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92 HARVARD BUSINESS REVIEW

Not All M&As Are Alike –

and That Matters

Ifs common to lump all M&As together, but there are five distinct varieties. If you can tell them apart, you stand a better chance of making them succeed.

by Joseph L. Bower

W E KNOW SURPRISINGLY LITTLE ABOUT mergers and acquisitions, despite the buckets of ink spilled on the topic. In fact, our collective

wisdom could be summed up in a few short sentences: ac- quirers usually pay too much. Friendly deals done using stock often perform well. CEOs fall in love with deals and don't walk away when they should. Integration's hard to pull off, but a few companies do it well consistently.

MARCH 2001 9 3

Not All M&As Are A l i k e – a n d That Matters

Given that we're in the midst of the biggest merger boom of all time, that collective wisdom seems inade- quate, to say the least. I recently headed up a year-long study of M&A activity sponsored by Harvard Business School. That study sought to examine questions of M&A strategy and execution with a new rigor. Our in-depth findings will emerge over the next year or two, in the form of various books, articles, and cases.

Our work has already revealed something intriguing, however. The thousands of deals that academics, consul- tants, and businesspeople lump together as mergers and acquisitions actually represent very different strategic ac- tivities. (See the table "M&A Strategies: Distinct Activities

Mean Differing Challenges" for a breakdown of large ac- quisitions from the last three years.)

Acquisitions occur for five reasons: • to deal with overcapacity through consolidation in ma- ture industries;

• to roll-up competitors in geographically fragmented in- dustries;

• to extend into new products or markets; • as a substitute for R&D; and – to exploit eroding industry boundaries by inventing an industry. Despite the massive number of books and articles pub-

Hshed about mergers and acquisitions, no one has ever

M&A Strategies: Distinct Activities Mean Differing Challenges

Example

Strategic Objectives

Major Concerns

The Overcapacity M&A

Chemical Bank buys Manu- facturers Hanover and Chase; Daimler-Benz acquires Chrysler.

The Geographic Roll-up M&A

Bane One buys scores of local banks in the 1980s.

The Product or Market Extension M&A

The acquiring company (partofan industry with excess capacity) will elimi- nate capacity, gain market share, and create a more efficient operation.

You can't run a merged company until you've rationalized it, so decide what to eliminate quickly.

If the acquired company is as large as the acquiring one and its processes and values differ greatly, expect trouble. Nothing will be easy.

If it is a so-called merger of equals, expect both compa- nies' management groups to fight for control.

These tend to be onetime events, so they're especially hard to pull off.

A successful company ex- pands geographically; oper- ating units remain local.

Members of the acquired group may welcome your streamlined processes. If they don't, you can afford to ease them in slowly.

If a strong culture is in place, introduce new values with extreme care. Use carrots, not sticks.

These are win-win scenar- ios, and they often go smoothly.

Quaker Oats buys Snapple.

Acquisitions extend a company's product line or its international coverage.

Know what you're buying: the farther you get from home, the harder it is to be sure.

' Expect cultural and govern- mental differences to inter- fere with integration.

The bigger you are relative I to your target company,

the better your chances for success,

I The more practice you * have, the better your

chances for success.

HARVARD BUSINESS REVIEW

Not All M&As Are AMke-and That Matters

tried to link strategic intent to the implications for inte- gration that result. It stands to reason that executives overseeing each of these activities face different chal- lenges. If you acquire a company heeause your industry has excess capacity, you have to figure out quickly which plants to close and which people to lay off. if, on the other hand, you acquire a company heeause it is developing a hot technology, your challenge is to hold on to the ac- quisition's best engineers. These two scenarios require the acquiring company to engage in nearly opposite man- agerial behaviors.

I will turn now to the problems that arise in differ- ent types of acquisitions, which I will examine using the

TheM&AasR&D

Cisco acquires 62 companies.

Acquisitions are used in lieu of in-hou5e R&Dto build a market position quickly.

