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Integration Strategies for Mergers & Aquisitions

 

Rapid integration is more likely to result in a merger that achieves the acquirer’s expectations.  For our purposes, the term rapid is defined as relative to the pace of normal operations for a firm. A Consulting firm studied 100 global acquisitions, each valued at more than $500 million, and concluded that most post merger activities are completed within six months to one year and that integration done quickly generates the financial returns expected by shareholders and minimizes employee turnover and customer attrition. This does not mean that restructuring ends entirely within this time period. Integration may continue in terms of plant sales or closures for years following the acquisition. Almost one-half of acquirers either sell or close target firms’ plants within three years of the acquisition. Acquirers having more experience in managing the target’s plants are more likely to retain the target’s operations than those whose experience in operating such plants is limited. If we extend the period to five years following closing, plant divestitures and closures increase by an additional nine to ten percent.

Realizing Projected Financial Returns
A simple example demonstrates the importance of rapid integration to  realizing projected financial returns. Suppose a firm’s current market value of $100 million accurately reflects the firm’s future cash flows discounted at its cost of capital (i.e., the financial return the firm must earn or exceed to satisfy the expectations of its shareholders and lenders). Assume an acquirer is willing to pay a $25 million premium for this firm over its current share price, believing it can recover the premium by realizing cost savings resulting from integrating the two firms. The amount of cash the acquirer will have to generate to recover the premium will increase the longer it takes to integrate the target company. If the cost of capital is 10% and integration is completed by the end of the first year, the acquirer will have to earn $27.5 million by the end of the first year to recover the premium plus its cost of capital ($25 + ($25 × 0.10)). If integration is not completed until the end of the second year, the acquirer will have to earn an incremental cash flow of $30.25 million ($27.5 + ($27.5 × 0.10)), and so on.

The Impact of Employee Turnover
Although there is little evidence that firms necessarily experience an actual reduction in their total workforce following an acquisition, there is evidence of increased turnover among management and key employees after a corporate takeover.  Some loss of managers is intentional as part of an effort to eliminate redundancies and overlapping positions, but other managers quit during the integration turmoil. In many acquisitions, talent and management skills represent the primary value of the target company to the acquirer—especially in high technology and service companies, for which assets are largely the embodied knowledge of their employees—and it is difficult to measure whether employees that leave represent a significant “brain drain” or loss of key managers. If it does, though, this loss degrades the value of the target company, making the recovery of any premium paid to target shareholders difficult for the buyer.
The cost also may be high simply because the target firm’s top, experienced managers are removed as part of the integration process and replaced with new managers—who tend to have a high failure rate in general. When a firm selects an insider (i.e., a person already in the employ of the merged firms) to replace a top manager (e.g., a CEO), the failure rate of the successor (i.e., the successor is no longer with the firm 18 months later) is 34%. When the board selects an outside successor (i.e., one not currently employed by the merged firms) to replace the departing senior manager, the 18-month failure rate is 55%. Therefore, more than half of the time, an outside successor will not succeed, with an insider succeeding about two-thirds of the time. The cost of employee turnover does not stop with the loss of key employees. The loss of any significant number of employees can be very costly. Current employees have already been recruited and trained; lose them, and you will incur new recruitment and training costs to replace them with equally qualified employees. Moreover, the loss of employees is likely to reduce the morale and productivity of those who remain.

Acquisition-Related Customer Attrition
During normal operations, a business can expect a certain level of churn in its customer list. Depending on the industry, normal churn as a result of competitive conditions can be anywhere from 20 to 40%. A newly merged company will experience a loss of another 5 to 10% of its existing customers as a direct result of a merger,  reflecting uncertainty about on-time delivery and product quality and more aggressive post merger pricing by competitors. Moreover, many companies lose revenue momentum as they concentrate on realizing expected cost synergies. The loss of customers may continue well after closing.
Rapid Integration Does Not Mean Doing Everything at the Same Pace
Rapid integration may result in more immediate realization of synergies, but it also contributes to employee and customer attrition. Therefore, intelligent
integration involves managing these tradeoffs by quickly identifying and implementing projects that offer the most immediate payoff and deferring those whose disruption would result in the greatest revenue loss. Acquirers often postpone integrating data-processing and customer-service call centers until much later in the integration process if such activities are pivotal to maintaining on time delivery and high-quality customer service.

