“For every problem, there is a solution that is simple, neat, and wrong.”
― H.L. Mencken
Consolidation looks like the obvious play in a shrinking industry space: put two friendly competitors together, eliminate redundant / duplicative activities, pocket the savings and move along happily. Sounds simple and neat. Uh oh.
Newsflash: M&A isn’t easy to do really well. It’s tough. And it demands tough-minded and clear-thinking preparation that goes well beyond routine “due diligence.” Due diligence is usually insufficient — it uses old data to understand and describe a situation that will not be relevant to the marketplace in the immediate future. What’s missing is the hard work of assessing the future and how the business will compete after the deal is done.
While the investment bankers, accountants, and attorneys can get the deal mechanics done, the much harder stuff is all strategic and anything but mechanical. That’s because it isn’t merely about doing the deal itself. Rather, it is the process of making a single enterprise out of two separate ones so that the resulting enterprise has a durable competitive advantage. In other words, the hard stuff is what gives you confidence that the expectations for future performance are reasonable and attainable.
1. Deep or Due?
Due diligence is a funny term. In the M&A context it means “expected” and “adequate.” And the due diligence usually done is barely sufficient. Too often it skirts the strategic entirely. Thorny questions that will have a material impact on the marketplace effectiveness of the combined enterprise become the proverbial tin can being kicked down the road until after the deal is done. That serves the financial and legal specialists well, who want the deal completed quickly and cleanly. But I wouldn’t want to bet the farm on homework that’s barely “adequate”, and understood to be.
A strategic assessment is essential. How do the two firms go to market? Is one a cost leader and the other a customized solution leader? Is one high tech and the other high touch? In the marketplace, is there a competitive advantage that the combined enterprise can create that the acquiring company cannot create alone?
Here’s a simple example of an issue that should never be kicked down the road and decided later: which brand is going to survive? Be careful about how you answer that. When First Union Bank acquired Wachovia, they dumped the First Union name and took the Wachovia name. For many customers, that was a wolf now wrapped in sheepskin coat, but my point is that the decision was made in advance and the brand was a great deal of the value being acquired. First Union had fairly negative brand reputation while Wachovia had a great marketplace presence.
“A whole new brand” is a cop out, and typically tells me that no one knows the real value of either of the legacy brands as the courtship begins. And a brand new brand has no brand equity. Why on earth should we expect a deal to thrive that abandoned that value of two legacy brands in favor of a new one devoid of value at the outset?
2. Scale or Scope?
What are you trying to gain? Are you trying to get significantly bigger? Or are you trying to diversify the spaces in which you compete? Shy away from the latter.
Playing in more spaces isn’t lower risk than dominating the space you know best. If getting larger (revenue) gives you more resources to create new customer value, the deal will likely succeed. If the deal widens your scope it may overtax your management capacity even to understand the enterprise, much less lead it effectively. Creating a “micro-conglomerate” isn’t a recipe for competitive success for which I can find a single case example.
Gaining significant scale can be valuable, though. If your larger scale enables you to innovate more quickly and more consistently, if it gives you the resources to build new sources of customer value, that can be well worth the effort to acquire.
That’s why answering the “scale or scope” question is incredibly important. If the combined enterprise is going to be more challenging and more confusing to manage once the transaction is complete, run the other way.
3. Capability or Capacity?
If you’re gaining new capabilities that will enable you to do more for your primary, core customer segments, great. That’s likely to be very effective. You’re going to become more valuable to your current customers, the easiest people to whom you can sell more services and win more revenue.
However, if you’re simply getting “more of the same” capacity (“Oh boy, we’re going to have FOUR 40″, six-unit presses all with inline coating!”) what are you really gaining? The ratio of revenue to assets employed may not improve a whit while the risk climbs notably.
The trick is to avoid looking like a trade show floor (“We’ve got one of everything!”) at the end of the exercise without knowing what it will actually enable you to do that your customers will value.
Therefore, an acquisition candidate that provides a different suite of services into your current core markets will usually be much more useful than an acquisition of a firm that already looks much like yours.
4. Material or Marginal?
I’m not a fan of “tuck ins.” “Bolt-ons” can be better. Tuck-ins rarely amount to much more than an escape plan for the selling owner. To be worth doing, a deal should have a material impact both on revenue and profits at the end of the first year. If you don’t expect to increase revenues by at least a full third, and to double your net pretax profit dollars and percentage, why are you doing the deal? Any acquisition is so demanding (done well or not) that it needs to offer a big payday.
This is counter-intuitive because a smaller acquisition can look “safer.” The rub is that any acquisition is demanding and distracting. It is never as easy as snapping up the salespeople and customers who are worth keeping, relocating the equipment worth keeping, and liquidating everything else. So the anticipated gains need to be measured against the real difficulty and distraction of the post-deal integration. If the deal isn’t a game-changer for you, why bother?
So, look for acquisition opportunities that will redefine the scale of your business and the range of services you can provide to your core market segments and primary customers now. An acquisition that enables you to become much more important to your core customers could well be worth doing, especially if it is a sizable deal.
