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Mergers and acquisitions and takeovers: Buying another business is easy but making the merger a success is full of pitfalls

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The easiest task in management is buying another business. You only need to identify the target, work out how much you want to pay, and make your offer. True, complications may follow. The other party may resist, forcing you into a costly takeover battle. Investors may not take kindly to the proposal. But since some investors (those in the target business) will benefit, you will not be acting in a uniformly hostile climate. Like BMW buying Rover, or Daimler-Benz buying Chrysler, or Ford buying Volvo cars, you can hope to complete the transaction to general hosannas.

As the BMW-Rover case has shown so dramatically, the cheering can soon change to jeering. BMW has invested £2.8 billion in a business which at last report was losing £360,000 annually. Doing the deal, the easy part, leads directly into making the merger or acquisition work, which can be very hard indeed. The difficulty starts with the strategic objective. Why do you want the other business in the first place? If the objective is wrongly chosen, the next logical question, whether the chosen purchase will help to achieve that aim, is irrelevant. The deal is bound to fail.

There's nothing wrong with buying a business in principle. Some of the perfectly acceptable purposes are to acquire new turnover (and probably new customers): to obtain new facilities, from factories to shops; to add new products; to purchase new technology; to enter new markets. All these laudable aims could be achieved by organic means, but acquisition is quicker and easier - provided you obey the rules. Any deal should be able to pass stringent tests. Would-be purchasers, no matter what the size of company that's buying or being bought, need to answer these questions:

1. What strategic aims must be achieved for this purchase to be justified? Why do I really want it?
2. If those aims are achieved, what financial benefits (making profits and/or preventing losses) will be realised? Have I done my sums?
3. Do the benefits represent an attractive return on the costs? Does it make financial sense?
4. What are the chances of the aims not being achieved? Are they acceptable? Can I live with any outcome?
5. If the proposed purchase vaults the above hurdles, how is the merger to be implemented and by whom? Do I have a plan?
6. What framework will be established for the combined venture? How will the buy be fitted in?
7. How quickly can the buy be integrated and the benefits start to be won? Will I have to wait too long for it to work?

INTENSIFIED RISKS
The last question is clearly critical. If you're buying to save time, it makes no sense to get tangled up in a long and costly process of integration. The risks involved in mergers are intensified if this question and the other six do not get proper answers. In the BMW-Rover case, the strategy was to broaden the buyer's product line. But the first combined product, the Rover 75, is directly competitive with BMW's mid-range models. The other Rover cars were too old and uncompetitive to broaden anything: and the task of replacing them has been left far too late.

The task of getting any financial benefits, let alone adequate ones, was made exceedingly difficult by the fact that Rover's reported profits, once submitted to BMW's accounting principles, were turned into large losses. If the Germans did sufficient 'due diligence' before buying Rover from British Aerospace, they must have had a sublimely optimistic view of their chances of achieving their financial aims.

That optimism, of course, flew in the face of the evidence from past mergers. Successful combinations are far outweighed by the number that either fail demonstrably or produce inadequate returns. It's an interesting reverse of the demerger coin. When a company sells a business which proceeds to establish a far higher capital value in only a year or two, that must mean that the vendor management either under-managed the business, or sold it too cheaply, or most likely both. Vodafone, the mobile telephone supplier, for instance, was spun off from Racal. It is now valued at $33.6 billion, which is 33 times the valuation of its erstwhile parent.

The value in Vodafone was unlocked by unlocking the business. In fact, the record of spin-offs looks to be far better than that of acquisitions. ICI and Zeneca provide another example where the parent is now worth far less than the child: £25 billion against a mere £4 billion. Both these two mighty mites, interestingly, are now engaged in massive mergers: Zeneca with Astra, Vodafone with its US counterpart, Airtouch. The deals could extend the companies' triumphant runs: more likely, the great increase in size and the complications of any acquisition will offset some, if not all, of the benefits.


