Should we do this deal? #1

According to the Deloitte 2019 M&A Trends Report, "A recent uptick in merger and acquisition (M&A) activity shows no signs of slowing down. Tax reform, a more relaxed US regulatory climate, and growing cash reserves fuel optimism among US dealmakers." This obviously can be attributed to the Trump tax cuts favoring big businesses and his focus on repealing regulations. Deloitte also commented, "There will be a heavier emphasis on more traditional customer base expansion and diversification of products and services. Also they appear to be looking to accelerate deal making to take advantage of current domestic policy." No doubt this suggests they are trying to complete deals prior to the 2020 election where the outcome is uncertain: will the favorable M&A climate continue if administrations change?

Merger Problems – 80 Percent Will Fail

Most important, Deloitte added, "While the M&A outlook is positive, a sizeable chunk of transactions still fall short of achieving the results initially envisioned". This is consistent with  many industry experts who believe that as many as 80 percent of these acquisitions will not succeed. Also, because the majority of acquisitions do not meet the original goals and objectives of the acquirers or other conditions change, some 40 percent of all businesses acquired will again be sold off within three to five years with a comment, "The company no longer fits our strategy."

Failures: The Major Reason

There are many factors that contribute to this high failure rate. As an example, Deloitte concluded that, "Corporations and private equity firms pin the most blame on external factors, but recognize the need for more effective due diligence and integration to make sure revenue projections materialize."

I agree with Deloitte that possibility of failure can be reduced through proper merger integration planning  such as using a process that Peter Drucker and I initially developed while working together in planning the integration of the Occidental Petroleum Corporation’s acquisition of the Cities Services Company. This was the second largest acquisition in United States history at the time. I later refined the process in my own M&A consulting practice.  However, important questions need to be asked before making the acquisition, that is: "Should we do this deal?" It is in this area that Peter Drucker provided some excellent insight in his “Drucker’s Rules” for firms contemplating a merger or acquisition.

Peter Drucker's Rules

Peter Drucker(1909-2005) listed the "rules" that should be followed - and key questions to be asked - before an organization makes an acquisition. The Drucker Rules include:

1. Acquisitions should be based on business, not financial, strategy

According to Drucker, "acquisitions based on financial strategies are more or less doomed to failure". Without a "business strategy", the acquiring firm does not know what to do with the company it bought. Successful acquisitions are based upon business plans, not financial analysis.

2. What the Acquirer Should Contribute

Too often, senior executives ask what the “target” company will contribute to the parent if it is acquired?  Drucker commented that, "The successful acquisition is based on what the acquirer contributes to the acquisition, not the reverse. It has to be more than money, something that gives the acquired business a new potential of performance. This contribution needs to be thought through, and planned for, before the actual acquisition takes place. It has to become fact fairly quickly."  As an example, while I was consulting with 3M China Ltd. in Shanghai, 3M acquired the Cuno Corporation in 2005. It had a subsidiary in China that allowed 3M to add a much better channel and distribution system that had been perfected during 3M’s over twenty years of being in China. This allowed Cuno to dramatically increased its China sales in consumer drinking water purification products.  

3. Common Core of Unity

The successful acquisition requires a common core of unity between the acquiring and acquired company. They have to have something in common, and it has to be an area in which both parties have high competence. It must also be truly important to the business of each, and a core competence. This does not mean they have to be in the same industries but may use similar technologies or market to similar customer segments. If the companies are in hi tech or other technical areas, they should at least be able to speak a common business language and understand each other’s more technical terminology.

4. Respect the Business, Products, Customers and Values

The acquiring company must respect the business of its acquired counterpart. No acquisition is likely to work unless people in the acquiring company believe in the business they take over. They must believe that it makes a contribution and, equally, have respect for its products, markets, and its customers. The acquisition must be a "temperamental fit." In the previous example, 3M obviously respected Cuno’s products and people who marketed them as well as having similar customers in the consumer area.

5. Provide Top Management

An acquisition is unlikely to do well unless the acquiring company is able and prepared to provide it with new top management within one year at most. In many acquisitions, the acquirer is attracted to the purchase because the acquisition has such good management. The acquirer believes this management will be there and will continue to run the company, only to quickly discover that these key people are leaving - even if the reward for staying on is made very profitable for them. One reason why top management of the acquired business leaves is that they were used to being the boss; now they find themselves to be mere "division managers" or if previously the owner, now as an “employee.”

6. Promote Across Lines

Often a merger or acquisition may create the need for a new organizational structure with new key positions to be filled. Another Drucker Rule to avoid the “My people are smarter than your people problem" is to select the most qualified people from both companies to fill these positions. Failure to do this and selecting only people from the acquiring company sends a signal to those in the target that few opportunities for future advancement now exist in this new business combination. The end result will be the loss of the best people the acquirer desired to keep, for they are the ones who will find it easier to get new jobs, often with your competitors and leaving the company with the average and below average performers.  

Additional Drucker Insight

Drucker also suggested that an acquirer asks some searching questions prior to making an acquisition:

• Why are we doing this?
• Does the acquisition fit with our Mission, Vision and Strategy?
• What do we contribute to the business combination?
• Do we know anything about the business?
• Is this an industry we should be in? Is it growing, stable or declining?
• What would we do with our resources if we did not acquire this company?

“Don’t make acquisitions because they are there – make them because they are right.”

Peter F. Drucker

 

In Part Two, we look at acquisition case studies to see how these rules stand up in real world situations.