However defined, organizational culture is seen as being important in determining an individuals commitment, satisfaction, productivity, and permanence within an
organization. This is because individuals tend to select groups that they perceive as having values similar to their own while trying to avoid dissimilar others (Veiga).
6.2
Which forms of acculturation exist?
Similarly to the possible integration scenarios (refer to chapter 5.1) Jns defines different degrees of acculturation between the acquiring and acquired firm while the degree of integration and degree of acculturation do not necessarily correspond to each other. This is due to the fact that the acculturation depends on the way companies manage the formal (organizational aspects) and informal (socialization aspects) integration process:
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1. Integration is characterized by cultural and structural changes on the part of both partners without a dominant culture. 2. Assimilation is a one-sided process where the acquiring company fully absorbs the acquired one. 3. Separation means minimal cultural exchange, the acquired company therefore remains almost unchanged. 4. Deculturation leads to completely new organizational practices and systems that are different from those of both previous cultures.
6.3
Are cultural stereotypes a real assist or just convenience?
Two statements reflect the conventional understanding of culture we have and how we normally think about it:
Surprisingly, the monolithic vision of organizational and national cultures is still dominant in the strategy field and has tended to use organization-wide or nationwide classifications (one organization one culture; one country one culture). (Irrmann)
Cultural stereotypes are a condensation of reality in that they simplify and overgeneralize the characteristics of a societal group. In the absence of detailed knowledge and direct experience of a potential merger partner or acquisition target, stereotypes offer a means of reducing the cognitive complexity of a decision. (Cartwright)
Thus, culture should not be considered as something objective and given which a nation or an organization has. For instance, companies can be characterized by subcultures linked to departments, professions and other communities. Although some scholars define national and organizational cultures as separate constructs, others agree that these two constructs are interrelated and have a strong influence on each other.
6.4
Can culture be measured?
As culture is intangible, it is a very difficult concept to evaluate. Although the concept of culture clash has been widely discussed in the context of M&A, the literature has been relatively quiet about how to empirically measure this phenomenon:
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Hofstede (1980, in Veiga) introduced a classification concept based on country indices for Power Distance, Uncertainty Avoidance, Individualism and Masculinity as a way of representing cultural distance between collaborating companies. Veiga et al. present a perceived cultural compatibility index (PCC) as a tool for assessing culture based on interviews with various people who live in the organization and [] could help to uncover the basic cultural essence. Different to Hofstede, Veiga et al. focus on the cultures of the single organizations and do not measure the level of compatibility of two merging national cultures only. They present 23 items to be considered for their congruence index within and across national and organizational contexts: The organization: 1. Encourages creativity and innovation 2. Cares about health and welfare of employees 3. Is receptive to new ways of doing things 4. Is an organization people can identify with 5. Stresses team work among all departments 6. Measures individual performance in a clear, understandable manner 7. Bases promotion primarily on performance 8. Gives high responsibilities to mangers 9. Acts in responsible manner towards environment, discrimination, etc. 10. Explains reasons for decisions to subordinates 11. Has managers who give attention to individuals personal problems 12. Allows individuals to adopt their own approach to job 13. Is always ready to take risks 14. Tries to improve communication between departments 15. Delegates decision-making to lowest possible level 16. Encourages competition among members as a way to advance 17. Gives recognition when deserved 18. Encourages cooperation more than competition 19. Takes a long-term view even at expense of short-term performance 20. Challenges persons to give their best effort
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21. Communicates how each persons work contributes to firms big picture 22. Values effectiveness more than adherence to rules and procedures 23. Provides life-time job security A respondents overall compatibility score can range from -20 to +20, where -20 signifies the highest degree of unattractiveness. A zero suggests neutrality, i.e. the respondent perceives no differences between the buying firms culture and the acquired firms culture. The calculation customizes each respondents assessment on each item by using their response to the respective value items ought to be question as a weight.
6.5
What is the result of perceived culture dissonance?
The impact of culture dissonance on the M&A project, the organizational structure and the employees behavior is frequently discussed in the literature. Lack of trust, lack of competence, unwillingness to cooperate, unacceptable behavior, bureaucratic system are just a few attributes often named when partners interact in M&A projects. Such phenomena are not exclusively restricted to M&A projects but to any sort of cultural interaction in business contexts such as team building, buyer-seller interaction and transformation projects in general. Irrmann and Jns report in their extensive study the most often perceived consequences of cultural dissonance in M&A projects cited by employees: Non-cooperation Information retention Lack of competence Organizational silence Competitive atmosphere within the company Mistrust among employees Increased bureaucracy Higher degree of hierarchy, bureaucracy and authority Avoidance of responsibility Bypass of hierarchy Stress and uncertainty due to potential layoffs Lower job satisfaction and commitment
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In the light of these perceived culture issues it becomes obvious that acquiring companies must view potential synergies in the light of realization problems. However, those perceived changes in structure and behavior must not solely be attributed to culture dissonance but must be seen in the overall context of integration difficulties.
6.6
How can one understand culture dissonance?
Considerable differences in corporate cultures as, for example, according to Veigas congruence index might impose serious culture clashes during and even after the M&A integration process. Irrmann argues that the often cited culture clashes mainly arise from communication dissonance and communication absence between acquiring firm and target as a result of two types of failures: the linguistic pragmatic failure and the business pragmatic failure. The first one is grounded in differences in: Accepted cultural forms of discourse Message content and medium of communication The second one is grounded in different interpretations of: The appropriate decision-making process The divergent vision of the appropriate business strategy to adopt The economic role of the acquired firm Beside culture dissonance it is the uncertainty surrounding acquisition events that causes executives and employees to defend positions they may have taken years to build. If employees feel uncertain about their personal situation, corporate goals may not matter so much to them (Jns). M&As are surrounded in an aura of conquest where employees and managers eventually have to break their bond with the way things were and conform to the culture of the buying firm:
Once a big fish in a small pond, acquired key people may feel a strong sense of alienation with their new proximate group, inferior in status to the acquiring top managers, and/or unappreciated by them [] known as the superiority syndrome. (Veiga)
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Post-M&A studies on the Daimler-Chrysler deal (Epstein) reported the emergence of a collective political and ideological resistance at the target to collaborate when Daimler top managers communicated the two-level strategy of the now combined firm where Daimler ought to be the premium brand and Chrysler ought to be the medium-to-low quality brand. Together with the distance to home country problem this ideological resistance led to the fact that Daimler-Chrysler remained a two-company firm until divestment of Chrysler. Mr. Hubert of Daimler-Chrysler half a year before divestment of Chrysler declared:
We are absolutely happy with the development of the merger, we have clear understanding: one company, one vision, one chairman, two cultures. (Ghauri)
Such Wir-gegen-die psychology is often observed, if no clear new strategy and vision are communicated and both partners do not value and respect the achievements of the other. A much more subtle example is given in Reimus where an acquired firm had to move into the buildings of the acquiring firm resulting in non-cooperation and mistrust.
6.7
6.7.1
What can be learned for practice to anticipate culture dissonance?