Integration   major activities Integrating a business into the acquirer’s operations involves six major activities that fall loosely into the following sequence: pre-Rapid integration is more likely to result in a merger that achieves the acquirer’s expectations.  For our purposes, the term rapid is defined as relative to the pace of normal operations for a firm. A Consulting firm studied 100 global acquisitions, each valued at more than $500 million, and concluded that most post-merger activities are completed within six months to one year and that integration done quickly generates the financial returns expected by shareholders and minimizes employee turnover and customer attrition. This does not mean that restructuring ends entirely within this time period. Integration may continue in terms of plant sales or closures for years following the acquisition. Almost one-half of acquirers either sell or close target firms’ plants within three years of the acquisition. Acquirers having more experience in managing the target’s plants are more likely to retain the target’s operations than those whose experience in operating such plants is limited. If we extend the period to five years following closing, plant divestitures and closures increase by an additional nine to ten percent.

Realizing Projected Financial Returns
A simple example demonstrates the importance of rapid integration to  realizing projected financial returns. Suppose a firm’s current market value of $100 million accurately reflects the firm’s future cash flows discounted at its cost of capital (i.e., the financial return the firm must earn or exceed to satisfy the expectations of its shareholders and lenders). Assume an acquirer is willing to pay a $25 million premium for this firm over its current share price, believing it can recover the premium by realizing cost savings resulting from integrating the two firms. The amount of cash the acquirer will have to generate to recover the premium will increase the longer it takes to integrate the target company. If the cost of capital is 10% and integration is completed by the end of the first year, the acquirer will have to earn $27.5 million by the end of the first year to recover the premium plus its cost of capital ($25 + ($25 × 0.10)). If integration is not completed until the end of the second year, the acquirer will have to earn an incremental cash flow of $30.25 million ($27.5 + ($27.5 × 0.10)), and so on.

The Impact of Employee Turnover
Although there is little evidence that firms necessarily experience an actual reduction in their total workforce following an acquisition, there is evidence of increased turnover among management and key employees after a corporate takeover.  Some loss of managers is intentional as part of an effort to eliminate redundancies and overlapping positions, but other managers quit during the integration turmoil. In many acquisitions, talent and management skills represent the primary value of the target company to the acquirer—especially in high technology and service companies, for which assets are largely the embodied knowledge of their employees—and it is difficult to measure whether employees that leave represent a significant “brain drain” or loss of key managers. If it does, though, this loss degrades the value of the target company, making the recovery of any premium paid to target shareholders difficult for the buyer.
The cost also may be high simply because the target firm’s top, experienced managers are removed as part of the integration process and replaced with new managers—who tend to have a high failure rate in general. When a firm selects an insider (i.e., a person already in the employ of the merged firms) to replace a top manager (e.g., a CEO), the failure rate of the successor (i.e., the successor is no longer with the firm 18 months later) is 34%. When the board selects an outside successor (i.e., one not currently employed by the merged firms) to replace the departing senior manager, the 18-month failure rate is 55%. Therefore, more than half of the time, an outside successor will not succeed, with an insider succeeding
about two-thirds of the time. The cost of employee turnover does not stop with the loss of key employees. The loss of any significant number of employees can be very costly. Current employees have already been recruited and trained; lose them, and you will incur new recruitment and training costs to replace them with equally qualified employees. Moreover, the loss of employees is likely to reduce the morale and productivity of those who remain.

Acquisition-Related Customer Attrition
During normal operations, a business can expect a certain level of churn in its customer list. Depending on the industry, normal churn as a result of competitive conditions
can be anywhere from 20 to 40%. A newly merged company will experience a loss of another 5 to 10% of its existing customers as a direct result of a merger,  reflecting uncertainty about on-time delivery and product quality and more aggressive post-merger pricing by competitors. Moreover, many companies lose revenue momentum as they concentrate on realizing expected cost synergies. The loss of customers may continue well after closing.
Rapid Integration Does Not Mean Doing Everything at the Same Pace
Rapid integration may result in more immediate realization of synergies, but it also contributes to employee and customer attrition. Therefore, intelligent
integration involves managing these tradeoffs by quickly identifying and implementing projects that offer the most immediate payoff and deferring those whose disruption would result in the greatest revenue loss. Acquirers often postpone integrating data-processing and customer-service call centers until much later in the integration process if such activities are pivotal to maintaining on time delivery and high-quality customer service.

Integration   major activities:

Integrating a business into the acquirer’s operations involves six major activities that fall loosely into the following sequence: pre-merger planning, resolving communication issues, defining the new organization, developing staffing plans, integrating functions and departments, and building a new corporate culture. Some activities are continuous and, in some respects, unending. For instance, communicating with all major stakeholder groups and developing a new corporate culture are largely continuous activities, running through the integration period and beyond.

