The Fundamentals of Strategic Logic and Integration for Merger … · The Fundamentals of Strategic...

The Fundamentals of Strategic Logic and Integration

for Merger and Acquisition Projects

A comprehensive introduction for practitioners to assess merger and acquisition

activity from an acquiring firm perspective – motives, synergy realization,

integration planning.

Marco Zappa

The Fundamentals of Strategic Logic and Integration for Merger and Acquisition Projects 2

Master Thesis Marco Zappa D-MTEC, ETHZ

Master Thesis in the course of study

Management, Economics and Technology

Submitted to the

Swiss Federal Institute of Technology ETH Zurich

Department MTEC

Prof. Dr. G. Von Krogh

Strategic Management and Innovation

Kreuzplatz 5

8032 Zürich

Switzerland

In collaboration with

METTLER TOLEDO AG Analytical

Sonnenbergstrasse 74

8603 Schwerzenbach

Switzerland



Author:

Marco Zappa

Dipl. Ing. ETH

Product and Marketing Manager

METTLER TOLEDO AG Analytical

Date of submission:

August 17, 2008



Table of content

1 Introduction ....................................... ......................................................................6

1.1 Motivation .........................................................................................................8 1.2 Objectives, perspective and limitations of this work...........................................8

1.2.1 Objectives .............................................................................................8 1.2.2 Perspective ...........................................................................................9 1.2.3 Limitations.............................................................................................9

1.3 Content description...........................................................................................9 2 Classification of mergers and acquisitions ......... ................................................11

2.1 The merger .....................................................................................................11 2.2 The acquisition................................................................................................12 2.3 Classification according to companies’ relatedness ........................................12 2.4 Other classifications........................................................................................13 2.5 ‘Merger and acquisition’ as used throughout this work ....................................14

3 Post-M&A firm performance studies.................. ..................................................15

3.1 Motivation to consider performance studies ....................................................15 3.2 How is post-M&A firm performance measured?..............................................15 3.3 What is failure and success? ..........................................................................16 3.4 Factors with and without relationship to post-M&A performance .....................16

3.4.1 Positive or negative relationship to performance .................................16 3.4.2 No significant relatedness to performance or conflicting evidence.......19

3.5 M&A performance...........................................................................................20 3.6 Diversification .................................................................................................21 3.7 Degree of integration ......................................................................................23 3.8 Criticism on performance study methodology..................................................23 3.9 Conclusion......................................................................................................25

4 Motives for merger and acquisition activity ........ ................................................27

4.1 Exploitation (synergy motives) ........................................................................28 4.1.1 What is ‘synergy’? ...............................................................................28 4.1.2 Classification of synergies ...................................................................29 4.1.3 Cost synergies (‘rationalization’)..........................................................30 4.1.4 Revenue synergies..............................................................................31 4.1.5 Synergies from intangibles ..................................................................31

4.2 Exploration......................................................................................................32 4.3 Preservation and survival................................................................................33 4.4 Managers’ self-interest and prestige ...............................................................34 4.5 Finance motives..............................................................................................35 4.6 Conclusion......................................................................................................36



5 Post-M&A integration and transformation............ ...............................................37

5.1 What is an adequate level of integration? .......................................................38 5.2 What are the difficulties and dangers during integration?................................40

5.2.1 Under- and overintegration..................................................................40 5.2.2 Post-merger management of positive and negative synergies.............41 5.2.3 Speed of integration ............................................................................41 5.2.4 Communication to internal and external stakeholders .........................42 5.2.5 Cultural fit and anticipation of culture dissonance................................43

5.3 Conclusion......................................................................................................43 6 National and organizational culture and culture cla shes ...................................44

6.1 What is culture in the M&A context? ...............................................................44 6.2 Which forms of acculturation exist?.................................................................44 6.3 Are cultural stereotypes a real assist or just convenience? .............................45 6.4 Can culture be ‘measured’? ............................................................................45 6.5 What is the result of perceived culture dissonance?........................................47 6.6 How can one understand culture dissonance?................................................48 6.7 What can be learned for practice to anticipate culture dissonance?................49

6.7.1 Avoid insurmountable integration problems.........................................49 6.7.2 Be aware of potential cultural dissonance ...........................................50

6.8 Conclusion......................................................................................................51 7 Success factors, reasons for failure and risks..... ...............................................52

7.1 Financial overextension and price premium ....................................................52 7.2 Realization of synergies..................................................................................54 7.3 Negative synergies .........................................................................................55 7.4 An example on the difficulties of synergy assessment and realization ............56 7.5 Strategic logic .................................................................................................57 7.6 Interview studies .............................................................................................58

8 Alternatives to mergers and acquisitions........... .................................................60 9 Reasoning of M&A activity in an early project phase .........................................63

9.1 The acquiring company’s strategy...................................................................63 9.2 M&A motives...................................................................................................63 9.3 Strategic fit between target and acquiring firm ................................................63 9.4 Sources of synergies and price premium ........................................................64 9.5 Integration, transformation and culture............................................................65 9.6 Costs and negative synergies .........................................................................65 9.7 Competition’s reaction ....................................................................................66 9.8 Alternative business collaborations .................................................................66

10 Conclusion......................................... ....................................................................69 Acknowledgement.................................... ...................................................................72 Literature ......................................... ............................................................................73



1 Introduction

‘Mergers and Acquisitions’ (M&As) are strategically planned transactions between two or

more companies in which the target and the acquiring firm jointly create a new entity to

gain competitive advantage in the market place. The motives and objectives for M&A

activity are various. Competitive advantage could arise from synergies due to economies

of scale, an increase in market share, better access to a customer base, ownership of

distribution channels and access to knowledge and technology to mention just a few. In

other words, mergers and acquisitions allow the purchase of assets that would be

difficult, risky, time-consuming or even impossible to obtain by other alternative business

collaborations or organic growth.