Avoid insurmountable integration problems
In terms of selecting a compatible target, Larsson and Risberg note that organizations tend to prefer to invest in neighboring territories or those with which they have the closest economic, linguistic and cultural ties (more like us tendency). While differences can lead to greater acculturation stress and integration difficulties, cultural differences do not necessarily result in negative outcomes. Cartwright et al. argue that cultural differences at the national level do not have such a negative impact as differences at the organizational level in domestic M&As, because there is a greater awareness and appreciation of national cultural differences and a greater tolerance for multi-culturalism. Larsson and Risberg (in Barmeyer) even show that M&A transactions where companies face both corporate and national culture differences have a higher degree of acculturation (creation of a joint corporate culture) than domestic firms with similar corporate cultures. The objective fact that cultural differences exist, however, does not necessarily imply that the acquired employees will resist any post-merger consolidation attempts.
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Many investigators agree that culture dissonance is likely to be more pronounced in cross-national M&As than in domestic ones since such M&A deals bring together not only two firms that may have different organizational cultures, but also two firms whose organizational cultures are rooted in different national cultures (Duncan). This results in a greater possibility of incompatibility between the acquirer and the acquired (Veiga). Researchers studying M&A have proposed the selection of similar partners for the merger to avoid culture dissonance. However, many studies show that although merging similar organizations does not in general reduce resistance and integration problems (Liu). Not to forget that the issue for acquirers is not solely whether the cultures are similar or different but whether the changes necessary to support the strategy of the combined firm will clash with either culture.
6.7.2
Be aware of potential cultural dissonance
The awareness of national and organizational culture issues is seen as being fundamental already in the target screening phase for potential M&A projects. An underestimation of the cultural factor in pre-M&A phase is fatal, because the merging of companies is a merging between different human beings. It is humans that create, follow or divert rules and structures of companies, and that make sure that companies live, function and make benefits. It is their ideas, strategies, thoughts and decisions that are transformed into action and they contribute to the success or failure of a company. How to anticipate culture dissonance and managing transformation during the integration process is a topic not discussed here in detail. When an acquirer fears strong cultural resistances from a target it can engage interventions such as discussions, intercultural mirroring workshops, gathering employees from both companies, organizing reciprocal visits at worksites, work on future common values that will characterize the new group to moderate the resistance. The creation of a new corporate entity that integrates the positive aspects of each culture helps to avoid conflicts. For practice, Irrmann suggests that investing in the development of intercultural communication skills, language skills and cultural intelligence could be a more fruitful approach for managers than the quest for cultural fit between merging organizations.
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Research shows that the perception of the partners credibility and trustworthiness are central success factors from the very beginning of M&A projects, while perception is largely rooted in the interpretation of the repeated interactions between the partners. The importance of creating a climate of mutual trust by anticipating problems and discussing them early with the other company is reported by Paine. Mutual respect and communication is, for example, enhanced by two-way transfer of knowledge having a positive motivational and early acceptance effect on the employees of both firms (Duncan).
6.8
Conclusion
Cooperation will not magically occur unless incentives and rewards are created that will induce changes in behavior. In the extreme, key employees and managers who are crucial to the business as a stand-alone may leave in anticipation of these problems (talent exodus). On the other hand, some cultural differences may even facilitate assimilation. For example, the acquired managers and employees may anticipate more opportunities for themselves, and may also hold the buying firm in high regard, perceiving it to be a high prestige firm, a world-wide leader, a firm that protects the environment etc. (Veiga).
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Success factors, reasons for failure and risks
The success factors, reasons for failure and risks presented here is according to the topics discussed so far. Additionally, results from direct interviews and surveys of key informants are presented. A firm that takes over another firm makes two assumptions. The first is that the acquiring firm can extract more value from the same assets than the current owners. The second assumption is that the value extracted will be more than the market price paid for the assets. The fact that this assumption is often erroneous is the core reason why many acquisitions fail as profit enhancing tool. Consequently, the price premium, the realization of synergies and the strategic logic are in the focus here.
7.1
Financial overextension and price premium
An acquisition premium is the amount the acquiring firm pays for an acquisition that is above the pre-acquisition price of the target company. Or in other words, it is the price pre-acquisition shareholders would not have to pay when investing in the firm to be acquired. In the M&A literature, the acquisition premium represents the expectation of synergy in a corporate combination. According to this explanation, acquirers pay a premium because the expected value of the combined companies is greater than the expected value of the sum of the independent parts. An acquisition premium thus must be understood as an up-front payment for some uncertain stream of additional payoffs sometime in the future. The acquirer needs to value the improvements when they are reasonably expected to occur. Warren Buffett in the Berkshire Hathaway 1982 Annual Report summarizes the problematic in a few words:
A too high purchase price for the stock of an excellent company can undo the effects of a subsequent decade of favorable business developments.
Or, as Sirower declares in his book The Synergy Trap in a more sloppy way:
The acquisition game is best described as a game with some distribution of payoffs and an up-front price to play the game. Master Thesis D-MTEC, ETHZ Marco Zappa
