Failure mergers

It’s no secret that plenty of mergers don’t work. Those who advocate mergers will argue that the merger will cut costs or boost revenues by more than enough to justify the price premium. It can sound so simple: just combine computer systems, merge a few departments, use sheer size to force down the price of supplies and the merged giant should be more profitable than its parts. In theory, 1+1 = 3 sounds great, but in practice, things can go awry.

Historical trends show that roughly two thirds of big mergers will disappoint on their own terms, which means they will lose value on the stock market. The motivations that drive mergers can be flawed and efficiencies from economies of scale may prove elusive. In many cases, the problems associated with trying to make merged companies work are all too concrete.
Coping with a merger can make top managers spread their time too thinly and neglect their core business, spelling doom. Too often, potential difficulties seem trivial to managers caught up in the thrill of the big deal.
The chances for success are further hampered if the corporate cultures of the companies are very different. When a company is acquired, the decision is typically based on product or market synergies, but cultural differences are often ignored. It’s a mistake to assume that personnel issues are easily overcome. For example, employees at a target company might be accustomed to easy access to top management, flexible work schedules or even a relaxed dress code. These aspects of a working environment may not seem significant, but if new management removes them, the result can be resentment and shrinking productivity.

WHAT IS A FAILED MERGER?

A failed merger can be understood in two ways: Qualitatively, whatever the companies had in mind that caused them to merge in the first place doesn’t work out that way in the end. Quantitatively, shareholders suffer because operating results deteriorate instead of improve.

     Studies reveal that approximately 40% to 80% of mergers and acquisitions prove to be disappointing. The reason is that their value on the stock market deteriorates. The intentions and motivations for effecting mergers and acquisitions must be evaluated for the process to be a success. It is believed that when two companies merge the combined output will increase the productivity of the merged companies. This is referred to as “economies of scale.” However, this increase in productivity does not always materialize.

 

Here’s a list of notorious failed mergers that evaluated in one way or another: AOL/Time Warner, HP/Compaq, Alcatel/Lucent, Daimler Benz/Chrysler, Excite/@Home, JDS Uniphase/SDL, Mattel/The Learning Company, Borland/Ashton Tate, Novell/WordPerfect, and National Semiconductor/Fairchild Semiconductor.

Some failed so spectacularly that the combined company went down the tubes, others resulted in the demise of the executive(s) that masterminded them, some later reversed themselves, and others were just plain dumb ideas that were doomed from the start.

There are several reasons merger or an acquisition failure. Some of the prominent causes are summarized below:

• If a merger or acquisition is planned depending on the (bullish) conditions prevailing in the stock market, it may be risky.
• There are times when a merger or an acquisition may be effected for the purpose of “seeking glory,” rather than viewing it as a corporate strategy to fulfill the needs of the company. Regardless of the organizational goal, these top level executives are more interested in satisfying their “executive ego.”
• In addition to the above, failure may also occur if a merger takes place as a defensive measure to neutralize the adverse effects of globalization and a dynamic corporate environment.
• Failures may result if the two unifying companies embrace different “corporate cultures.”

It is traditional to assume that acquisitions fail. In 1987, Harvard professor Michael Porter observed that between 50 and 60% of acquisitions were failures. There have been several other studies since then, and the results have continued to support his conclusions. In 1995, for example, Mercer Management Consulting noted that between 1984 and 1994, 60% of the firms in the “Business Week 500″ that had made a major acquisition were less profitable than their industry. In 2004, McKinsey calculated that only 23% of acquisitions have a positive return on investment. Academic research in strategy and business economics have taken these conclusions further, suggesting that acquisitions destroy value for the acquiring firm’s shareholders, although they create value for the shareholders of the target firm, something that was confirmed by a recent study carried out by the Boston Consulting Group (2007). Of course results vary depending on the type of acquisition, the similarity of the two protagonists’ industry, the international or domestic nature of the operation, etc., but the overall trend remains the same.

It would not be correct to say that all mergers and acquisitions fail. There are many examples of mergers that have boosted the performance of a company and addressed the well-being of its shareholders. The primary issue to focus on is how realistic the goals of the prospective merger are.

 

Companies merge when, for one reason or another, their strategic plans indicate they should.

That being the case, there must also be operating synergies between the two companies. In a nutshell, that means the whole will be financially healthier than the sum of the parts. Said differently, at some point after the merger is complete and the companies are integrated with redundant functions eliminated, shareholder value increased. It’s that simple theoretically.

