Why Integration is the most critical for M&A success involving Digital targets?

M&A activity is increasing globally with record number of deals completed this year.

Reason for high M&A activity

Due to the low interest rates, borrowing has become cheaper which has led to more money available for Financial acquirers like Private Equity firms to invest their dry powder in buying companies.

Reduction in corporate rates combined with growing economy has led to increased earnings in companies balance sheet.Some of these earnings are reinvested back to their growth strategy especially towards acquisitions

Rise of Digital and technology disruption

  • Technology has played a huge role in increase of M&A activity globally.Around 80% of the M&A deals are focused towards buying companies that offer emerging Technologies like Big Data, Automation, Cloud Computing, Customer Experience and in Digital transformation.
  • In addition Technologies has disrupted all industries like Banking, Healthcare and Retail.This has led rise to new entrants in these industries and traditional firms in order to counter this threat has resorted to acquiring these companies and protect their market share.

Why large number of M&A deals fail to add any value?

Inspite of increase in M&A activity which is used as a strategy to attain quick growth, we see many M&A deals fail to achieve their objectives. In fact 70% of M&A deals fail to build any shareholder value.

Two main reasons for their failure are:

  • There was no clear strategic rationale to acquire or in other ways a wrong target company was chosen to acquire.Proper analysis would not have been done how the target would complement or increase the acquirer’s growth long term.Some of these acquisitions are purely done for tactical reasons like reducing cost, achieving scale or increase margins or revenues without taking to account the long term implications of how the acquirer shall help the target achieve its growth and vice versa.Hence we see within few years the acquirer would sell the target company or write off their assets.
  • Poor Integration strategy and acquirer lack of capabilities in integrating the target company rightly. In cases where proper strategic rationale was there to acquire the company which was followed by comprehensive due diligence and deal negotiations the M&A deal failed because the acquirer was not able to integrate the target and realize the synergies that was planned during the initial stage.Most of the times the focus and motivation is on closing the deal as that is where most of the glamour and importance is given. Once the deal is closed the deal team does not have motivation to pursue the integration and achieve the synergies.To address this the deal team is tasked to ensure that the integration achieves the planned synergies and other value benefits.

Integration Planning and its importance

It is very important there is an integration manager who is tasked with responsibility of integrating the entities and generate value.The integration manager should be a very senior resource directly reporting to Corporate office.

Once there is an Integration office created and tasked with resources, it is very important that they are involved very early in the deal.In some cases the integration team works very closely with Corporate Development team right from sourcing stage itself and involved all the way from Business Case valuation, to Term sheet stage to confirmatory due diligence. The advantage here is that the integration manager very well understand the contours of the deal, why this deal was made and what are the synergies expected from this acquisition.This would make it easy for him while planning the integration as he knows that he need to implement the value drivers that the acquiring team foresee during the acquisition.As he was involved in the due diligence, he would also know the risk and opportunity that this deal will bring and he will take that into account while coming up with the integration strategy.

Each Deal is Different and so the integration strategy

We know that each M&A deal is different and reasons to acquire each company is different.Companies are acquired for Scale, Scope, Capabilities and in some cases even to diversify to different business.

Hence strategy deployed to integrate the company should also be different as one size fit all approach will not work here. Integration strategy will also differ depending on the size of the target and if the target and acquirer business are common or complimentary.

Importance of Cultural Integration and Alignment

Although success of a M&A deal is graded on the basis of revenues achieved or costs saved by the combined entity, one of the most important factors which are also ignored is the culture fitment and integration.This task is generally given to the HR team who are responsible in bringing the two companies to work together.This is not a right approach and it is very important that a senior person from business team is involved and tasked with Culture integration

Harvard Business Review case study on importance of Cultural Alignment

An HBR study showed how a cultural differences between the buyer and the seller can lead to deal destruction by taking a real life example of an American company acquiring a British company.During integration the American company imposed their free dressing culture on Brits and instructed them not to wear ties during office hours.The Brits who are conservative and had huge pride on wearing ties during office hours didn’t like this change.Few of them refused to adhere to this decision and this cultural clash led to many of them quit the organization.

Over a period of time the target was spun off as it did not add the expected value and synergies to acquirer.This shows that the acquirer needs to have a detailed approach and understanding of the target company operations before making any changes.Even a minor change like asking to remove ties have the potential to destroy the deal

Importance of Day1 planning in Integration

  • Day1 as per the M&A methodology is the day where the acquirer owns the combined entity.At this stage the target company ceases to operate and becomes the part of the acquirer.Important thing that the integration manager needs to keep in mind is to ensure that the operations of the two entities continue without any disruption.Customers of both target and buyer should not have any discontinuity or negative effect in their business due to this acquisition. The same applies for employees also.Sufficient planning should have been done to transition the employees from target pay rolls to acquirer.In addition basic requirements like access rights, location access and reporting structure should have been decided so that the employee knows whom he has to report to and whether there are any changes in his current role.
  • During initial phases, basic integration activities like closing the target financial books and migrating to acquirer balance sheet, backoffice integration in legal and finance has to be completed.This is to ensure the acquirer starts to track the target business activities, its revenues, order book and collections
  • Post that the integration manager should start to focus on value drivers that was created during the acquisition to realize the synergies.For instance the value drivers can be revenue increase, cost savings or integrating IP.These value drivers should be quantified and taken as performance targets by the integration team.One performance metrics can be Revenues of Combined entity should increase by 10% in Year 0 and 20% in Year 1.Once the targets are created, planning needs to be done on how to achieve this target.Since there are more than one value drivers for every deal, planning needs to be done to prioritize and then implement.In some cases we can have multiple teams taking each value driver as a goal and work on implementing that goal.
  • Once planning is done on how to realize the value, the next step would be to assign this to the relevant team who will be accountable to fulfill this goal.This will be done by involving the relevant teams from both buyer and target and communicate to them on why this goal needs to be achieved and their contribution in achieving this goal.In this way each team member has clarity in what is expected from him.
  • One more approach is to take the bottom up approach where the relevant teams from acquirer and target are asked to share the opportunities that are available and can be exploited to achieve the goals assigned.As these teams have field level experience, they shall be better equipped on the current opportunities available that can be exploited to achieve the value.

Tracking Integration

Once the integration goals are assigned and each team is made accountable to their goals the next step is to track the performance of the team.This is done by tracking the current progress against the assigned goals so that review and changes can be suggested based on the progress achieved.In some cases we can even change the target number if we realize that an aggressive target number is taken that is difficult to achieve.Once the synergies are realized and we come to a steady state approach; we can evaluate the integration approach taken and make changes to refine it further.In many cases integration allows the acquirer to revisit his business operations and make some positive changes to it.Here he can borrow the target best practices or lend his own expertise to target for some of the process.

Hence at the end, the combined entity shall have the best of practices from both the entities which shall make it more formidable and strong to compete in market

Conclusion

  • In the age of Digital era and Technological disruption, integration is the most important factor for a deal success.When companies are acquiring niche technologies companies they need to understand not only the business and revenue model but also their working culture so that the target operating model takes into account these implications.
  • Alignment of value drivers envisaged during the deal phase should be followed in the integration.The integration team should have a laser focused approach in ensuring that all the value drivers and synergies are achieved taking into account the risks.
  • Communication is very important and it has to be precise and consistent. The target employees need to be involved in every phase of the integration so that trust is built between the acquirer and target which will go a long way in not only achieving the planned synergies but also increase the brand reputation and market share of the combined entity


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