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According to a KPMG study (2000), 83% of recent deals failed to deliver shareholder value and an alarming 53% actually destroyed value. While this study was already cited when discussing post-M&A performance (refer to chapter 3) the more important result in this context is that the report concludes that underperformance is the outcome of excessive focus on closing the deal at the expense of focusing on factors that will ensure its success and that the pricing decision becomes completely detached from any synergies that may be realizable. Garrette in his study argues already in 2000 on the Daimler-Chrysler deal:
Daimler Benz is said to have acquired Chrysler in order to strengthen its presence in North America and to enter lower segments of the automobile market. [] This move was justified by the fact that earlier attempts [] to expand their product lines through internal growth had proved extremely difficult. However, [] the price paid by the acquiring firm is such that it is unlikely that [] this acquisition will ever become profitable.
Cartwright argues in a more pragmatic way. Even if the market price fully reflects the future profit stream of the acquired assets, then there is no scope for profit from the acquisition. In a perfectly competitive market, bidding firms that complete a merger or acquisition will not obtain abnormal returns, even if they are completely successful in exploiting anticipated relatedness with a target, since the value of relatedness will be reflected in the price of a target, and thus distributed as abnormal returns to the share holder of acquired target firms (Sirower). Assuming that assets are priced at their fair value, the only way to earn excess returns is if there exist limits to competition such that assets do not get bid up to their fair value. Other opportunities for profit arise in situations where assets do not have a market price, as is the case with private firms or divisions of multi-unit companies. However, the uncertainty in the valuation of future income streams remains as an important issue in takeovers. The complexity of the modern firm complicates easy analysis. The assets of interest may be difficult to identify and may be overvalued or undervalued for some time. This may especially be the case where the value of the target is largely tied up in intangible assets such as people and knowledge.
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7.2
Realization of synergies
From a traditional synergy motive perspective managers in acquisitions have to accomplish what shareholders cannot accomplish on their own. This means that synergies must be realized to an amount that lies above the price premium paid for that synergy potential. But history shows that expectations rarely reflect realizations (Cartwright). When one considers that the acquisition premium implies certain requirements of performance improvements and calculate the probability of achieving these improvements, one can predict the probable losses to shareholders of acquiring firms (Sirower). One has to recall that realized synergies are actual improvements in combined performance above what the two firms were already expected to accomplish independently (Cullinan). A study by Sirower, summarized in his book, The Synergy Trap, found that of 168 deals analyzed, roughly two-third of all companies studied too often think they can generate synergy faster and in greater amounts than is really possible. In the M&A literature, authors widely agree that the most frequently encountered causes for insufficient synergy realization are (Palmatier; Schweiger): Synergies that are either not present or exaggerated by the buyer. Synergies that cannot be effectively realized due to integration difficulties As already argued when discussing performance studies (refer to chapter 3) formal merger consideration (pre-M&A and due diligence) still begins and ends far too often with the analysis of financial indices only (such as stock price, earning, tangible and intangible assets, investments, assets, liabilities, revenues/expenses, accounting and budgeting practices etc.) instead of reviewing also strategic logic, valuation of synergy potential and detailed planning of synergy realization, organizational fit and the ability to merge cultures (Epstein). In particular, management fails to think through integration and synergy realization at the very beginning of an M&A project having no detailed conception and action plan on how value should be generated (Cartwright; Palmatier). The literature has not yet addressed exactly how much synergy or performance gains would be generated if the various integration problems did not occur (Sirower).
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Further, researchers have not yet offered propositions regarding the prediction of when problems are more likely to occur and how managers may react when these problems persist. Additionally, one has to consider the temporal nature of synergy as an important factor limiting the value of performance improvements. Synergies tomorrow are not as valuable as synergies today. For example, synergies expected at some point in the future give competitors more time to compete them away before they even occur (or e.g. the synergies like knowledge and patents get obsolete with time). If synergies are expected to come from short-term increasing sales they must emerge from cross-selling opportunities. Cross-Selling opportunities exist, however, mostly not to the extent expected. Performance improvements on the other hand may take years to develop. It is well known that realizing operating synergies (e.g. economies of scale) or standardization and coordination of business processes can take several years and can turn out to be extremely complex and difficult management tasks with huge conflict potential. But given the required performance improvements embedded in most acquisition premiums, the gains need to begin immediately, otherwise value will be destroyed. If these improvements occur far down the road, they may have little value (Schweiger).
7.3
Negative synergies
While the term negative synergies often is related to an internal firm perspective considering integration, culture and communication difficulties (refer to chapter 6) the outside perspective is mostly neglected (Epstein). Questions how integration difficulties or endangered synergy realization might impact customers and other stakeholders arise in this context: What is the influence on customer satisfaction and long-term innovation capabilities when closing factories or subsidiaries or laying off of redundant employees? How can a firm anticipate customers uncertainty about future quality, support and service and general relationship? With which means can a firm prevent confusion of customers through a product offering that can not longer be overseen?
