by: David Fubini
A normal acquisition process seeks to ensure something basic: a strategic rationale for a deal, supported by a thoughtful selection process, with known risks identified by a short, intense due diligence. But what isn’t practiced, and too often ignored, is the process of asking: “What are the likely challenges we will face as we integrate these two complex companies over the next 1-2 years?”
My experience, after being involved in considerable numbers of such transactions over the past decade, is that in the majority of cases little due diligence is done beyond the financials to investigate the challenges of having two organizations become one. Management is usually shocked to find the degree of differences that exist between their two, soon to be merged, organizations — and too few actively consider these integration challenges before the deal.
What this requires is doing some integration due diligence as part of the MA process. You can define this type of due diligence with a few key steps:
- Assessing the institutional strengths of the acquired company and comparing and contrasting these to the acquiring company to map where there are welcomed overlaps and where there are redundancies.
- Understanding the cultural dynamics of the acquired organization, including how they operate, the manner in which they develop their talent, how are they motivated to succeed, and their executive management decision making style.
- Doing a stakeholder analysis to understand the additional challenges from political, regulatory, union, and community sources to be expected in the wake of a merger.
While this may sound like common sense, the reasons for ignoring this due diligence step are numerous. CEOs often fear that such analyses require involving too many people, when they have an understandable desire to complete deal negotiations with only a very few trusted lieutenants and advisors involved — and to conduct them in secrecy so as not to alert external markets. Investment bankers resist having to consider integration challenges lest the prospects for a deal be undermined by the realization of the all too numerous challenges that lie beyond their valuation analyses.
Plus, unlike financial due diligence, which can be done through data rooms and shared financials, integration due diligence requires an examination of another’s institutional capabilities, operating cultures, and management talent — all of which are difficult and time consuming to investigate when in the midst of an intense deal negotiation.
The result of this lack of due diligence is played out all too publicly when deals suddenly fall apart. For example, in 2014, mining giants Barrick and Newmont had to unwind their planned transaction after only nine months due to what published reports stated were “clashes over leadership and governance.” Barrick also claimed that the Newmont wanted to “renegotiate foundational organizational elements of the deal.” It was reported that among the causes of the breakup were disagreements about headquarters location, management roles, and other strategic and structural disagreements.
Publicis and Omincom had to unwind their $35 plus billion transaction after they were unable to agree on who would run the combined organization and whose operating strategy would be adopted in a newly merged agency. Now both agencies have to go back their suite of clients and explain why the value of the merger they had been so recently touting wasn’t needed any longer.
Office Depot and OfficeMax announced their intended merger deal without an agreement of which (if either) CEO would run the combined retailer, without an agreement on retail brand strategy, and without a chosen corporate headquarters location.
Each of these deals might have greater potential for success with due diligence, before the deal, on the post-merger integration challenges. This kind of due diligence, even if CEOs can get past all the reasons above why not to do it, is hard and unglamorous work: It requires CEOs to look beyond the financials and the strategic rationale and see the stark challenges the integration will require.
Such a cultural due diligence can be done by talking to past members of the target organization, interviewing common suppliers, customers, industry observers, and analysts. It is an “outside-in” analysis that can be undertaken in parallel to all the financial negotiations.
Those who conduct integration due diligences have two major advantages. First, they can build on their knowledge of their own strengths as the acquiring entity. Knowing these strengths means the acquirer can better focus their integration planning, adding only at the margin from the acquired entity into those areas of known strengths. In turn, this means one can focus the integration activities on areas of their weakness. Acquiring management will know at the outset what they need to receive from the acquired entity to strengthen and build a more collective competitive operation.
Second, the whole integration plan is more easily designed, easier to execute, and can be implemented at a faster pace. It’s easier to make decisions about retaining crucial staff, forming the new leadership structure, making changes to management systems, and segregating the integration from the base business to protect revenues during this vulnerable period. CEOs and their senior teams can be more confident and more directive in their communications after the deal announcement right up to legal close.
A prerequisite for any transaction is financial due diligence. But boards and CEOs need to make the integration due diligence as much of a core part of their pre-deal effort. For those that do, the benefit is faster paced, more focused integration planning efforts. Those that don’t risk adding to the enormous probability of failure that already surround such transactions.
About the Author
David Fubini is Director Emeritus of McKinsey & Company, Inc., where he founded and led the firm’s global practice supporting mergers and integrations, and currently serves as senior lecturer at Harvard Business School.
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