Pre-merger Integration Planning
While some argue that integration planning should begin as soon as the merger is announced, assumptions made before the closing based on information accumulated during due diligence must be re-examined once the transaction is consummated to ensure their validity. The pre-merger integration planning process enables the acquiring company to refine its original estimate of the value of the target and deal with transition issues in the context of the merger agreement. Furthermore, it gives the buyer an opportunity to insert into the agreement the appropriate representations and warranties as well as conditions of closing that facilitate the post-merger integration process. Finally, the planning process creates a post-merger integration organization to expedite the integration process after the closing.
To minimize potential confusion, it is critical to get the integration manager involved in the process as early as possible—ideally as soon as the target has been identified or at least well before the evaluation and negotiation process begins.  Doing so makes it more likely that the strategic rationale for the deal remains well understood by those involved in conducting due diligence and post-merger integration.

Putting The Post-merger Integration Organization In Place Before Closing
A post-merger integration organization with clearly defined goals and responsibilities should be in place before the closing. For friendly mergers, the organization—including supporting work teams—should consist of individuals from both the acquiring and target companies with a vested interest in the newly formed company. During a hostile takeover, of course, it can be problematic to assemble such a team, given the lack of trust that may exist between the parties to the transaction. The acquiring company will likely find it difficult to access needed information and involve the target company’s management in the planning process before the transaction closes.
If the plan is to integrate the target firm into one of the acquirer’s business units, it is critical to place responsibility for integration in that business unit. Personnel from the business unit should be well represented on the due diligence team to ensure they understand how best to integrate the target to realize synergies expeditiously.

The Post-merger Integration Organization: Composition and  Responsibilities
The post-merger integration organization should consist of a management integration team (MIT) and integration work teams focused on implementing a specific portion of the integration plan. Senior managers from the two merged organizations serve on the MIT, which is charged with realizing synergies identified during the pre-closing due diligence. Involving senior managers from both firms captures the best talent from both organizations and sends a comforting signal to all employees that decision makers who understand their particular situations are in agreement. The MIT’s emphasis during the integration period should be on activities that create the greatest value for shareholders.
In addition to driving the integration effort, the MIT ensures that the managers not involved in the endeavor remain focused on running the business. Dedicated work teams perform the detailed integration work. These teams should also include employees from both the acquiring company and the target company. Other team members might include outside advisors, such as investment bankers, accountants, attorneys, and consultants.
The MIT allocates dedicated resources to the integration effort and clarifies non-team-membership roles and enables day-to-day operations to continue at premerger levels. The MIT should be careful to give the teams not only the responsibility to do certain tasks but also the authority and resources to get the job done. To be effective, the work teams must have access to timely, accurate information, receive candid, timely feedback, and be kept informed of the broader perspective of the overall integration effort to avoid becoming too narrowly focused.

Developing Communication Plans for Key Stakeholders
Before publicly announcing an acquisition, the acquirer should prepare a communication plan targeted at major stakeholder groups.

Addressing Employees Issues Immediately
Employees are interested in any information pertaining to the merger and how it will affect them, often in terms of job security, working conditions, and total compensation. Thus, consistent and candid communication is of paramount importance.
Target firm employees often represent a substantial portion of the acquired company’s value, particularly for technology and service-related businesses with few tangible assets. The CEO should lead the effort to communicate to employees at all levels through on-site meetings or via teleconferencing. Communication to employees should be as frequent as possible; it is better to report that there is no change than to remain silent. Direct communication to all employees at both firms is critical. Deteriorating job performance and absences from work are clear signs of workforce anxiety. Many companies find it useful to create a single information source accessible to all employees, be it an individual whose job is to answer questions or a menu-driven automated phone system programmed to respond to commonly asked questions. The best way to communicate in a crisis, however, is through regularly scheduled employee meetings.
All external communication in the form of press releases should be coordinated with the PR department to ensure that the same information is released concurrently to all employees. Internal e-mail systems, voice mail, or intranets may be used to facilitate employee communications. In addition, personal letters, question-and-answer sessions, newsletters, and videotapes are highly effective ways to deliver messages.

Customers: Under committing and Over delivering
Attrition can be minimized if the newly merged firm commits to assuring customers that it will maintain or improve product quality, on-time delivery, and customer service. Commitments should be realistic in terms of what needs to be accomplished during the integration phase. The firm must communicate to customers realistic benefits associated with the merger. From the customer’s perspective, the merger can increase the range of products or services offered or provide lower selling prices as a result of economies of scale and new applications of technology.