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What dangers arise when channel partners are changed? Critical to synergy in general is to leverage the realization potential without additional costs. As an example, costs of managing an external relationship to a supplier may be replaced by internal coordination costs. Or the gains from a more complete product portfolio might be offset by the dilution of the sales force. Summarizing, while synergy sometimes is explained as one plus one equals three, it seems that a much better explanation is one plus one equals 2.1 (Sirower).
7.4
An example on the difficulties of synergy assessment and realization
Cloodt in his studies argues that technological learning is expected to be a key determinant in creating and sustaining a competitive advantage for industries that are mainly knowledge driven. These opportunities increase when a firm is exposed to new ideas based on differences in technological capabilities between the acquiring and the acquired firm. The unification of two related knowledge bases can provide opportunities for synergies in future innovation and shorter innovation lead-time while reducing redundant R&D efforts. However, a few difficulties can rapidly be identified even with very obvious synergy potentials: Some degree of differentiation in technological capabilities between the two firms may enrich the acquiring firms knowledge base and create opportunities for learning. However, technological knowledge and engineering capabilities that are too similar to the already existing knowledge of the acquiring company will contribute little to the post-M&A innovation performance (James). The challenge for companies is not just to acquire knowledge bases but also to transfer and integrate them in order to improve the post-M&A innovation performance. The integration of a knowledge base that is of a relatively large size can disrupt existing innovative activities and render the different integration stages more complex, more time consuming and full of risks (DiGuarda). As a result synergies are often overestimated while in fact an M&A leaves fewer resources for the actual innovative endeavor until the knowledge base is integrated.
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Studies of knowledge transfer across (and within) firms show that in the early stages, the perception of the partners trustworthiness, competence, and professional status are determinant factors in the decision to transfer knowledge or not (Irrmann). If this perception is damaged in the course of overall integration difficulties the transfer of knowledge and the corresponding realization of synergies might be seriously endangered. Knowledge depreciates and loses its value over time. The rate at which the value of knowledge depreciates is likely to vary across industries but it is especially high in technology intensive industries. For companies in high-tech industries even quite recent knowledge dating a couple of years or months already becomes less valuable or obsolete and thus this knowledge plays a positive role only a limited period of time after an M&A has taken place. Concluding, a firms absorptive capacity for knowledge transfer and integration and the right degree of differentiation in technological capabilities put severe limitations onto synergy realization. The valuation of intangible assets as knowledge and technology in the light of synergy potential might prove to be even more difficult.
7.5
Strategic logic
Bad motives (e.g. excessive confidence, agency and hubris, external pressure) are obvious reasons why a firm might not reach performance targets. A prominent reason reported by Epstein for M&A failure in this context is that the availability of target firms determines the strategy of the acquiring company. Such illegitimate strategic logic might be induced by a competitors action spreading the fear of no suitable targets being left for an M&A deal. Thus, the strategic vision of a company should clearly articulate an M&A rationale that is centered on the creation of long-term competitive advantage. Whether and how much synergy exists in a particular acquisition is likely to be a function of the strategic objectives driving a deal. While integration or culture issues often are reported as the main reason for an M&A project to fail or not to reach the required performance, insufficient strategic logic interestingly is hardly considered as a reason for failure (Epstein). Thus, a central question arises here: To which extent does an insufficient strategic logic endanger M&A
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success or to which extent difficulties can be attributed to the integration problematic itself? At first glance, rather simple questions like the following might be straightforward to answer: How big is the overlap in products and territories with the target firm? How similar are the markets between the combined firms based on their customer groups? How complementary are the production processes between the combined firms based on their required resources? However, according to Palmatier and Ghauri an acquiring firm has only a partial knowledge of customers, products, and channels and has a biased perspective (asymmetric information). As a result, estimation of strategic fit and synergy potential, choice of integration level and anticipation of negative synergies based on uncertain or even incorrect information can subsequently cause major integration difficulties and can indeed cultivate culture dissonance. A study on post-M&A integration by Ravenscraft and Scherer (in Datta) supports these findings. They conclude that, on average, acquiring firms have not been able to maintain the pre-merger levels of profitability of the targets. They argue that an acquiring firm does not know enough about the potential of the company it is buying and consequently can unconsciously destroy success factors of the target firm.
7.6
Interview studies
Beside these most prominent reasons for M&A failure discussed above Lucks in his interview studies reports various other reasons for failure or dangers for synergy realization that were reported by management and key employees (in no particular order): Management, key people and employee departure No participation of middle management during strategic planning, due diligence and integration
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Double burden of managers, dilution of management attention onto the main business Underestimation of acquisition (legal, advisory, due diligence) and integration (conflict resolution, standardization, IT) costs Missing internal and external dedicated people No consideration of expectation of partner firm No clear assignment of competencies Unprofessional communication (partners, employees, shareholders, media, customers etc.) Bounded rationality (M&A being an overly complex task that cannot be fully captured anymore)