While strategic logic for M&A projects seems to be straightforward, however, most

empirical studies reveal that a majority of M&A projects fails to reach their objectives

(Datta; Chatterjee) as shown in Fig. 1.1:

Fig. 1.1: M&A failure analysis from consulting companies and research studies (Picot).



These findings raise a paradox: Why do managers continue to transact M&A deals on

such a massive scale in both number and monetary terms (Fig. 1.2 and Fig. 1.3), when

there is little economic justification for M&As?

Fig. 1.2: Merger and acquisition waves in U.S. industry from 1898 to 2000 (Ghauri).

Fig. 1.3: Number of M&A deals related to U.S. firms from 1895 to 2001 (Picot).



1.1 Motivation

The present work is conceptualized around the set of questions raised above. The work

is motivated by the recent necessity of the author’s employer to obtain a comprehensive

introduction to the field of mergers and acquisitions that is of practical relevance in the

employer’s current economic context.

The Strategic Business Unit (SBU) MatChar (Materials Characterization) of

METTLER TOLEDO AG faces a worldwide consolidation phase in the field of Thermal

Analysis and neighboring analytical lab techniques. Competitors’ mergers and

acquisitions and the limited organic growth potential due to harsh competition make it

necessary to consider M&A as a feasible mechanism for growth and protection.

However, beside financial analysis a systematic assessment concept and the

corresponding knowledge required in a pre-M&A phase are largely missing.

Considering the fact that an M&A deal can be one of the biggest decisions a company or

business unit ever makes, missing fundamentals for a proper decision put a high risk to

the acquiring company. Many managers however do not have adequate time and

knowledge to carefully evaluate merger and acquisition projects. Such time pressure

increases the chance of rushing headless into unqualified decisions of poorly planned

M&As, leaving important areas of uncertainty unresolved and resulting in the widely

reported disappointing outcomes.

1.2 Objectives, perspective and limitations of this work

1.2.1 Objectives

Metz in his studies argues:

„Es ist keineswegs übertrieben, von einer nicht mehr überschaubaren Zahl von

Veröffentlichungen aus betriebs- und volkswirtschaftlicher, juristischer sowie

vereinzelt aus sozio- und psychologischer Sicht zu sprechen.“

Indeed, research on M&A consists of two distinct categories: the empirical performance

literature and the post-merger integration and culture literature. While these two very

extensive areas of research dominate the whole M&A literature, they are highly

specialized focusing mostly on very distinct subjects. As a consequence they provide

little guidance for managers due to their very fragment-like research questions.



Interestingly, there is even very little literature on strategic concerns of mergers and

acquisitions not to mention a comprehensive (but still trustworthy) introduction for

practitioners.

As a consequence, the overall objective of this work is to:

� Provide a comprehensive introduction to subjects being relevant in an early stage

of a merger and acquisition project (before due diligence) to increase the

likelihood of M&A success.

� Allow an informed decision on strategic logic and integration matters of merger

and acquisition projects and to sensitize to the profound interdependence of

these to subjects.

� Introduce the prerequisites for a systematic assessment and more objective

comparison of potential target firms.

� Evaluate alternative business collaborations.

� Be a guide for practitioners enabling them to cope with the many difficulties

attached to M&A projects and to build awareness of common pitfalls.

1.2.2 Perspective

The addressed readers of this work are managers of acquiring firms and consultants that

need to evaluate, advice on, decide on and conduct merger and acquisition projects.

1.2.3 Limitations

Although the following matters find their reflection in this work it is not a guide on how to:

� Conduct a due diligence

� Define and review a company’s strategy

� Perform a market or company analysis

1.3 Content description

The first step towards the objectives defined above is to present various definitions and

categorizations of mergers and acquisitions emphasizing the multifaceted and complex

nature of such undertakings (refer to chapter 2).

On this basis, the most often reported findings of empirical post-M&A firm performance

studies are reviewed to gain insight into why certain M&A projects fail and others



succeed and to discover universally valid performance-enhancing key success factors

that do not depend on the specific characteristics of an M&A project (refer to chapter 3).

From the results of these performance studies and the critical review of their

methodology, a broader set of motives and objectives for mergers and acquisition

activity emerges and is discussed in the light of multiple motive M&As. In particular, an

extensive overview on the manifold classical strategic motives like synergy is presented

and illustrated with a few examples. While considering a number of motives that receive

far less attention also irrational and illegitimate motives find their reflection (refer to

chapter 4).

Once this basic framework is established, various integration and transformation

concerns are discussed like the adequate level of target firm integration, generic

scenarios and the parameters determining the level of integration. In particular, it is

illustrated how M&A projects can be compromised to reach their objectives, if post-

merger management fails to realize positive synergies and does not foresee negative

synergies. Beside strategic considerations of the integration and transformation period,

determining national and corporate cultural fit between target and acquiring firm, results

of cultural dissonance and means of anticipation for culture clashes and are deduce d

from a group of surveys (refer to chapters 5 and 6).