I Build industrial-strength evaluation processes so that you buy first-class businesses.

This category allows no time for slow assimilation, so cultural due diligence is a must.

Put first-rate, w e l k o n – nected executives in charge of integration. Make it a high-visibility assignment.

Above all else, hold on to the talent if you can.

The Industry Convergence M&A

Viacom buys Paramount and Blockbuster; AT&T buys NCR, McCaw, and TCI.

A company bets that a new industry is emerging and tries to establish a position by culling resources from existing industries whose boundaries are eroding.

Cive the acquired company a wide berth. Integration should be driven by specific opportunities to create value, not by a perceived need to create a symmetri- cal organization.

As a top manager, be prepared to make the call about what to integrate and what to leave alone; also, be ready to change that decision.

resources-processes-values framework. Resources refer to tangible and intangible assets, processes deal with activi- ties that turn resources into goods and services, and val- ues underpin decisions employees make and how they make them. (See the sidebar "Some Order in the Chaos" for more on these terms.)

Scenario 1: The Overcapacity M&A A great many mergers and acquisitions occur in industries that have substantial overcapacity; these tend to he older, capital-intensive sectors. Overcapacity accounts for 37% of the M&A deals in our breakdown. (See the exhibit "Ra- tionales for M&A Activity.") Industries in this category include automotive, steel, and petrochemical. From the acquiring company's point of view, the rationale for ac- quisition is the old law of the jungle: eat or be eaten. This kind of deal makes strategic sense, when it can be pulled off. The acquirer closes the less competitive facilities, eliminates the less effective managers, and rationalizes administrative processes. In the end, the acquiring com- pany has greater market share, a more efficient oper- ation, better managers, more clout, and the industry as a whole has less excess capacity. What's not to like? (Un- less you overpaid.) Thousands of deals are undertaken with these objectives in mind. However, few of these deals have been judged successful after the fact. Why?

Decades of experience show us that it's extraordinarily difficult to merge well-estahlished, large companies that have deeply entrenched processes and values. This, of course, describes most companies in mature industries. These are usually win-lose games: the acquiring company keeps open more of its own facilities, retains more of its own employees, and imposes its own processes and val- ues. Employees of the acquired company don't have much to gain. As with any win-lose scenario, the loser doesn't make it easy for the winner. And because these are often megamergers, they tend to be onetime events, so the ac- quirer doesn't learn from experience.

For those reasons and more, excess-capacity deals re- quire special attention, since just about anything that can go wrong with integration does. I'll explain each element along the resources-processes-values spectrum.

First, consider resources. It's far from easy to make good on the goal of rationalization. Inevitably, irrational fac- tors intervene, in the form of interorganizational power dynamics, legal issues, or plain old human nature. These issues complicate what might initially seem to be clear priorities.

Joseph L. Bower is the Donald K. David Professor of Busi- ness Administration at Harvard Business School in Boston. This is his sixth article for HBR. His most recent article, coau- thored with Clayton M. Christensen, was "Disruptive Tech- nologies: Catchingthe Wave" (HBR January-February 1995),

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Not All M&As Are A l i k e – and That Matters

Let's start at the top, with the senior managers from both companies. Especially in a merger of equals, this piece is always messy,time-consuming, and political. Man- agement teams focus their energies on the battle to main- tain their positions, and the business suffers. This pattern is repeated all the way down the ranks. Problems exist even in acquisitions where one company is much larger. The best people from the new company are likely to

Some Order in the Chaos In trying to make sense of the challenges posed by the different kinds of mergers and

acquisitions, I've drawn on a framework familiar to HBR readers: the resources-

processes-values framework that Clayton Christensen and I first used to describe the

difficulties of coping with disruptive change. By resources, I mean both tangible assets

(such as money, materials, and people) and intangible assets (such as information,

brands, and relationships). Processes are company activities that convert resources

into goods and services. While not necessarily unique, they are specific to a company

and change slowly. Values are the special way employees think about what they do and

why they do it. Values shape priorities and decision making. The framework doesn't

hold up perfectly in this case, because it's not as useful when we get to the newer

forms of M&A activity. However, it has helped me locate and illuminate distinctive

challenges posed by mergers and acquisitions.

leave. When mixed teams remain, employees must rec- oncile company cultures. Years after such mergers, it is common for managers from acquirer Alpha to describe an employee from the acquired company as a Beta com- pany guy.