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Alternatives to mergers and acquisitions
In order to pool assets, combine resources and exploit synergies, firms can either permanently merge their operations within a new legal entity through an M&A project or they can choose to collaborate on well defined and limited areas of business while retaining their strategic and legal autonomy through forming an alliance, a co-operation or a joint venture. Both strategies make it possible to capture business opportunities that neither partner could pursue alone. Alliances, co-operations and joint ventures are very different in nature. However, they are all feasible alternatives to industry concentration through mergers and acquisitions since they can produce some of the effects that could also be obtained from merging partner firms. They can be an attractive move to expand and capture valuable capabilities without running the high risk of failure and without having to pay the premium attached to an acquisition. These alternatives make it possible to avoid the culture and organization shock to a certain extent by proceeding step-by-step and by gradually adapt to the partner. From such a perspective, they provide not only an alternative to M&A deals but also can be a first step toward a merger during which partners can learn about each other and uncertainty can be reduced. Alliances, co-operations and joint ventures also share a similar set of motives as do mergers and acquisitions projects (refer to chapter 4). However, the literature indentifies a few additional specific motives for such common business activities, in particular the possibility to: spread costs and risks across partner firms, collaborate with a less rigid arrangement allowing for fast formation and break up (e.g. to react to highly volatile demand or to react to rapid changes in product technology), collaborate in a project- or business-specific manner with the option for an enduring business relationship. Beside these evident advantages of such alternative business activities there are also some shortcomings due to the inherent setup of those. Any rationalization pursued with
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those alternatives will be limited in scope and effectiveness because of some characteristics that distinguish them from mergers and acquisitions: All decisions must be made by consensus among the partner firms. One of the parties cannot force the other to accept any particular solution. And even if one of the partners dominates the alliance, it would be unwise for it to enforce too many of its own decisions against the wishes of the partner. Such a behavior would very likely lead to the collapse of the alliance. This multiplication of decision-making centers (Garrette) makes it considerably longer and more complex (if not paralyzing) to decide on controversial issues as e.g. innovation and product development, eliminating redundant assets, rationalizing product lines etc. Alliances and co-operations are temporary in nature and must remain reversible. By definition it has to be possible to terminate alliances without putting both partner firms at risk. One of the basic justifications for choosing alliances over more permanent forms of organization is exactly that they can be undone relatively easily. As a result achieving economies of scale is rather difficult because it makes terminating the alliance practically impossible. Garrette et al. argue that for firms seeking to achieve economies of scale, a complete merger will allow for a greater rationalization than alliances. This reasoning, however, remains questionable in the light of limited synergy realization reported in the literature and the many difficulties during integration in M&A projects discussed so far. Risk of learning and skill/technology transfer A study by Garrette et al. shows that a vast majority (75%) of inter-continental alliances are formed mainly to benefit from complementarity, while intraEuropean alliances, on the contrary, predominantly seek to benefit from increased economies of scale (84%). If one of the partners uses the alliance or co-operation to progressively capture the knowledge contributed by the other the initial complementarity of the alliance is eroded away by the learning taking place between the firms. Then, the entire raison dtre of the partnership disappears. As learning is usually not
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simultaneous and reciprocal one of the partners becomes able to operate on its own while the other continuously depends heavily on the partnership. In such cases, it is not unusual that the partner that has succeeded in acquiring all the necessary skills terminates the partnership while keeping the formerly common business running on his own. Such learning phenomenon is unusual with scale alliances since both partners have very similar skills and little to learn from each other such that no major competencies are transferred:
Fig. 8.1: The outcomes of scale and complementary alliance regarding skill transfer (Garrette).
Some countries, such as the People's Republic of China and to some extent India, require foreign companies to form joint ventures with domestic firms in order to enter a market. This requirement often forces technology and knowledge transfers to the domestic partner.
Summarizing, managers should consciously balance the reasons for and against an M&A deal and consider alternatives. Beside alliances, co-operations and joint ventures, a strategys objectives eventually can be achieved by internal investments. As an example, Dickerson et al. (in Ghauri) show that company growth through acquisition yielded a lower rate of return than growth through internal investment. However, starting a new business from scratch does not impose the disadvantages of M&A projects on a firm but brings with its own difficulties.
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Reasoning of M&A activity in an early project phase
Independent of the motives for an M&A project, the acquiring company must evaluate whether both firms are proper choices as merger partners and the right fit to fulfill the strategic vision. No set of questions could fully capture a phenomenon as complex as M&A. However, as a summary, the following guideline shall represent all merger and acquisition matters discussed throughout this work in a condensed form to prevent managers from one-sided and poorly thought-through decisions and common dangers putting a high risk to the M&A project. Without plausible response to these fundamental questions on strategic logic and some preliminary integration matters, acquirers are on their way to losing the acquisition game from the beginning even before the due diligence or even the integration starts to happen:
9.1
The acquiring companys strategy