DIFFERENT CULTURES

Why should this be the case? Sheer enlargement provides part of the answer. The management span at the top becomes much wider, which imposes new strains. The managers' chances of coping successfully with their new burdens are reduced by the inevitable difficulties of accommodating two different cultures and pushing through downsizing measures which are bound to be resented by those affected - including those who stay behind. The upheavals of the early negative measures then exhaust the appetite for change, and needed positive action is postponed

Delay is deeply dangerous after acquisitions. In Rover's case, as one senior BMW manager told the Financial Times, 'We set out targets, but left them to get on with it. But nothing much happened'. But without developing the new models on which it has made so little progress, Rover cannot possibly hope to meet any worthwhile targets. The expert acquirer, if the bought business has such evident problems, plans the onslaught on the deficiencies before the takeover. The takeover ace then implements the planned actions with ruthless speed as soon as closer inspection has confirmed the plans.

However, Walter Hasselkus, the German installed at Rover by BMW, took much care in handling the 'very strong culture' at Rover - probably excessive care. He told Elizabeth Marx, author of Breaking Through Culture Shock, that 'At Rover we set our goals very high with the expectation that we will not quite hit them. If we hit 80%, that's OK. This is completely unacceptable to BMW. At BMW (maybe typical of a German organisation) the goals are clearly defined, and the expectation is that you reach these goals. Your goals may not be as high, but they are realistic'.

Frankly, this passage does much to explain just why Hasselkus lost his job, to be followed in a now celebrated boardroom putsch by the chief executive who appointed him, Berndt Pischetsrieder. Setting goals which you never meet is low-grade management in any language, including English. Allowing such behaviour to continue is fully as unacceptable. A company that meets only 80% of its goals, and is allowed to do so, will operate well below 100% in all aspects of its operations.

The 80% phenomenon helps to explain the success of spin-offs and the unsuccess of large multi-business companies. Subsidiary managements, even in growth businesses like mobile telephony and pharmaceuticals, negotiate the easiest targets they can. If the group management imposes higher numbers, the chances are that the targets will be missed. The group then faces an unpleasant choice between replacing the failed management or putting up with the failure. Even if the numbers are on target, they may well conceal poor performance in some of the subsidiary operations.

This was the case with Zeneca, where one £930 million division was making only 2.8% on sales under ICI management. That cannot have been the only case of under-management within the sprawling chemicals empire. So you have to wonder about the chances of much the same ICI managers successfully executing their very different master strategy. It sounded perfectly sensible. Spin off Zeneca to take advantage of the inflated price-earnings ratios of pharmaceuticals, and switch out of bulk chemicals, where margins are intrinsically low, and into speciality chemicals, where customers are relatively indifferent to price.

STRATEGIES MAKE SENSE
The strategy sounds perfectly sensible. Strategies nearly always do. What you are saying, after all, is that, if all goes according to plan, you will end up with a far superior business. Because outcomes lie in the future, nobody can prove you wrong: BMW might even have made a success out of Rover. But what manager has ever known anything go exactly according to plan?

The assumptions may be wrong. The market may change. The implementation may be flawed. If the strategy has been effected by acquisition, moreover, you may find the company burdened intolerably by the financial albatross that you have hung around its neck.

BMW, after paying its £800 million for Rover, invested the extra £2 billion mostly in the wrong places (the factories, not the products), with no sign of let-up in the annual losses. All this failure stemmed from the assumption that BMW, with its concentration on executive cars, produced in relatively small quantities, was strategically vulnerable in an industry dominated by far larger entities. Events since the buy have seen the giants get larger still. But this doesn't prove the strategic thesis. What if Ford, Daimler and the rest of the industry are wrong?

The tendency is to believe two theses. First, all those great brains, if they come to the same conclusion, can't be wrong. Second, bigger is better: bigger resources and greater economies of scale ineluctably mean better results and still better resources. But if that were so, how did BMW climb to its present eminence? It was a tiny player surrounded by giants when the wondrous ascent began. It is now relatively far more powerful. Honda's is an equally relevant example. In fragmenting markets, why should sheer size rule the roost? Even Ford's ability to build cars on the same platform all round the globe is only valuable if the fragmenting customers want those cars and are not tempted away by more attractive products.

As for the supposition that great minds think not only alike but right, merely contemplate what has happened to a grand strategy in pharmaceuticals. Giants like SmithKline Beecham are now having to sell recently purchased drug distribution companies for half the huge sums that they paid. The shared strategic idea was that owning distribution would strengthen the companies' holds over the prescriber market. That view turned out to be nonsense, as were the prices paid in the competitive struggle to jump on a bandwagon that was heading nowhere.