Suppliers: Developing Long-Term Vendor Relationships
The new company should seek long-term relationships rather than simply ways to reduce costs. Aggressive negotiation may win high-quality products and services at lower prices in the short run, but that may be transitory if the new company is a large customer of the supplier and if the supplier’s margins are squeezed continually. The supplier’s product or service quality will suffer, and the supplier eventually may exit the business.

Investors: Maintaining Shareholder Loyalty
The new firm must be able to present a compelling vision of the future to investors. In a share exchange, target shareholders become shareholders in the newly formed company. Loyal shareholders tend to provide a more stable ownership base and may contribute to lower share price volatility. All firms attract particular types of investors—some with a preference for high dividends and others for capital gains—and they may clash over their preferences, as America Online’s acquisition of Time Warner  illustrates. The combined market value of the two firms lost 11% in the four days following the announcement: Investors fretted over what had been created, and there was a selling frenzy that likely involved investors who bought Time Warner for its stable growth and America Online for its meteoric growth rate of 70% per year.

Communities: Building Strong, Credible Relationships
Good working relations with surrounding communities are simply good public relations. Companies should communicate plans to build or keep plants, stores, or office buildings in a community as soon as they can be confident that these actions will be implemented. Such steps often translate into new jobs and increased tax collections for the community.

Creating a New Organization
Despite the requirement to appoint dozens of managers—including heads of key functions, groups, and even divisions—creating a new top management team must be given first priority.

Establishing a Structure
Building new reporting structures for combining companies requires knowledge of the target company’s prior organization, some sense as to the effectiveness of this organization, and the future business needs of the new firm. Prior organization charts provide insights into how individuals from both companies will interact within the new company, because they reveal the past experience and future expectations of individuals with regard to reporting relationships.
The next step is to create a structure that meets the business needs of the new firm. Common structures include functional, product or service, and divisional organizations. In a functional organization, people are assigned to specific departments, such as accounting, engineering, and marketing. In a product or service organization, functional specialists are grouped by product line or service offering, and each has its own accounting, human resources, sales, marketing, customer service, and product development staffs. Divisional organizations, in which groups of products are combined into divisions or strategic business units are the most common. Such organizations have their own management teams and tend to be highly decentralized.
The benefits of a well-managed, rapid postmerger integration suggest a centralized management structure initially with relatively few management layers. The distance between the CEO and division heads, measured in terms of intermediate positions, has decreased substantially, while the span of a CEO’s authority has widened.

Functional Integration
The management integration team must first determine the extent to which the two firms’ operations and support staffs are to be centralized or decentralized. The main areas of focus should be information technology (IT), manufacturing operations, sales, marketing, finance, purchasing, R&D, and the requirements to staff these functions. However, before any actual integration takes place, it is crucial to revalidate data collected during due diligence, benchmark all operations by comparing them to industry standards, and reset synergy expectations.

Revalidating Due Diligence Data
Data collected during due diligence should be reviewed immediately after closing. The pressure exerted by both buyer and seller to complete the transaction often results in a haphazard preclosing due diligence review. For example, to compress the time devoted to due diligence, sellers often allow buyers access only to senior managers. For similar reasons, site visits by the buyer are often limited to those with the largest number of employees—and so risks and opportunities that might exist at other sites are ignored or remain undiscovered. The buyer’s legal and financial reviews are typically conducted only on the largest customer and supplier contracts, promissory notes, and operating and capital leases. Receivables are evaluated, and physical inventory is counted using sampling techniques. The effort to determine whether intellectual property has been properly protected, with key trademarks or service marks registered and copyrights and patents filed, is often spotty.

Benchmarking Performance
Benchmarking important functions such as the acquirer and target manufacturing and IT operations is a useful starting point for determining how to integrate these activities. Standard benchmarks include the International Standards Organization’s (ISO) 9000 Quality Systems—Model for Quality Assurance in Design, Development, Production, Installation, and Servicing. Other benchmarks that can be used include the U.S. Food and Drug Administration’s Good Manufacturing Practices and the Department of Commerce’s Malcolm Baldrige Award.

Reset Synergy Expectations
Companies that re-examine their synergy assumptions after closing seem to achieve higher synergies than those that do not. Companies that are most successful in realizing incremental value resulting from integrating the target firm are often those that use their pre-deal estimates of synergy as baseline estimates (i.e., the minimum they expect to achieve). Such firms are four times more likely to characterize their deals more highly successful than executives of acquiring firms that do not reset their synergy expectations. Additional value is often realized by making fundamental operational changes or by providing customers with new products or services that were envisioned during the due diligence process.  For example, Belgian brewer InBev’s 2008 takeover of U.S. brewer Anheuser-Busch initially envisioned eliminating about $1.5 billion in the combined firm’s annual operating expenses. Two years later, more than $2 billion in annual expenses had been cut.