Apart from the above mentioned reasons, given below are some more reasons which result in failed mergers:

1. Lack of Communication
2. Lack of Direct Involvement by Human Resources
3. Lack of Training
4. Loss of Key People and Talented Employees
5. Loss of Customers
6. Corporate Cultural Clash
7. Power Politics
8. Inadequate Planning

 

While it is true that some of these failures can be largely attributed to financial and

market factors, many studies are pointing to the neglect of human resources issues as the

main reason for M&A failures. A 1997 PricewaterhouseCoopers global study concluded

that lack of management and related organizational aspects contribute significantly to disappointing post-merger results.

  Provided that they have equal or less information than their management, shareholders of each firm accept the merger agreement. The merger goes then ahead and fails. This happens because the obtained synergy gains do not compensate the costs of merging.

Accordingly, these mergers are unprofitable. Share prices, on the other hand, can

rise at the moment of the merger announcement if markets do not have merging firms’

private information about the synergy gains.

 

A majority of corporate mergers fail. Failure occurs, on average, in every sense:

acquiring firm stock prices tend to slightly fall when mergers are announced; many acquired companies are later sold off; and profitability of the acquired firm is lower after the merger (relative to comparable non merged firms).

One of the main difficulties in measuring acquisition performance lies in the assessment methods used. These methods include measuring the stock market reaction, valuing the whole entity after acquisition, abnormal returns, synergies and economies of scale, to name just the most common. However, they all lack the capacity to isolate the sole impact of the acquisition on the firm’s value from the plethora of events that occur in these circumstances. When one assess the stock market reactions to an acquisition over a 180-day window, a number of other events have impacted on the share value during this period. At best these methods allow us to measure the financial markets’ short-term reaction.

Many business commentators are now acknowledging that failure does not have its roots simply in financial, monetary and legal issues but in lack of intercultural synergy. Research suggests that up to 65% of failed mergers and acquisitions are due to ‘people issues’, i.e. intercultural differences causing communication breakdowns that result in poor productivity.

DAIMLERCHRYSLER MERGER, A CULTURAL MISMATCH?

A recent example of such intercultural failure has been that of DaimlerChrysler.  Both sides in the partnership set out to show that intercultural hurdles would and could be overcome in their global merger.  Recent articles in the Wall Street Journal and Business Week suggest however that DaimlerChrysler underestimated the influence of culture, and due to culture clash, almost two years later is still struggling to become a unified global organization.

In the period leading up to the Daimler-Chrysler merger, both firms were performing quite well (Chrysler was the most profitable American automaker), and there was widespread expectation that the merger would be successful (Cook 1998). People in both organizations expected that their “merger of equals” would allow each unit to benefit from the other’s strengths and capabilities. Stockholders in both companies overwhelmingly approved the merger and the stock prices and analyst predictions reflected this optimism.

 Performance after the merger, however, was entirely different, particularly at the Chrysler division. In the months it was found that the high rate of turnover among management at acquired firms was not related to poor prior performance, indicating that the turnover was not due to the pruning of underperforming management at the acquired firm.

Following the merger, the stock price fell by roughly one half since the immediate post merger high. The Chrysler division, which had been profitable prior to the merger, began losing money shortly afterwards and was expected to continue to do so for several years. In addition, there were significant layoffs at Chrysler following the merger (that had not been anticipated prior to the merger. Differences in culture between the two organizations were largely responsible for this failure.

 

Operations and management were not successfully integrated as “equals” because of the entirely different ways in which the Germans and Americans operated: while Daimler-Benz’s culture stressed a more formal and structured management style, Chrysler favored a more relaxed, freewheeling style (to which it owed a large part of its pre merger financial success). In addition, the two units traditionally held entirely different views on important things like pay scales and travel expenses. As a result of these differences and the German unit’s increasing dominance, performance and employee satisfaction at Chrysler took a steep downturn. There were large numbers of departures among key Chrysler executives and engineers, while the German unit became

increasingly dissatisfied with the performance of the Chrysler division. Chrysler employees, meanwhile, became extremely dissatisfied with what they perceived

as the source of their division’s problems: Daimler’s attempts to take over the entire organization and impose their culture on the whole firm failed.

