17 May
Executives approach a possible transaction with the steely resolve to be disciplined in negotiations. Accountants, investment bankers and lawyers are hired to assist internal resources in this process. Then somewhere along the line, this self-imposed discipline breaks down and the prices and terms which are accepted are much less attractive than planned.
I had the pleasure of collaborating with the head of M&A practice for a premiere New York law firm. His firm specializes in mergers and acquisitions and is involved in many of the largest transactions. I asked my colleague to explain the phenomenon in which executive teams start off with a disciplined approach to price and terms, only to see that discipline erode towards the end of negotiations. My friend laughed, and then gave a colorful explanation. He said that what happens at the start of the process is that the executives give instructions to advisors that they must get the deal done on the executives’ terms. With that mandate, the lawyers begin hard negotiations with the other side. Then somewhere along the way, the instruction changes to “win the deal”. While it is seldom said “Win the deal at all costs”, that is essentially the message.
My next question was, “What happened to cause this change?” My friend said, “Simple, it becomes personal”. That is, these transactions often go from a disciplined, business approach to personal competition of who will win. How this might happen is understandable given most executives are competitive by nature. “Winning” becomes defined as closing the deal, which shapes the approach taken by advisors to the executive team. My friend described this as “The Testosterone Factor”, in which primitive forces overshadowed good judgement.
My following question was, “How does that happen”? In other words, “how is this personal competitiveness enabled and explained”. My friend laughed and said just one word, “Synergies”. This is confusing if looked at from definition of synergies:
Synergies is defined as the cooperation and interaction between two or more organizations to produce a combined effect greater than the sum of their individual effects.
The definition of synergies is the essence of value creation in acquisitions, i.e., two companies combining to create more than either could individually. How then could synergies be “misused”? My friend said that in practice the financial values assigned to synergies is often based more on what is needed to reach the desired sales price, rather than an accurate projection of what will be achieved in post-acquisition integration. Said bluntly, synergies are a “plug” inserted into the financial models to make the transaction look prudent. Hence the seduction of synergies.
Seduction of Synergies
Synergies is the “cooperation and interaction between two or more organizations to produce a combined effect greater than the sum of their individual areas”. This greater effect can be anticipated through increased geographical reach, expanded market share, improved technologies, introduction of new products and services and reduction in costs due to elimination of redundancies and stream lining operations. Perhaps the most seductive of all synergies is this latter category of cost savings. Cost saving synergies are often a primary financial basis which justifies making the acquisition. That is, the purchase price to be paid for the acquisition is justified based on expected synergies from cost savings. These cost savings are based on eliminating redundant groups and positions. This practice is so common that a classic joke says that “the word synergy is unemployment spelled backwards”.
While this practice of identifying synergies as initial cost savings continues, the data does not really support the validity of this practice. Numerous studies have reported that the expected financial savings are not achieved. Further, these expected savings are not maintained over time. Among the reasons for are:
- The estimated cost savings are a mirage or myth. The numbers work in spreadsheets, but lack a basis in reality. Once the effort to reduce costs begins, it is discovered that the groups and functions are more intertwined with operating the business than understood by the analysts running the spreadsheets.
- Achieving sustainable cost reductions is complicated, and requires more than slashing departments and laying off people. Unless the work being done by those departments and people is eliminated or redesigned when the positions were eliminated, the costs will creep back. If only the people doing those roles went away, the work to be done stayed, and in some cases expanded due to complications of the combined organizations.
Accommodating the Seduction of Synergies
Once the transaction closes and post-acquisition integration begins, the challenge facing the integration project managers and teams is to create and capture as much value as possible. The predictable response is to close the gap with cost reductions. This usually means cutting deeper than originally planned. While this give appearance of responsible actions, it often has the opposite impact on achieving the expected long term synergies. A classic English expression which describes this is ‘Penny wise, pound foolish”.
We believe that synergies are best achieved by creating Breakthrough Projects. These projects teams are empowered to create new thinking which will produce sustained values. If cost reduction is needed, that can be reflected in the Charter for one of these Breakthrough Projects. The team is instructed to first focus on how to reduce the unnecessary work and only then explores if headcount reductions are required. These Breakthrough Projects focus on primarily on getting costs out, rather than getting people out. When a Breakthrough Project concludes that people reductions are inevitable, then the actions related to eliminating positions is more widely supported by employees and more effectively implemented.
Summary
The reduction in self-imposed discipline is often accelerated by the seduction of the types of synergies in mergers and acquisitions. Unfounded expectations are established for value creation from the combining of the two organizations. The task of achieving these unfounded expectations falls on the post-acquisition integration project managers and teams. Using Breakthrough Projects to accelerate value creation with synergies has proved to be very successful.
Half of M&A transactions fail to create value. Ever wonder why? Download our whitepaper ‘The Conundrum of People in M&A’, and understand the critical elements that impact mergers and acquisitions success or failure.
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- Eight common flaws in decision-making often made by executives in M&A transactions
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