From all these areas under discussion, success factors, reasons for failure and risks of

an M&A project are figured out (refer to chapter 7). As an addition, feasible alternative

business collaborations are contrasted with mergers and acquisitions in terms of

strategic motives and objectives to be realized (refer to chapter 8).

As a summary, a guide to reason M&A activity in an early project phase is developed.

Without credible answers to these basic questions, acquirers are on their way to losing

the acquisition game from the beginning even before the due diligence or even the

integration starts to happen (refer to chapter 9).



2 Classification of mergers and acquisitions

‘Merger and acquisition’, or ‘M&A’ is a field of study in which the definitions often vary in

different publications. The traditional framework how to distinguish between ‘mergers’

and ‘acquisitions’ is the perspective on the legal independence of the business entities

(Fig. 2.1):

Fig. 2.1: Types of collaboration between business entities categorized by effect on legal

independence (Metzenthin).

2.1 The merger

A ‘merger’ is a combination of assets of two previously separate firms into a single new

legal entity. All involved companies lose their legal independence as all their assets

become the pieces of a new firm. A ‘merger’ may be characterized by an equal rank of



the involved firms with respect to their sizes, resources and power. In this context, the

phrase ‘merger of equals’ is frequently used to refer to the equality of the formerly

independent companies. However, even when theoretically and officially ‘mergers’ are

supposed to be between equal partners, most result in one partner dominating the other

(Ghauri). Terming the combination a ‘merger’ rather than an ‘acquisition’ thus can be

done purely for political or marketing reasons. The number of ‘real’ mergers in M&As is

either way almost vanishingly small. Less than 3% of cross border M&As by number are

mergers (Ghauri).

2.2 The acquisition

‘Acquisition’ (or ‘takeover’) usually refers to a purchase of a smaller firm or a part of a

firm by a larger one. In an ‘acquisition’, the control of assets is transferred from one

company to another. The acquired firm (target) loses its legal independence, while the

acquiring firm is not affected in that respect.

‘Acquisitions’ can be subdivided into full absorption or a subsidiary status within a

corporate group depending on the level of organizational integration of the acquired firm

(refer to chapter 5.1).

Sometimes, however, a smaller firm acquires management control of a larger or longer

established company and keeps its name for the combined firm. This is known as a

‘reverse takeover’.

2.3 Classification according to companies’ relatedn ess

While the traditional distinction between ‘mergers’ and ‘acquisitions’ is mainly based on

their differences in legal structure there exist many other ways how to categorize M&As.

One is to group M&As into four categories with respect to the companies’ relatedness

(Ghauri):

� Horizontal: takes place where the two combining companies produce similar

products in the same industry and/or are competitors.

� Vertical: occur when two firms, each working at different stages in the production

of the same good (value chain), combine (e.g. buyer-seller, client-supplier).

� Conglomerate: takes place when the two combining firms operate in unrelated

businesses (unrelated diversification).



� Concentric: occurs where two combining firms are in the same industry (related

diversification), but they have no customer or supplier relationship (e.g. a merger

between a bank and a leasing company).

2.4 Other classifications

Depending on the perspective on M&As other criteria for classification are discussed in

the literature. These perspectives are reflected in the field of M&A performance studies

(refer to chapter 3) to conclude on the key success factors for mergers and acquisitions

projects. Here, list of some alternative classifications is given (Metzenthin; Ghauri):

Management cooperation perspective:

M&As can be friendly or hostile. In the former case, the companies cooperate in

negotiations, finally agree to the transaction and ensure that the deal is beneficial to both

parties. In the latter case, the acquiring company purchases the majority of outstanding

shares of a company in the open market while the takeover target is unwilling to be

bought or the target's board has no prior knowledge of the offer.

Stock market perspective:

‘Accretive’ mergers are those in which an acquiring company's earnings per share (EPS)

increase and/or in which a company with a high price to earnings ratio (P/E) acquires

one with a low P/E. ‘Dilutive’ mergers are the opposite of above, whereby a company's

EPS decreases. The company will be one with a low P/E acquiring one with a high P/E.

Financing perspective:

Stock-financed versus cash-financed (self-finance or borrowed)

Fig. 2.2: Types of collaboration categorized on the basis of involved capital investments

(Metzenthin).



Market perspective:

Both partners focus onto the same or different target customers, distribution channels,

technologies, products and services.

Motives perspective:

Similarity M&A versus complementary M&A

Geographic perspective:

Domestic versus cross-border M&As

Technology perspective:

Technology oriented enterprises versus non-technology firms

Strategic perspective:

Diversification (cross-industry, focus decreasing) versus concentration (focus increasing)

Integration perspective:

Degree of loss of control or degree of integration of the target firm

2.5 ‘Merger and acquisition’ as used throughout thi s work

The various perspectives on the field of M&A emphasize how multifaceted and complex

such an undertaking is. Since most of the perspectives given above will find their

discussion throughout this work the terms ‘merger’ and ‘acquisition’ are not assigned to a

specific type of deal. In fact, the term ‘merger’ and ‘acquisition’ or ‘M&A’ is generally

used for a project where two firms (the target and the acquiring company) combine to

one legal entity or one or several parts of a firm (target) change their belonging to the

entity of the acquiring firm. However, ‘merger and acquisition’ is clearly set apart from

collaborations as ‘alliance’, ‘co-operation’ or ‘joint venture’ (refer to chapter 8).