What are your companys competitive gaps (weaknesses, strengths) and challenges (threats, opportunities) in a given market? Is your companys strategy independent of M&A as a strategic option and independent of acquisition candidates available on the market?
9.2
M&A motives
How can a merger and acquisition support your companys strategy? Which types of motive are considered: exploitation, exploration, preservation or survival? Rational or irrational? What is the relevance of an M&A for the implementation of the overall strategy? To which class of M&As does the project belong: horizontal, vertical, conglomerate or congeneric?
9.3
Strategic fit between target and acquiring firm

Does the target company improve the acquiring firms competitive advantage? Which attributes does a target company need to fit into the strategy?
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What is the degree of diversification: focus-increasing or focus-decreasing?
9.4
Sources of synergies and price premium

What are the stand-alone expectations of acquirer and target? What types of synergy potential exists? - modular, reciprocal or sequential? - complementarity or similarity? - cost, revenue, intangibles? Schweiger et al. assess synergy potential depending on the strategic objective for an M&A (Fig. 9.1):
Fig. 9.1: Linking strategic objectives and synergies (Schweiger).
Value assessment: Where will performance gains emerge in detail as a result of the M&A? How big are these gains? What is the time-frame for realization? Does the value of synergies depend on time? Risk assessment: What is the severity of non-achievement to M&A objectives?
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What is the probability of non-achievement? What is the degree of control and detectability to these risks? Measurement: How is the progression of the project measured? How is M&A project success and failure defined?
9.5
Integration, transformation and culture