Integrating Manufacturing Operations
The objective should be to re-evaluate overall capacity, the potential for future cost reductions, the age and condition of facilities, the adequacy of maintenance budgets, and compliance with environmental laws and safety laws. The integration should consider carefully whether target facilities that duplicate manufacturing capabilities are potentially more efficient than those of the buyer. As part of the benchmarking process, the operations of both the acquirer and the target company should be compared with industry standards to evaluate their efficiency properly.

Integrating Information Technology
IT spending constitutes an ever-increasing share of most business budgets—
and about 80% of software projects fail to meet their performance expectations or deadlines.  Nearly one-half are scrapped before completion, and about one half cost two to three times their original budgets and take three times as long as expected to complete.18 Managers seem to focus too much on technology and not enough on the people and processes that will use that technology. If the buyer intends to operate the target company independently, the information systems of the two companies may be kept separate as long as communications links between them can be established.

Integrating Finance
Some target companies will be operated as stand-alone operations, while others will be completely merged with the acquirer’s existing business. International acquisitions involve companies in geographically remote areas and operate largely independent of the parent. This requires considerable effort to ensure that the buyer can monitor financial results from a distance, even if the parent has its representative on site. The acquirer should also establish a budgeting process and signature approval levels to control spending.

Integrating Sales
Significant cost savings may result from integrating sales forces, which eliminates duplicate sales representatives and related support expenses, such as travel and entertainment expenses, training, and management. A single sales force may also minimize customer confusion by allowing customers to deal with a single salesperson when buying multiple products.
Whether the sales forces of the two firms are wholly integrated or operated independently depends on their relative size, the nature of their products and markets, and their geographic location. A small sales force may be readily combined with a larger sales force if they sell sufficiently similar products and serve similar markets. The sales forces may be kept separate if the products they sell require in-depth understanding of the customers’ needs and a detailed knowledge of the product. It is quite common for firms that sell highly complex products such as robotics or enterprise software to employ a particularly well trained and sophisticated sales force that must employ the “consultative selling” approach. This approach may entail the firm’s sales force’s working with the customer to develop a solution tailored to their specific needs and may require keeping the sales forces of merged firms separate. Sales forces in globally dispersed businesses are often kept separate to reflect the uniqueness of their markets. However, support activities such as sales training and technical support are often centralized.

Integrating Marketing
Enabling the customer to see a consistent image in advertising and promotional campaigns may be the greatest challenge facing the integration of the marketing function. Steps to ensure consistency, however, should not confuse the customer by radically changing a product’s image or how it is sold. The location and degree of integration of the marketing function depend on the global nature of the business, the diversity or uniqueness of product lines, and the pace of change in the marketplace. A business with operations worldwide may be inclined to decentralize marketing to the local countries to increase awareness of local laws and cultural patterns. Companies with a large number of product lines that can be grouped into logical categories or that require extensive product knowledge may decide to disperse the marketing function to the various operating units to keep marketing personnel as close to the customer as possible.

Integrating Purchasing
Managing the merged firm’s purchasing function aggressively and efficiently can reduce the total cost of goods and services purchased by merged companies by 10 to 15%.20 The opportunity to reap such substantial savings from suppliers comes immediately after the closing of the transaction. A merger creates uncertainty among both companies’ suppliers, particularly if they might have to compete against each other for business with the combined firms. Many will offer cost savings and new partnership arrangements, given the merged organization’s greater bargaining power to renegotiate contracts. The new company may choose to realize savings by reducing the number of suppliers. As part of the premerger due diligence, both the acquirer and the acquired company should identify a short list of their most critical suppliers, with a focus on those accounting for the largest share of purchased materials’, expenses.

Integrating Research and Development
Often, the buyer and seller R&D organizations are working on duplicate projects or projects not germane to the buyer’s long-term strategy. Senior managers and the integration team must define future areas of R&D collaboration and set priorities for future R&D research.

Building a New Corporate Culture
Corporate culture is a common set of values, traditions, and beliefs that influence management and employee behavior within a firm. Large, diverse businesses have an overarching culture and a series of subcultures that reflect local conditions. When two companies with different cultures merge, the newly formed company will often take on a new culture that is quite different from either the acquirer’s or the target’s culture. Cultural differences can instill creativity in the new company or create a contentious environment.

 

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