3 Post-M&A firm performance studies

The most often researched and reported findings of post-M&A firm performance studies

are described here focusing on those being of strategic importance in a pre-M&A stage.

A critical review on performance studies methodology is given and other sources of

evidence are discussed.

3.1 Motivation to consider performance studies

The surveys on acquiring firms’ post-M&A performance build the vast majority of all

research studies beside those focusing on M&A integration matters (Paine). Thus, one

could assume that performance studies provide, first, insight into why certain M&A

projects fail and others succeed and, second, present universally valid performance-

enhancing key success factors that do not depend on the specific characteristics of an

M&A project.

3.2 How is post-M&A firm performance measured?

In the literature manifold ways can be found how an acquiring firm’s post-M&A

performance is measured relative to its pre-M&A performance:

� Turnover and profit growth

� Relative firm value

� Short- and long-term stock price (event study methodology)

� Abnormal stock return (difference between actual returns and the previously

expected returns)

� Present value of the post-M&A incremental cash flows

In most studies the underlying assumption about what constitutes a ‘legitimate’ M&A can

be summarized as follows: Shareholder wealth creation is the goal of the firm and thus

the acquiring firm will only engage in M&A where it will increase economic value for

acquiring shareholders (Hitt). In other words, it is assumed that any manager engaging

in an M&A which may provide neutral or negative returns is transacting an ‘illegitimate’

deal.



For a more complete understanding of different types of performance studies and their

characteristics (data collection, time horizon considered, statistical evaluation, relative

performance vs. absolute performance methodology, definition of failure and success

etc.) refer to the corresponding literature. Beside the many performance studies also a

large number of reviews can be found of which those by Sirower and Agrawal are the

most complete and most recent.

3.3 What is failure and success?

Failure has been understood in terms as extreme as ‘resale’, ‘liquidation’ or ‘divestment’,

or as conservative as “failing to reach certain projected growth or profit” in

benchmarking. As a result, the definition of failure and success depends on the

performance measures applied and thus is exceedingly broad and almost a peculiarity of

every single performance study.

3.4 Factors with and without relationship to post-M &A performance

This work distinguishes between factors having a positive/negative impact and factors

having no significant or a highly controversial impact on a firm’s performance. Since

there is mostly no agreement on the extent of positive or negative impact no concrete

figures are given here.

The findings on the factors ‘M&A activity’, ‘Diversification’ and ‘Degree of Integration’

have biggest significance for the validation of potential firms to be acquired and thus are

discussed in more detail subsequently to the list below.

3.4.1 Factors for which a majority of empirical studies found a positive or negative

relationship to performance of the acquiring firm:

1. M&A activity (e.g. Dyer)

Most studies report, on average, a negative long-run performance following

M&A deals (see a more detailed discussion subsequent to this list).

2. Acquisition premium (e.g. Epstein)

The level of the acquisition premium (price paid) has a strong negative effect on

performance across most measures of shareholder performance. The higher the



premium is, the larger the subsequent loss. Alberts and Varaiya (in Datta)

conclude that post-acquisition gains to most bidding firms were not adequate to

cover the premiums paid to acquire the targets.

Epstein reports that even if the price paid is not public, acquiring companies

experience a decrease in stock price when the market is anxious that the bidder

will overpay for growth opportunities of the acquired firm.

3. Multiple bidders (e.g. Datta; Goergen)

The presence of multiple bidders has a negative impact on short- and long-term

acquiring firm performance. As a result, bidding firms should avoid getting

involved in tender offers. The vast majority of worldwide M&As are single-bidder

auctions (more than 72%). The increased competitiveness in such cases tends to

drive up acquisition premiums.

4. Means of payment (e.g. Loughran; Goergen)

An all-cash offer for acquisitions results in better performance than an all-equity

or a combination of cash and equity. The fact the takeover will be paid with

equity might signal to the market that the bidding managers believe that their

firm’s shares are overpriced or already expect a subsequent long-term

underperformance of the combined firms.

5. Percentage of the target firm shares acquired (e.g. Sirower)

Majority holdings in the target firm correlate positively with the acquiring firm’s

long-term performance.

6. Managerial ownership (e.g. Goergen)

The fraction of managerial ownership (e.g. through equity stakes) in the acquiring

firm is found to be strongly significant for long-term performance. This suggests

that managers are more likely to undertake value-destroying M&A deals, if they

do not own equity in their firm.

7. Type of takeover (e.g. Loughran; Goergen)

In comparison to friendly M&A offers, hostile bids trigger large positive abnormal

returns for the target shareholders but significant, negative returns for the bidder.



The overwhelming proportion of M&As are friendly. In 1999, there were only 30

hostile takeovers out of 17’000 friendly M&As.