What are the major integration necessities in the target and in the acquiring firm? Which integration efforts are required: consolidation, standardization or coordination? What is an appropriate level of integration to realize the synergies defined? Which integration scenarios do exist? What are the milestones of the implementation plan? Who are the key managers and employees responsible for the implementation? Which are the critical success factors of the target company? Are they preserved or diminished by the pursuit strategy? Which actions are taken to prevent destroying these success factors? What incentives exist to foster M&A integration for acquiring and acquired firm management and employees? Does the target company fit the national and corporate culture of the acquiring company?
9.6
Costs and negative synergies

How big are the efforts and investments needed for synergy realization and integration? What are the impacts of the M&A project on internal and external stakeholders and on the core business? Which strategic considerations and integration processes might undermine synergy realization or even create negative synergies?
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Does cultural difference between target and acquiring firm foster or hinder postM&A integration? What additional investments will be required to anticipate negative synergies or resolve conflicts?
9.7
Competitions reaction
Which competitors are affected by the pursuit M&A? How will those competitors respond? How will the response concern the M&A projects objectives?
9.8
Alternative business collaborations

Which objectives and performance gains cannot be realized with alternative investments? Which risks and costs could be prevented by alternative business collaboration? What are the ratios between gains and risks, gains and costs for M&A and feasible alternatives?
Dyer evaluates alternatives according to five criteria: type of synergy potential, ratio between intangible and tangible resources, amount of redundancy, market uncertainty, and intensity of competition for resources (Fig. 9.2):
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Fig. 9.2: Evaluation of alternative business collaborations according to the criteria type of synergy potential, ratio between intangible and tangible resources, amount of redundancy, market uncertainty, and intensity of competition for resources (Dyer).
Taking into account all these matters the all-dominant questions are: Can the acquiring firm extract more value from the target firm than the current owners? The value extracted will be more than the price paid for the assets?
Picot illustrates in a qualitative and simple example how managers should see their merger and acquisition evaluation in a summary (Fig. 9.3):
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Fig. 9.3: Determination of net value of a merger and acquisition deal in the light of acquiring and target firm value, synergy value, transaction costs, value of alternatives, price and price premium paid (Picot).
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10 Conclusion
The overall conclusion from hundreds of studies is that most mergers and acquisitions fail to achieve superior financial performance but have a modest negative effect on the long-term performance of acquiring firms. According to a KPMG study in 2000, 83% of deals failed to deliver shareholder value and an alarming 53% even destroyed value. Sirower in his book The Synergy Trap argues: So many mergers fail to deliver what they promise that there should be a presumption of failure. Despite decades of research, what impacts the financial performance of firms engaging in M&A activity remains largely vague, unexplained or full of contradicting evidence in particular from a strategic management perspective. A research stream is best characterized to be mature when (1) a substantial number of empirical studies have been conducted, (2) these studies have generated reasonably consistent and interpretable findings, and (3) the research has led to a general consensus concerning the nature of key relationships (Palich). The M&A performance literature fails to satisfy the last two criteria. That fact is troubling since no significant and generally valid success factors for M&A deals that drive the success can be extracted. Haspeslagh and Jemison in their studies have argued that nothing can be said or learned about acquisitions in general. It would be unfortunate if this were the only wisdom one could offer managers gambling with shareholder resources. Altogether it seems that managers must still suffer from an overdependence on intuition due to missing significant results from research on M&As and the many conflicting findings reported in the literature. The present work uncovers two major shortcomings of most and even todays M&A performance studies that might reason the widely reported vagueness and lacking evidence: methodology of the studies and their M&A motive assumption. Regarding methodology, most researchers have studied M&A performance on populations of deals with little regard to the characteristics of those deals, for example vertical vs. horizontal M&As, level of integration, size of deal, culture concerns etc. In particular, strategic logic and insufficiencies thereof have been widely neglected. However, context is important since specific matters of dissimilar types of deals may not generalize very well. As a consequence, it does not astonish that these studies could not extract significant success factors and argue on downsides of mergers and acquisitions being of value for
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practitioners. Concerning motives, the vast majority of studies assume that M&A deals must improve returns to shareholders. However, this ignores many other legitimate and illegitimate motives for M&A activities beside synergy realization and that managerial actions could be in the best interest of the firm and still may not result in improved firm value from that transaction. Based on the deficiencies of performance studies on generally valid strategic success factors, the present work offers then a more complete overview on M&A motives in an early project stage reviewing the research literature and consultant surveys and incorporating expert interviews and manager surveys. The broad set of rational and irrational motivations presented, first, allows a much more subtle assessment of postM&A firm performance, second, simplifies a sound review of strategic logic and reasoning for M&A activity and, third, opens a much broader view on upcoming integration and transformation difficulties like negative synergies and culture concerns. A framework is presented then to assess an M&A project and its characteristics on an individual basis to increase the likelihood of success. No guide or checklist could fully capture a phenomenon as complex as M&As since they involve the interaction of a large number of target and acquiring firm variables. However, the sporadic nature of M&As and their dissimilarity from mangers regular experience make a condensed framework as presented throughout this work a valuable tool that shall prevent managers from onesided and poorly thought-through decisions and common dangers putting a high risk to the M&A project and the acquiring firm. Without plausible response to fundamental questions on strategic logic and some preliminary integration matters, acquirers are on their way to lose the acquisition game from the beginning even before the due diligence or even the integration starts to happen. It is not that mergers and acquisitions cannot succeed - but there are many barriers to be overcome and pitfalls to be avoided: A firm that takes over another firm makes two assumptions. The first is that the acquiring firm can extract more value from the same assets than the current owners. The second assumption is that the value extracted will be more than the price paid for the assets. The fact that these assumptions are often incorrect is the core reason why many merger and acquisition projects fail as profit enhancing tool. Insufficient synergy realization is mainly caused by synergies that are either not present or exaggerated by the buyer, or, by synergies that cannot be effectively realized due to integration difficulties. A study by Sirower found that of 168 deals analyzed, roughly twothird of all companies studied too often think they can generate synergy faster, in greater
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amounts and with less additional costs than is really possible. In particular, management fails to think through integration and synergy realization at the very beginning of an M&A project having no detailed conception and action plan on how value should be generated. Independent of the underlying motives for an M&A project, during postmerger integration many different matters must be carefully blended such as for example different strategies, brands, product portfolios, production processes, knowledge and technology, pricing policy, support functions, sourcing and distribution partners, administrative policies and processes including the management of human resources, technical operations, marketing activities and customer relationships. Depending on the level of integration such a blending imposes many difficulties and pitfalls for synergy realization and for reaching other M&A objectives. Formal considerations in a pre-M&A phase on the other hand still begin and end far too often with the analysis of financial indices only instead of reviewing also strategic logic of target firm selection, valuation of synergy potential and detailed planning of synergy realization, anticipation of negative synergies, considerations of additional human and monetary resources required for implementation, knowhow management, assessment of organizational fit between target and acquiring firm, preservation of the target firms success factors, the ability to merge two organizational or national cultures and the consideration of feasible alternative business collaborations beside M&A.
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Acknowledgement
First of all, I would like to thank Prof. Dr. Georg Von Krogh for giving me the opportunity to complete my master thesis at his chair in Strategic Management at ETH Zurich. In particular, I thank his PhD student Matthias Strmer for the supervision of my thesis, for his helpful and careful discussions and for his guidance.
I would like to express my appreciation to Mr. Thomas Kehl as the head of the strategic business unit MatChar at Mettler-Toledo AG and to Mr. Urs Jrimann as the head of the marketing and product management department for providing me the great chance to carry out my studies and my master thesis during my position as product and marketing manager. I very much appreciated that you took charge of my work and I acknowledge the generous financial funding of Mettler-Toledo AG.
Finally, I would like to give my very special thank to my girlfriend Victoria for another important support while completing my thesis and during my whole studies your love, your understanding and your impulsive power! I would not have accomplished my master degree as fast and as successful without you. Thank you very much!
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Literature
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The Fundamentals of Strategic Logic and Integration for Merger and Acquisition Projects

