Despite their popularity as a vehicle for growth, mergers and acquisitions have a very poor track record. About two thirds of transactions fail to produce economies of scale or strategic benefits. Also, the majority not only fall short of expectations, they generate negative shareholder returns and cause serious long-term damage to the business.
The reasons why transactions fail are varied and depend on the type of business and management. But there are a number of commonalities that can be identified.
Overpayment, wrong deal structure, poor strategic fit, and poor operational, financial and managerial synergies are problems that generally reflect poor due diligence. Due diligence on synergies is more important than many businesses realise as it helps lower systemic risk and cost of capital.
Once you pass the due diligence hurdles, transaction failures usually happen for four main reasons:
- A focus on cost cutting over revenue generation.
- Indigestion – the target is too big to be absorbed.
- Culture clashes that reduce morale, resulting in staff turnover, customer losses and a fall in productivity.
- Poor execution.
Loss of revenue
One reason transactions fail is because the acquirer focuses on cost-cuts over revenue generation. Acquisitions are expensive and cost-cuts and job losses are needed to fund the purchase, often hurting customer satisfaction and revenue.
In an old but still regularly cited piece of research, McKinsey Consulting notes that small changes in revenue can outweigh major changes in cost savings. A merger with a one per cent shortfall in revenue growth requires a 25 per cent improvement in cost savings to compensate for the loss of revenue. Conversely, exceeding revenue-growth targets by only two per cent to three per cent can offset a 50 per cent failure on cost-reduction.
So revenue growth, not cost control, should be the focus post acquisition. To many, this seems to be counter-intuitive given the entire financial rationale of transaction is to save money through integration. But bringing technology together, culture and brands often punishes customers. A softly, softly approach is recommended, as is the adoption of strong internal and external communication programs.
Even if management is not obsessed with cost-cutting, integration is a time-consuming task that sucks resources from the business, which can result in a loss of customers and revenue momentum, which can prove the death knell for an M&A. This represents a catch-22 for businesses. Too big, and a company can be hard to absorb, too small and the percentage benefit of an acquisition can be too low. This requires a conscious balancing act on behalf of the acquirer in both the due diligence and execution phases.
Clashing corporate cultures can prove one of the most difficult hurdles to manage. Post-acquisition, managers tend to focus on financial, strategic and operational goals as integration at these levels is where the value of the purchase is realised. However, they often forget people make a company. It is the people that have generated the business’s success and will continue to do so. Just because companies operate in the same industry doesn’t mean they are interchangeable – it is often that very difference that attracts a customer. Again, the revenue-cost-cutting trade off matters. Takeovers spur fear, distrust, low morale, low productivity and loss of key staff and customers. Respect and strong internal communication are critical to handling this astutely.
Some transaction failures are due simply to poor execution. If you doubt your ability, hire professional help. Also remember it’s a numbers game. Companies that make frequent acquisitions develop experience in this area and tend to do them better than their peers.