8. Industry phase

A study by Kröger evaluating 30’000 firms over 15 years reports successful M&A

deals in almost 60 per cent of the cases across various industries in their opening

phase (Öffnungsphase) and accumulation phase (Kumluationsphase) of his

model (Fig. 3.1). In the subsequent focusing phase (Fokussierungsphase) the

success rate diminishes to 30 per cent and even less in the balance phase

(Balancephase). The reason for this decline in success rate is seen in the

decreasing realizable synergy potential due to the raising price premiums paid for

target firms and, when the industry matures, the value chains that are already

substantially optimized in the later phases of the model.

Fig. 3.1: Success rate of M&As as a function of the degree of consolidation

(Kröger).



3.4.2 Factors for which no significant relatedness to the acquiring firm’s performance or

heavy conflicting evidence is found:

1. Stock market behavior at announcement (e.g. Goergen)

There is little consensus about the announcement effects for the bidding firms.

About half of the studies report small value-destructive effects for the acquirers’

shareholders (Sirower) whereas the other half finds zero or small positive

abnormal returns. Considering that the average target is much smaller than the

average acquirer, the combined net economic gain or loss at the announcement

is expected to be rather small.

However, the literature findings for target firms’ returns are much more

consistent. Goergen et al. in their extensive empirical study across various

industries find large announcement effects of 9% for target firms, but the

cumulative abnormal return that includes the price run-up over the two-week

period prior to the event rises to 20%.

2. Acquisition experience

According to Straub the number of acquisitions in the years prior to the relevant

acquisition is not significantly related to performance while Duncan identifies a

company’s previous acquisition experience as a factor for success.

Selden et al. (in Sirower) on the other hand find that most companies

outperforming the S&P500 have low M&A activity, and if, rather small firms are

acquired.

3. Diversification (e.g. King)

Strategic relatedness does not generally outperform strategic unrelated M&As

(see a more detailed discussion subsequent to this list).

4. Size of merging firms

There is lacking evidence on the correlation between the relative size of the

merging firms and long-term performance. Some researchers have suggested

that small mergers (mergers where the two firms are very different in size) tend to

produce higher performance than larger mergers (mergers where the two firms

are similar in size). They attribute these performance differences to the ease of

combining operations. With smaller mergers the integration of the new entity is



more easily controlled and the disruption to the organization as a whole is

minimized. With a large merger, the integration problems are multiplied and

disruption can occur throughout the whole organization. On the other hand, those

researchers neglect the fact that a small merger often provides also less

significant gains to the large organization. However, as Lubatkin and Seth point

out, the few studies that have examined this size issue have found that larger

mergers, on average, tend to be more successful than smaller ones.

5. Degree of integration

The post-merger integration level (i.e. fully integrated versus not or partially

integrated) has no relationship with a firm’s performance (see a more detailed

discussion subsequent to this list).

Many other factors exist being reported in a smaller number of studies, as for example

the pre-merger book-to-market ratio (e.g. Rau and Vermaelen in Megginson), the pre-

merger financial performance (e.g. Kruse), the net cash held by the target and growth

potential of target as central factors influencing long-term firm performance of the

merged firms.

3.5 M&A performance

Success and failure with M&A deals has been studied in the vast majority of all surveys

in terms of narrow measures as given in chapter 3.2 leading to the claims that most

M&As fail. Acquiring firms loose, on average, 10 per cent of stock value in a five years

period as found by Dyer in his study across various industries. Only about 35% of

acquisitions are met with positive stock market return. According to a KPMG study

(2000), 83% of recent deals failed to deliver shareholder value and 53% actually

destroyed value. Also Porter (in Datta), based on an analysis of acquisitions made by 33

Fortune-500 firms, concludes that acquisitions have been largely unsuccessful when one

considers that over half were subsequently divested.

When gains to targets and bidders are combined, most acquisitions are wealth creating.

Although Seth et al. (in Ghauri) find that positive total gains occur in 74% of the

acquisitions they estimate in their review that total gains are only 7.6% of the pre-

acquisition value of the combined firm. From a macroeconomic point of view one can



argue that acquisitions transfer resources from less to more productive sectors of the

economy. However, bidders have only minimal or no incentives at all to be a participant

in such transactions (Datta). Ghauri claims that more than 50% of the mergers so far

have led to a decrease in share value of the bidder firm and another 25% have shown

no significant increase. Ghauri reports that targets realize the majority of the gains, while

acquirers appear to experience positive effects on shareholder value only in about one-

third of M&As and gain nothing on average.

In summary, the aggregate evidence from the performance literature is toward negative

performance for acquiring firms in M&A deals. Results indicate that while the target firm’s

shareholders gain significantly from M&As, those of the bidding firm do not. Moreover,

historical evidence documents that the returns to acquirers have gotten progressively

worse, on average, for acquisitions occurring in the 1960s, 70s, 80s and 90s,

respectively (Sirower). As a conclusion one is tempted to claim that the M&A activity

itself inherently is a reason for under-performance or failure of M&A deals.

Clearly this negative evidence raises serious doubts over the massive and still

increasing size and number of M&A deals over the last 40 years (refer to chapter 3.8).

3.6 Diversification

There is considerable disagreement in the literature about whether strategically related

acquisitions are more beneficial than strategically unrelated acquisitions. However, most

publications suggest from a theoretical point of view that corporate focus is the primary

determinant of long-term M&A performance. Continuing to focus on the acquiring firm’s

core business should help to maintain its strengths and to minimize the risks associated

with acquiring a business in an industry of which the firm may have only limited

knowledge. However, many studies document that relatedness (focus-preserving or

focus-increasing, FPI mergers) had a marginal positive effect on long-term performance.