Master Thesis in the course of study

Management, Economics and Technology

METTLER TOLEDO AG Analytical Sonnenbergstrasse 74 8603 Schwerzenbach Switzerland

Master Thesis D-MTEC, ETHZ

Date of submission: August 17, 2008

Master Thesis D-MTEC, ETHZ

Master Thesis D-MTEC, ETHZ

Master Thesis D-MTEC, ETHZ

Master Thesis D-MTEC, ETHZ

Master Thesis D-MTEC, ETHZ

Objectives, perspective and limitations of this work

Metz in his studies argues:

Master Thesis D-MTEC, ETHZ

Classification of mergers and acquisitions

Master Thesis D-MTEC, ETHZ

Classification according to companies relatedness

Merger and acquisition as used throughout this work

Master Thesis D-MTEC, ETHZ

Post-M&A firm performance studies

Motivation to consider performance studies

How is post-M&A firm performance measured?

Master Thesis D-MTEC, ETHZ

What is failure and success?

Factors with and without relationship to post-M&A performance

Master Thesis D-MTEC, ETHZ

Master Thesis D-MTEC, ETHZ

Master Thesis D-MTEC, ETHZ

Master Thesis D-MTEC, ETHZ

Master Thesis D-MTEC, ETHZ

Criticism on performance study methodology

Master Thesis D-MTEC, ETHZ

Master Thesis D-MTEC, ETHZ

Motives for merger and acquisition activity

Master Thesis D-MTEC, ETHZ

Exploitation (synergy motives)

Master Thesis D-MTEC, ETHZ

Master Thesis D-MTEC, ETHZ

Synergies from intangibles

Master Thesis D-MTEC, ETHZ

Preservation and survival

Master Thesis D-MTEC, ETHZ

Managers self-interest and prestige

Master Thesis D-MTEC, ETHZ

Master Thesis D-MTEC, ETHZ

Post-M&A integration and transformation

Master Thesis D-MTEC, ETHZ

What is an adequate level of integration?

Master Thesis D-MTEC, ETHZ

Master Thesis D-MTEC, ETHZ

What are the difficulties and dangers during integration?

Under- and overintegration or the appropriate level of integration

Master Thesis D-MTEC, ETHZ

Post-merger management of projected positive and negative synergies

Angwin in his studies argues:

Communication to internal and external stakeholders

Master Thesis D-MTEC, ETHZ

Cultural fit and anticipation of culture dissonance

Master Thesis D-MTEC, ETHZ

National and organizational culture and culture clashes

What is culture in the M&A context?

Which forms of acculturation exist?