5. Serial or Single?
If you’re going to invest the effort necessary to learn to do this well (rather than be lead solely by the financial and legal specialists) why would you make that effort in order to do it only once? Instead, acquisitions need to be the core of your ten year plan for growth, and your intention from the beginning should be preparing for multiple deals.
Those firms that make the preparation, build the skills, and create the systems to manage the whole acquisition process understand that it only makes sense if you’re going to leverage it repeatedly. A good metaphor is building muscle: do it to use it.
Multiple, strategic, and serial acquisitions can build both scale and capabilities. In some cases, acquisitions can build competitive capabilities faster than you can grow them internally. That temptation can be incredibly seductive, and it needs to be tempered. It is most effective if you’re looking to gain completely new capabilities rather than simply better ones than you already have. And that doesn’t mean simply production or manufacturing capabilities either.
6. Strategy or Synergy?
Are you looking for a deal that offers strategic gains or merely one that offers synergistic gains. “Synergy” is, of course, the fig leaf used to refer to savings that comes from eliminating duplicated expense and duplicative staff. And it is important, particularly during valuation, to understand clearly what to pay for the acquisition.
The acquisition and integration costs need to be offset directly by the anticipated synergies over an appropriately short period. If they don’t cancel each other out, you’re paying too much. But the synergies are typically as short-lived as are the transaction and integration expenses when the objective of the deal is sustained, organic growth.
If there is a strategic marketplace advantage you can create through an acquisition, the acquisition is much more likely to succeed. If the benefit is primarily leveraging back office expenses across the combined entities, the deal is more likely to go sideways than deliver the anticipated results. Two struggling firms that believe they can get more breathing space together aren’t likely to do much with it if they lack a clear, strategic intent for what they are going to do in the marketplace and for their customers.
7. Focused Integration or Futile Integration?
Do you intend to integrate the existing enterprises completely — to the greatest degree possible? Why? What do you gain? Some of the smartest acquirers have learned that treating the existing enterprises as divisions can be much more productive than trying to force every possible integration. Is it really vital that every division look alike in every way? Resources are spent uselessly trying to achieve the sort of consistency Emerson was talking about when he said: “A foolish consistency is the hobgoblin of little minds.”
If there is nothing to be gained by making things consistent or identical, leave them alone. And the gain needs to be significant and financial. If the process of achieving consistency cannot be justified based on its one year payback, forget it. Instead, focus on where integration really matters. It rarely matters on the back end, but it matters much on the front end. Integrating the disparate parts of how you go to market matters a great deal. The objective is to have customers looking at the results of the deal, seeing that they won in the process, and continuing to rave about being your customers.
8. Market-facing or Myopic?
Too many deals infect the acquiring enterprise with a life-threatening case of what I call “four walls myopia.” Eyes get taken off the marketplace and turned inward. The attention paid to customers is cursory and short-lived (first 90 days) because all attention is trying to wring “synergies” out of the combined operation as fast as possible. Resolving critical market-facing and customer-facing integration needs become back-burner tasks. Customers defect, new business development wobbles, and the integration goes sideways.
I know it is heresy to urge you to focus on brand, business development, and customer retention ahead of anything else. But where those are the areas of primary focus the deals thrive. That’s why I warn against deals where no one is excited about what they will be able to do in the marketplace that they cannot do now. If you’re not a bigger, stronger, tougher competitor at the end of the day, why are you doing the deal in the first place? Why invest that much effort, expense, and risk if you’re not going to scare the heck out of your competitors once the deal is done?
A few weeks ago, I offered a viewpoint to understand the strategic implications of the RRD / CGX acquisition. Interestingly, industry analysts still question whether “synergies” will help justify the expense and difficulty of integrating CGX into RRD. I rather doubt that Tom Quinlan and the RRD leadership team is worried about it. They know there’s likely limited opportunity for “synergies” because Joe Davis has run a tight ship for decades. Davis hates unnecessary spending like Mr. Clean hates dirt. But if you consider the customer-facing aspects of the deal, it is genuinely strategic and very interesting. And it is being pursued by a team for whom this acquisition is anything but their first rodeo.
Strategic due diligence easily beats settling for the perfunctory, mechanical approach which focuses on the short-term risks and leaves the success of the deal to be sorted out at some future, post-transaction point in time. Strategic due diligence looks at the future rather than the target company’s past. It focuses on whether the acquisition will succeed, rather than on whether the deal can be done. And it digs into the strategic assumptions on which the acquisition is based, rather than solely working to avoid unpleasant surprises. It’s the vital effort that can make an acquisition (or series of acquisitions) genuinely strategic.
If you’re seriously considering an acquisition in the near term, what are the strategic criteria any deal needs to meet? And are you already preparing to do the necessary strategic due diligence to make yours one of the deals that delivers?
by Wayne M. Peterson, Principal
The Black Canyon Consulting Group Inc.
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