On the other hand, unrelatedness (focus-decreasing, FD mergers) is often reported to

result in significantly negative long-term performance (e.g. Megginson; Duncan). To

classify corporate diversification Megginson uses the ‘Herfindahl Index’ (HI), which

describes the merger-related degree of change in corporate focus (Megginson). He finds

that every 10% reduction in focus results in a 9% loss in stockholder wealth, a 4%

discount in firm value, and a more than 1% decline in operating performance. These



results suggest that companies should not attempt to do what investors can do better

themselves, i.e. creating a diversified portfolio.

However, several authors have found no significant effect of relatedness on

performance. Some researchers even have found that acquiring firms making

conglomerate (i.e. unrelated) acquisitions outperform those making non-conglomerate

acquisitions (Sirower; Kruse; review in Megginson). They report advantages of unrelated

M&A to be improved cash management, more efficient allocation of investment capital

and reduced cost of debt capital.

In summary, although a majority of studies have found overperformance of related M&A

deals, the evidence is very vague. Boutellier reminds that the decision for relatedness or

unrelatedness is very dependent on the industry within which the firms operate. This

matter of fact is visualized by Palich et al. (Fig. 3.2):

Fig. 3.2: Performance versus degree of diversification: (a) the linear model; (b) the

inverted-U model; (c) the intermediate model (Palich).

An excellent summary on various studies (with conflicting findings) regarding

diversification and relatedness can be found in Sirower and Agrawal.



3.7 Degree of integration

The finding that the degree of integration of the acquired into the acquiring firm is a

particularly interesting result because performance gains presumably should be driven

by some type of synergy realization through integration. On the other hand, the level of

integration is assumed to be related to the number of integration difficulties limiting the

realization of the synergy potential. As a result one could conclude that the advantages

of a full or moderate integration are diminished by the disadvantages such integration

creates.

3.8 Criticism on performance study methodology

Empirical performance studies have almost exclusively concentrated on whether M&A

projects create abnormal shareholder value or profitability for the acquiring and the

target company and whether strategically related acquisitions are more beneficial than

strategically unrelated acquisitions. The overall conclusion from hundreds of studies is

that most M&A fail. The vast majority of studies on M&A performance in the last 40 years

show failure rates for acquirers of between 40% and 85% with an average of

approximately 2/3 on a wide variety of measures (Angwin).

Despite considerable research effort being devoted to assess M&A performance the

findings of strategic importance in a pre-M&A stage are mainly vague or inconsistent.

That fact is troubling since first, no significant success factors for M&A deals that drive

the returns can be extracted and second, a reasoning of the findings in these studies

seems to be inappropriate in the view of such lacking evidence:

“[…] M&As’ influence on post-acquisition firm performance remains inconclusive.

[…] the existing empirical post-acquisition performance studies have not

recognized any prerequisites that would be useful in forecasting post-acquisition

performance.” (Straub)

These findings raise a paradox: Why do managers continue to transact M&A deals on

such a massive scale in both number and monetary terms, when there is little economic

justification for M&As from the bidding shareholders’ point of view? This difference

between action (the continued pursuit of mergers) and performance (the low rate of

successful mergers) are caused by:



� Managers being overly optimistic, continuing to make estimation errors in valuing

target firms, thinking that they have learned from past merger mistakes and that

the next merger will be successful (while in fact they continue to make the same

merger mistakes).

� Past empirical studies being inaccurate because of data collection, time-periods

covered, statistical errors or aggregation of different deal structures (e.g. size of

merger, cross-industry comparison etc.). Angwin states that too often M&A

projects are considered as a whole homogeneous entity not taking into account

project-specific characteristics. For example, if one accepts that acquisitions are

often a search for a unique asset embedded in a firm, then returns from that

asset will vary as the size of the unique element varies as a proportion of the total

company. It is desirable that research in future differentiates among different

types of M&As so that similarities and differences among deals are clearly

understood. This could lead to a much more specific set of findings with much

less contradictory findings and thus substantial practical value.

� Managers pursuing goals other than shareholder wealth maximization and, thus,

empirical research is using an inaccurate measure of performance (e.g. Angwin).

Some researchers raise the fundamental issue of whether the financial markets

are always best placed to value the actions of management. For instance, a CEO

embedded in an industrial context may be more of an expert on how firms should

be run and necessary investment decisions which should be made (such as

M&A) than financial analysts and shareholders eventually far away from that

context. The CEO may take actions which may not result in positive shareholder

returns in the short run but could be of vital importance to the long-term success

of the firm.

Evaluation of long-term changes in stock price must be done with care since

merger strategies often require years of integration efforts before potential

benefits are reflected in stock price. And, changes in stock price often tells little

about the M&A and its motives but more about the company overall and the

economic context.

If the existence of multiple merger motives and motives other than share holder

wealth creation is correct, then past merger studies that attempt to measure



merger success by examining single financial indicators of performance (most

commonly profitability and share value) tend to undervalue the achievement of

other goals and may fail to provide an accurate picture of M&A success. Thus,

the results from performance studies may be biased since many deals are being

assessed on motives which were never the main intention of management. To

test performance M&As should at least be judged in terms of what management

primarily attended to achieve with the deal and whether the deal was superior to

possible alternatives (refer to chapters 8 and 9.8).