Deciding which physical facilities to eliminate is not nec- essarily simpler or cleaner than deciding which people to cut. Facilities vary by location, product mix, accounting costs, environmental problems, degree of governmental oversight, and staffing. Companies inevitably argue about the relative quality of their resources. The surviving busi- ness will usually assert that its resources are superior, but that is not always the case. And acquired managers, asked to decide which facilities or product lines to cut, are al- most never able to design a good exit strategy; they're just too invested in the status quo.

Al Dunlap claimed that these cuts can be made quickly and with blunt tools. However, case studies of Scott Paper, where Dunlap (as CEO) succeeded, and Sunbeam, where Dunlap (as chairman and CEO) didn't, reveal something else. At Scott Paper, operating managers had an extensive understanding of the need for rationalization and how it could be accomplished; at Sunbeam, they did not. Dun- lap's top-down approach-and his bluster-masked the important work of lower-level Scott Paper managers.

Business processes are no easier to integrate than em- ployees. Large companies have elaborate systems for mea- suring performance, developing products, and allocating

resources, which are absolutely central to how they do business. Simply imposing a set of new systems takes time, and it may take years for managers to use them ef- fectively. When Daimler-Benz and Chrysler merged, the questions multiplied by the day, and they ranged from the trivial to the profound.

Daimler-Chrysler started as a merger of equals in an industry the two companies' analysis revealed to have

staggering overcapac- ity. The top manage- ment of both compa- nies recognized the particular assets and qualities that made the other a perfect fit. But startling differences in their management approaches soon dis- rupted their working relationships.

German manage- ment-board members had executive assis- tants who prepared detailed position pa- pers on any number of issues. The Americans

didn't have assigned aides; they formulated their deci- sions by talking directly to engineers or other specialists. A German decision worked its way through the bureau- cracy for final approval at the top. Then it was set in stone. The Americans allowed midlevel employees to proceed on their own initiative, sometimes without waiting for ex- ecutive-tevel approval. The Germans smoked, drank wine with lunch, and worked late hours, sending out for pizza and beer. The old Chrysler banned smoking and alcohol in its facilities. The Americans worked around the clock on deadlines but didn't stay late as a routine.'

Not surprisingly, these cultural and process differences were exacerbated, not improved, when tensions between the people at the very top intensified. When Thomas Stall- kamp, Daimler-Chrysler president, created an in-house advisory staff to support the Chrysler members of the Daimler-Chrysler board, Jurgen Schrempp, Daimler's CEO, accused him of block voting. When Stalikamp raised questions about working style, Schrempp chastised him for whining.

Finally comes the issue of differing company values. These are somewhat harder to pin down than processes, but they're just as important. Values include shared as- sumptions about what the company owes its employees and vice versa, which kinds of behaviors are rewarded, and what the company stands for. It's common for companies that merge in mature, oligopolistic industries to have sim- ilar values. For example, when Chemical Bank acquired

96 HARVARD BUSINESS REVIEW

N o t A l l M & A s A r e A l i k e – a n d T h a t M a t t e r s

Manufacturers Hanover and, later. Chase, these New York banks had similar cultures led by professional bankers, and their integrations were successful.