 

       While cultural conflict often plays a large role in producing merger failure, it is often neglected when the benefits of a potential merger are examined. For instance, following the announcement of the AOL Time Warner deal, a front-page Wall Street Journal article (Murray et al. 2000) discussed possible determinants of success or failure for the merger (such as synergies, costs, competitor reaction, and so forth). The only clear discussion of possible cultural conflict is a single paragraph (out of a 60-column-inch article) revealing how the “different personalities” of AOL’s Steve Case and Time Warner’s Gerald Levin reflect cultural differences between the two firms. A similar article included a single paragraph entitled “What could go wrong with the synergy strategy.” Moreover, in these sorts of short, cursory, obligatory discussions of possible cultural conflict, there is rarely discussion of what steps might be taken if there is dramatic conflict. While culture may seem like a “small thing” when evaluating mergers, compared to product-market and resource synergies, we think the opposite is true because culture is pervasive. It affects how the everyday business of the firm gets done—whether there is shared understanding during meetings and in promotion policy, how priorities are set and whether they are uniformly recognized, whether promises that get made are carried out, whether the merger partners agree on how time should be spent, and so forth.

 

The guiding hypothesis is that an important component of failure is conflict between the merging firms’ cultural conventions for taking action, and an underestimation by merger partners of how severe, important, and persistent conflicts are. Cultural conventions emerge to make individual firms more efficient by creating a shared understanding that aids communication and action. However, when two joined firms differ in their conventions, this can create a source of conflict and misunderstanding that prevents the merged firm from realizing economic efficiency

Such discourse is highlighting the need for more intercultural training both within the framework of mergers and acquisitions and for key personnel such as managers and HR departments. In both instances culture is being ignored rather than being embraced and used positively.

Piero Morosini emphasizes that, “misunderstood national cultural differences have been cited as the most important factors behind the high failure rate of global JVs [joint ventures] and alliances.”

Morosini argues that when intercultural differences are ignored during the evaluation and negotiation stages of a merger, integration inevitably fails.  He adds that the manner in which an organization handles intercultural challenges is directly correlated with the performance of the merger in the post-integration stage and can mean the difference between long-term success or failure.

If intercultural understanding is to be recognized within the systems of processes of mergers and acquisitions, staff training is critical. It is the leaders, managers and HR personnel of companies that must have intercultural competency. However, it appears that companies are not investing enough in intercultural, or for that matter any, training.

In the Business Energy Survey, where 1,500 managers were surveyed, only a third had received training in the last 12 months. If management is receiving such low levels of support one can assume that other functions are receiving as much or even less.

STEPS TO AVOID FAILURE MERGERS:

Despite months of work, millions of dollars in fees, and a firm conviction that the transaction makes all the sense in the world, your merger is going down in flames. The two cultures are not meshing. Key talent is heading for the door. And everyone knows it.

One of the solutions put forward by researchers is to study acquisition survival. An acquisition is regarded as successful if, over a certain period of time (generally several years), it has remained in the hands of the acquiring firm. Studies on survival confirm the previously obtained results, in other words a failure rate of between 50 and 75%. Divestment as a success criterion poses a major problem, however: if an acquisition is sold off at the end of 4 years with a large profit, can we really consider it as a failure? Obviously not.

There are some transactions, such as the marriage of HP and Compaq, which are troubled from the start. There’s little anyone can do. Fortunately, this is far from the norm. More than two-thirds of transactions that fail do so at the execution stage. DaimlerChrysler, for example, neglected early on to establish a proper set of guiding principles based on the merger’s strategic intent, and then continued to misfire by failing to align leadership and integrate the cultures of the two organizations.

Bringing disparate groups of people together as one company takes real work and represents an effort that is often largely overlooked. Culture change management is not indulgent; it is a critical aspect of any transaction. However, simply acknowledging the issue or handing it off to specialists is not enough. Management must set a vision, align leadership around it, and hold substantive events to give employees a chance to participate. Detailed actions and well articulated expectations of behavior connect the culture plan to the business goals.

Companies must start to become more aware of these deficiencies and their possible future impacts. If the mergers and acquisitions of the future are to prove fruitful, companies must design and implement comprehensive intercultural training programs for staff; assess and tackle possible areas of intercultural difficulties prior to, during and after mergers and put into place mutually agreeable intercultural frameworks of understanding to act as guidelines for post-merger synergy.

These tasks should not be seen as reactive, damage limitation exercises but as a positive, proactive means of creating cohesion, maximizing efficiency and building a competitive advantage.