Bandwagon is the word. In early 1998, a top American manager, avidly bidding for a smaller financial services company, was asked by his advisors why he was so interested in the pursuit. 'Aw, shucks, fellers', he replied. 'All the other kids have got one'...

This childish attitude lies behind much of the theorising about why, to cope with intense competition, global and national, companies of all sizes have to reshape their strategies around mega-buys. Some, as in telecommunications, are vying with eachother to create networking supremacy. Others are reorganising round 'core businesses', disposing of superfluous interests and buying new ones to strengthen the core.

The trouble is that the new groupings thus created (as at ICI) still have no genuine coherence. For such a strategy to work, managers have to demerge on a far more thoroughgoing scale. The model here is Nokia, which made its exit from paper, tyres, metals, electronics (including PCs), cables and TV sets to devote itself to mobile telephony. The Finnish company has now knocked Motorola off its perch at the top of the industry, and has also outpaced and out-innovated Ericsson. Unlike these two diversified rivals, Nokia concentrates on its core - which is a real core, not just a playing with words. The reverse merging enabled it to manage brilliantly.

MANAGEMENT IMPERATIVES
The ease of acquisitions is thus highly misleading. Making the deal does not require management: making the deal work is a straight exercise in managing, both in the initial integration and in the subsequent joint development. The strategic argument must take second place to the management imperatives.

It doesn't matter whether the deal is in theory being used as the building block of a carefully planned new structure. The structure must still be made to operate as planned. Your plan may be to transform the business by imaginative linkages of formerly separate activities. The blend must still be made to appeal to the market. You can make one or two opportunistic key deals to achieve great leaps forward. But this splendid ambition, too, depends on post-acquisition practice.

Whatever the motivation, mergers and acquisitions are only as good as the management of the people affected. This is the least understood aspect of a management activity which, despite its enormous costs, risks and responsibilities, has been oddly neglected. There are innumerable books on corporate strategy: hardly any on overcoming the management problems of using mergers in pursuit of strategic ambitions. Just how do you guide managers towards the overriding goal - using amalgamation to achieve superior organic growth?

TRY SWOT ANALYSIS
If they have done their work properly before the acquisition, the managers will have proved that they have sound, logical reasons for the purchase - which is a key principle in itself. 'Aw, shucks, fellers, all the other kids have got one' leads but to the grave. To check the logic of any buy, try a SWOT analysis.

• What new Strengths will the buy bring to the company?
• How will management capitalise on those strengths?
• What are the Weaknesses of (a) the target and (b) the combined businesses?
• How will management eliminate the weaknesses?
• What Opportunities are available to the combined businesses that are not already available to the buyer?
• How will management seize those opportunites, if any?
• What Threats will the buy avert?
• What new Threats will be created by the acquisition?
• How does management propose to overcome the threats?

This analysis dovetails neatly with the key questions already mentioned. Why do I really want this buy? Have I done my sums? Does it make financial sense? Can I live with any outcome? Do I have a post-acquisition plan? How will the buy be fitted in? Will I have to wait too long for it to work? Both analysis and questions tend to encourage caution, which raises a real problem. Buying a business excites the animal juices in every type of management personality. The conservative manager sees it as confirming the company's strengths. The pragmatist thinks it will eliminate weaknesses and deal with threats. The visionary sees new vistas of taken opportunities.

So the normal, uneasy balance at the top of companies vanishes, to be replaced by unanimity, which, of course, is often mistaken. In other circumstances, the conservative wants nothing but the preservation of the status quo, the pragmatist will accept change, but only after it has been tried and proven somewhere else: and it's left to the visionary, often battling against the odds, to try and drive the company into the future. If organic ventures won the same enthusiasm and commitment as acquisitions, the latter would be needed far less as engines of growth.

The reason why Silicon Valley wonder-companies have enjoyed acquisition success far beyond the norm, despite whopping prices, is that the targets have mostly been small and have been picked off against a background of dynamic growth in the existing businesses. The buys, moreover, have been slotted into a receptive culture, in which new ideas are the key currency and visionaries dominate - led by a visionary chief executive who has delegated all operating duties to others. Let these attributes be a lesson to everybody - and it's one which can be easily learnt.


mergers and takeovers

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