But when participants in a megamerger don't share values-as in the case of Daimler and Chrysler-seri- ous problems can arise. As I've noted, these companies' working styles and assumptions were extremely different from the start. And their differences ran even broader and deeper than they first appeared to. Daimler was an engineering-centered company; Chrysler was more sales and marketing focused. Daimler executives had more perks, but Chrysler executives were paid much more. Schrempp, Daimler's dynamic leader, thought he had ac- quired a lean, innovative automobile company. For him, the entire experience was frustrating. Having moved into the ex-president's office at Chrysler, in Auburn Hills, Michigan, he turned off the sprinkler system so that he could smoke cigars, and he installed a bar for his red wine. He could do that.

What he couldn't do was hold on to the people he needed. The sources of Chrys- ler's energy-the top leaders of Chrysler's manufactur- ing, engineering, and public relations departments-left quickly as they learned that their fate was to subordinate themselves to the functional bureaucracies in Stuttgart. The perfect fit that seemed so obvious in the abstract was foundering on very real, fundamental differences in the way two groups of man- agers thought about them- selves, their roles, and their companies.

Integrating companies and cultures is complex and idio- syncratic. No rule fits all situ- ations, of course, but some general observations can be made about the merger and acquisition process, and a list of recommendations follows the discussion of each stra- tegic activity. These guide- lines discuss what works, what does not, and what to watch out for as you consider a merger or acquisition.

Recommendations

You can't run the merged company until you've ra- tionalized it, so figure out how to do that quickly and effectively. Don't assume your resources are bet- ter than the acquired company's resources. And don't expect people to destroy something they've spent years creating.

Impose your own processes quickly. If the acquired company is as large as yours and its processes are dis- similar, expect trouble. Some key people will leave, making it harder to rationalize the merged entities. Voluntary agreement is best, but early agreement is necessary. Don't try to eradicate differences associ- ated with country, religion, ethnicity, or gender.

Rationales for M&A Activity 1997-1999

To determine the relative importance of the rationales identified in this article, I ana-

lyzed all U.S. M&A deals over $500 million made between 1997 and 1999.Overcapacity

deals and product-line extensions were the most common. The third-largest category

was a type not covered in this article: deals in which a multibusiness company sold

a division to a financial acquirer. Geographic roll-ups were next. Not surprisingly,

M&A as R&D and industry convergence deals are still uncommon compared with

the more established strategic rationales. (I suspect that, had I looked at M&As in the

$250 mill ion to $499 million range, we'd have seen a higher percentage of R&D deals.)

Industry Convergence M&A as R&D

Geographic Roll-up 9% •

Investors 13% • —

Overcapacity

Product-line Extension 36%

The data for this analysis are from Securities Data Company. Target companies and acquirers were identi- fied by a four-digit SIC code. When the acquisition was made by a division of a multibusiness company, the division's SIC code identified the acquirer. Where the SIC code of an acquiring division was not identified, the deal was dropped. The sample contained 1,036 deals. The deals were sorted by strength-of-business sim- ilarity measured by comparing the companies'SIC codes. Deals in which all four SIC code digits matched were most alike,folhwed by three-digit matches, then two digit matches, and so on.

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N o t A l l M & A s A r e A l i k e – a n d T h a t M a t t e r s

Remember that if a high premium is required, you'll have even less time to get results.

But if what you've acquired is valuable precisely be- cause of processes and values, then time is required. Conquests by executives who didn't understand or ap- preciate those processes before the deal won't work after the deal is done.

Ifyou're considering a megamerger and the two com- panies' processes and values aren't similar, back off and reconsider.

Scenario 2: The Geographic Rotl-up M&A Geographic roU-ups, which appear at first glance to re- semble overcapacity acquisitions, differ substantially in part because they typically occur at an earlier stage in an industry's life cycle. Many industries exist for a long time in a fragmented state: local businesses stay local, and no company becomes dominant regionally or nationally. Eventually, companies with successful strategies expand geographically by rolling up other companies in adja- cent territories. Usually, the operating unit remains local if the relationship with local customers is important. What the acquiring company brings is some combina- tion of lower operating costs and improved value for the customers.