A number of researchers have suggested that the proper way to measure

strategic performance is against a firm’s set of key success factors. These factors

may include financial indicators but as well as other quantitative and qualitative

objectives. By using key success factors as the measure of merger performance,

managers can get a better idea of the benefits attained from the merger, not just

a measure of whether shareholder value has changed.

3.9 Conclusion

A broader set of motivation for M&A deals (refer to chapter 4) may explain why so many

deals appear to perform poorly in performance studies and may explain also why so

many M&A deals continue to take place. Although the suggestion of multiple motives for

M&A deals other than share holder wealth creation or profitability increase is not new,

traditional performance studies as discussed so far prevail also nowadays. One reason

might be that researchers face substantial resistance when studying the real M&A

motives since management hardly will officially report motivations other than the

traditional and most legitimate intention of improving financial performance of the firm.

‘Less acceptable’ motives will be downplayed or even neglected. Metz in his studies

remarks:

„Ursprünglich war geplant, an Fallbeispielen zu analysieren, wie

Unternehmungen Synergieeffekte planen, messen und kontrollieren und wie sie

diese in ihren Entscheidungen berücksichtigen. Die Vertraulichkeit der

Informationen verhinderte jedoch, den Kreis der Beispiele zu weit zu ziehen.“



The sheer difficulties in obtaining data from managers and honest answers on their true

motives and thoughts tend to overcomplicate empirical M&A studies since researchers

must rely on relatively small samples and unknown data quality.

In the light of these difficulties it seems much more convenient to rate a firm’s M&A

performance through easy access to performance measures allowing for quantitative

and statistical evaluation. Even if the ‘true’ motives for M&A deals would be taken into

account one can assume that still a large portion of M&A transactions remain

unsuccessful since the main motive for M&As remains the ‘traditional’ value creation

resulting from synergies (refer to chapter 4.1).



4 Motives for merger and acquisition activity

Categorization of mergers and acquisitions according to the management’s motives is

fairly generic since motives can have manifold facets, overlapping each other or even

belong to several categories. While it is attractive to categorize M&A deals into single

motives research studies show that this would be an oversimplification. A survey from

Angwin in 2000 involving CEOs of 100 domestic acquirers in the UK about their

motivations for carrying out a specific M&A transaction reveals up to seven reasons in

some instances, 45% gave three or more reasons and 71% of CEOs gave two or more

reasons.

Angwin in his survey groups motives into four categories:

� Exploitation of the target through synergies to increase acquirer value with a high

degree of certainty (classical motivation)

� Exploration of new territories of latent value and for future opportunities with low

certainty of improving returns to the acquirer but with a big potential

� Preservation (‘stasis’) attempting to defend the acquirer’s competitive situation

through control of potential new competitors

� Survival attempting to prevent the acquirer’s end through being acquired itself

The payoffs for these different types of motives are different. From ‘exploitation’ deals

there should be reasonable certainty about value created. ‘Exploration’ deals may have

the potential for much greater returns than exploitation deals as well as much higher risk

about whether those returns will be achieved and how far into the future. For

‘preservation’ deals the acquirer may not receive any direct benefit, with neutral or even

mildly negative returns but the negative threat of severe future change maybe reduced.

‘Survival’ deals are not so much about increasing value as to survive potential takeover

threat or current demise of the firm. For ‘preservation’ and ‘survival’ type deals, value

creation maybe an inappropriate way of viewing performance. Instead ‘worse off test’

should be applied answering the questions “would the acquirer be substantially worse off

if it did not transact a particular acquisition?”



4.1 Exploitation (synergy motives)

Synergy motives are widely seen as the most frequently mentioned motives when

managers argue for an M&A project (Schweiger). Synergies are accepted as a legitimate

reason for such undertakings since their realization appears to directly correlate with the

enhancement of economic performance of a firm.

4.1.1 What is ‘synergy’?

A target firm has an intrinsic value that is based on what a firm is worth as a stand-alone

entity. This value is typically based on the expected stream of cash flows it can produce

as a going concern. If an acquirer pays more than this value (price premium), value is

likely to be destroyed. However, a buyer can utilize the acquisition to improve cash flows

of either the target, itself or both such that value still can be created. This concept is

known as ‘synergy realization’.

Kuhn in his publication gives a few examples of synergy realization, however, not

without closing his illustration with an ironic undertone:

„Schnell etablierte sich die Unterscheidung zwischen Kosten- und

Umsatzsynergien. Im ersten Fall sinken die Ausgaben des neuen Unternehmens,

weil es etwa Skaleneffekte im Einkauf erzielt, nur noch ein Rechenzentrum

benötigt oder – im idealen Fall – Manager und Mitarbeiter die besten

Geschäftspraktiken der jeweils anderen Seite übernehmen.

Im zweiten Fall erzielt die fusionierte Firma höhere Umsätze, weil der Vertrieb

den Kunden aus der kombinierten Produktpalette attraktive neue Angebote

zusammenstellen kann, nun die kritische Masse vorhanden ist, um neue Märkte

zu erschliessen, oder sich Stärken in verschiedenen Vertriebskanälen ergänzen

– eigentlich kein allzu ambitioniertes Ziel.“

In other words, ‘synergy’ is the increase in performance of the combined firm above what

the two firms are already expected to accomplish as independent firms through gains in

competitive advantage. Thus, the synergy hypothesis proposes that M&As take place

when the value of the combined firm is greater than the sum of the values of the

individual firms.