Because both overcapacity acquisitions and geographic roll-ups consolidate businesses, they can be difficult to tell apart except on a case-by-case basis. However, they vary in some fundamental ways. For one thing, their strategic rationales differ. Roll-ups are designed to achieve econ- omies of scale and scope and are associated with the building of industry giants. Overcapacity acquisitions are aimed at reducing capacity and duplication. They happen when the giants must be trimmed down to fit shrinking world markets.

Geographic roli-ups-unlike excess-capacity acquisi- tions-are often a win-win proposition, and, consequently, they're easier to pull off. Being acquired by a larger com- pany can help a smaller company solve a broad range of problems. These include succession; access to capital, na- tional marketing, and modern technology; and competi- tive threats from larger rivals. For the acquirer, the deal solves problems of geographic entry and local manage- ment. The large accounting firms were assembled this way. So were the superregional banks, the large chains of funeral homes, many hotel chains, and the emerging, large Internet consulting companies.

Resources aren't usually an issue in geographic roll-ups; the acquirer generally wants to keep the smaller com- pany intact and very often retains local management. (I should add a caveat: resources aren't a problem, unless it turns out you didn't buy what you thought you did. Of

course, any type of M&A deal can turn out to be a poor target-company choice and cost more than it was worth.) The challenges are largely about introducing the com- pany to new processes and values.

While holding on to the target company's resources (local managers, brands, and customers), the acquirer nearly always imposes its own processes (purchasing, IT, and so on). Quite often, the deal makes sense because of the acquirer's processes: they turn the target company into a far more efficient business. But acquirers don't need to rush this second step along; in fact, they should go easy in the beginning. Target-company managers often need time to familiarize themselves with the new processes.

Bane One had a remarkably successfial history of rolling up local and regional banks during the 1980s and early 1990s. It was particularly attentive to process issues. Under the rubric of "The Uncommon Partnership," Bane One's managers moved quickly to install their more straightforward processes for handling banking mechan- ics. But they allowed managers of acquired banks to learn how to meet new economic objectives much more

One huge challenge i<&LJ dcquirers must face is holding on to key people. The expertise of these individuals is far more valuable than the technology they've developed.

gradually, using extensive mentoring and training as well as creative compensation incentives.

Many roll-ups involve the purchase of small, some- times family-owned, businesses. If these small companies have strong, distinctive values, acquirers that force them to change quickly may lose the baby with the bathwater. This happened when Cap Gemini Sogeti bought the MAC Group and alienated the consultants, prompting an exodus of MAC talent. Cap Gemini's executives worked mostly on large systems projects, and they didn't know how to handle the MAC Group's highly paid strategic problem solvers.

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Not All M&As Are Alike – and That Matters

Recommendations

Acquired companies often welcome more stream- lined, efficient processes. But if you encounter sub- stantial resistance, you can afford to ease the target company's employees into new processes. In geo- graphic roll-ups, it's more important to hold on to key employees-and customers-than to realize efficien- cies quickly.

Ifa strong culture is in place, introduce different val- ues subtly and gradually. Carrots work better than sticks-especially with high-priced, hard-to-replace employees.

Scenario 3: The Product or Market Extension M&A The third category is the M&A deal created to extend a company's product line or international reach. Some- times these are similar to geographic roll-ups; sometimes they involve deals between big companies. They also in-

volve a bigger stretch-into a different country, not just into an adjacent city or a state.

The likelihood of success depends in part on the companies' relative sizes. If near equals merge, the problems that crop up in overcapacity deals are in play: difficulties imposing new processes and values on a large, well-established busi- ness. If, on the other hand, a large player (think GE) is making its nth acquisition of a small company, chances for success go way up.

Although extension deals have much in common with roll-ups, the challenges of introducing new processes, let alone values, are greater. When Quaker Oats acquired Snapple, for instance, it found that its advertising and distribution pro- cesses were wholly unsuited to the tar-

get company's product line. Similarly, British retailer Marks & Spencer found that its famed distribution sys- tems couldn't cope with Canadian geography when it ac- quired Peoples Department Stores.

GE, by contrast, has enjoyed great success with exactly this type of acquisition. Under Jack Welch's leadership, the giant company has learned to be extremely careful about the kinds of symmetry it imposes on its businesses. Executives identify and pay attention to the important distinctions between GE central and valued acquisitions.

Take Nuovo Pignone, the Italian engine producer GE acquired in 1992 from ENI. it would be hard to imagine two companies-one in Turin, Italy, and the other in Sche- nectady. New York – t h a t differ more from each other cul-

turally. Both enjoy technical excellence, but the Italians had operated in the stultifying culture of a state-owned and subsidized conglomerate run with substantially po- litical objectives-hardly Jack Welch's GE. Still, Paolo Fresco, then GE vice chairman responsible for interna- tional operations, wanted to prevent the "colonization"of Nuovo Pignone. As a result, he introduced a president whose explicit task was to "keep the bureaucrats away." GE systems would be introduced in time, but far more critical was getting NP's managers to use GE's resources to grow their business.

Recommendations

Know what you're buying. The farther you get from your home base, the harder it is to be confident of that knowledge.

Be aware that processes you consider core may turn out to be very different from those used by the target company.Cultural differences and governmental reg- ulation often interfere with the implementation of core processes.

Take the time to figure out how the target company achieved the success that led you to buy it. If it's bril- liant at product development and you're not…well, you figure it out.

Keep in mind that the bigger you are relative to your target company, the better your chances for success.

Scenario 4: The M&A as R&D The next-to-last category, acquisitions as a substitute for in-house R&D, is related to product and market exten- sions, but I'll treat it separately because it's so new and untested. An assortment of high-tech and biotech com- panies use acquisition instead of R&D to build market po- sition quickly in response to shortening product life cy- cles. As John Chambers, Cisco's president and CEO, says, "If you don't have the resources to develop a component or product within six months, you must buy what you need or miss the opportunity." Since 1996, Cisco has ac- quired 62 companies, as it races to dominate the Internet server and communication equipment fields. From the target company's point of view, an acquisition is often desirable, since it takes a massive amount of money to build a sustainable company in technical markets. And potential acquirers (such as Microsoft) can easily crush you if you compete with them directly.

The successes of Microsoft and Cisco, both of which ag- gressively substitute acquisitions for R&D, indicate that the strategy can work. But the results of long-term re- search with a large sample are not in yet. Some evidence suggests it's a better strategy for IT than for biotech com- panies; many of the Pharmaceuticals' R&D acquisitions

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Not All M&As Are Alike – and That Matters

have yet to pay off. The difference may well relate to the modularity of IT design. According to Carliss Baldwin and Kim Clark in their book Design Rules, Volume l. The Power of Modularity, many computer and chip designs are based on compatible independent components, and this makes it simpler to buy technology that can he readily inte- grated. In contrast, we can imagine that the organic na- ture of pharmaceutical products makes integration far more difficult.

It's much too soon to attempt any definitive statements about the challenges facing R&D acquirers. But I can point out the obvious trouble spots, which spread pretty evenly across the resources-processes-values spectrum.

When AT&T acquired computer

manufacturer NCR, it did so because

AT&T (and many others) thought

that computers and telecommunica-

tions were convergent industries. The

combination never succeeded.

One huge challenge acquirers must face is holding on to key people. The expertise of these individuals is far more valuable than the technology they've developed. Generally, the acquisition won't succeed if they leave. Yet in all likelihood, the acquisition itself made these people rich, so they can easily leave if they don't like the ways in which the company is changing. And no matter how care- ful acquirers are about imposing new processes and val- ues, the small, entrepreneurial company is going to feel a lot more constrained-even bureaucratic-than it used to. A regional banker who sold out to Bane One could enjoy the low-cost capital, broad product range, and mar- keting power of the bigger bank, while still holding on to the title "president" – and generally reckoned it a good deal. However, it takes considerably more skill and effort on the …