The relationship between price, synergy and value is illustrated in Fig. 4.1.



The figure illustrates that value can be created when the price paid for a target is below

its stand-alone value. When the price exceeds the stand alone value, synergies must be

captured for value to be realized. When the price exceeds all synergies, there is no

chance that value can be created.

Fig. 4.1: The relationship between price, synergy and value (Schweiger).

4.1.2 Classification of synergies

Dyer proposes the following classification of synergies:

� Modular synergy: if firms manage their resources independently but their final

outcomes combine to potential synergy realization (e.g. common usage of

distribution channels)

� Sequential synergy: if one firm completes its activities first and transfers the

outcome to the partner firm (e.g. after-sales offering)

� Reciprocal synergy: if firms jointly work together in activities and mutually share

resources along the value chain (e.g. common R&D activities)



Other authors divide synergy according to the types ‘cost’, ‘revenue’ and ‘intangibles’

(Angwin; Weber; Schweiger; Ghauri; Cullinan):

4.1.3 Cost synergies (‘rationalization’)

Reducing costs is one clear way to increase cash flows and has been the most common

form of synergy. If synergies are expected to come from cost savings for price and/or

cost structure competitiveness, they must emerge from eliminating duplication due to

similarities between the firms. Synergistic benefits from potential duplicated resources

can come as fixed or variable cost synergies:

� Economies of scale i.e. increasing volume of production/sales reduces costs

per unit

� Economies of scope i.e. spreading or shearing resources across more business

activities

Examples: sharing of products/services, marketing/advertising and brand

development efforts

� Bargaining power along the value chain i.e. increasing power over suppliers

(purchasing efficiency) and distributors to reduce transaction costs

� Elimination of redundant functions i.e. reduction of overlapping work force

(administration, overhead, corporate staff like finance, IT, human resources etc.)

and rationalization of processes (production facilities, distribution/sales,

warehousing, servicing etc.)

� Control over value chain i.e. vertical integration

Such moves are made to increase value added into the business, to gain control

over more aspects of the business (supply, distribution) and to reduce transaction

costs in the value chain.

Examples: Lower variable costs of raw material through control over raw

materials, lower overall costs through improved product development and

manufacturing interfaces.

� Flexibility of capacity i.e. using excess capacity of one firm to fill the other firm’s

excess demand (improved agility).



4.1.4 Revenue synergies

Typically, revenue synergies are associated with complementary (i.e. non-overlapping)

activities resulting in higher volume and revenue sales:

� New customer base i.e. increase sales coverage or acquire new distribution

network or new sales channel that can result, for example, in more profitable or

loyal customers.

� Cross-selling of products or services through complementary sales

organizations or distribution channels that serve different geographic regions,

customer groups or technologies (increased sales productivity by selling more

volume with the same number of sales people).

� Broadening a company’s products and services portfo lio to provide needed

bundling or a more complete/full offering.

� Internationalization i.e. increase sales volume and market share through

geographic extension and access to new customers

M&As are means to expand internationally more rapidly or they make it possible

to enter new markets using the distribution network and the specific knowledge of

local partners. Thanks to the contributions of these partners, the foreign company

is offered a geographic presence, less effort and time has to be put into learning

how to succeed in very different local environments (Garrette).

Internationalization can also foster a company’s responsiveness by moving

production processes, distribution, warehousing, and after-sales activities closer

to customers. This can result in increased competitiveness by being better able

to serve customers with needs for broader geographic coverage.

4.1.5 Synergies from intangibles

This type of synergy results from the acquisition of immaterial goods or goods that hardly

can be acquired in the market:

� Access to brands, reputation and intellectual prope rty

Example: increase appeal to more and better distributors, suppliers and

employees.



� Access to human resources i.e. people, knowledge, experience, skills,

brainpower (talent-based M&A).

� Access to technology and the attached knowledge, in novation and product

development efforts i.e. create new business opportunities or enhance a firm’s

core business.

Knowledge often cannot be acquired in the market as it is bundled with other

assets. Due to the asymmetric information regarding knowledge and technology

the valuation of this asset is extremely difficult however important as it is very

often the key reason for an acquisition.

� Access to superior managerial practices , business models and operational

excellence (e.g. quality control system, delivery concepts, after-sales service…).

The reverse is ‘victim infusion’ (Ghauri): a firm can infuse the ‘victim’ with better

management, organization skills, or superior marketing.

4.2 Exploration

There are motives other than synergy realization which receive far less attention:

� Greenfield entry

As new markets and knowledge emerge there will always be a need to engage in

these areas. By definition there will be significant uncertainty since acquirers

cannot know the future. They can form views about whether the potential of an

M&A deal maybe high, but in new unfamiliar areas (geographic, technological

etc.) the information available maybe extremely unreliable or difficult to interpret.

There are huge question marks over the potential, how the market may evolve or

whether a market will actually emerge at all. In conventional terms such M&A

deals might likely to be a failure but the deal could be significant in influencing

market development and placing the acquirer in a privileged position for future

strategic moves. Not to participate in an emerging area may also have a cost of

being late or even excluded from participation.



� Learning prologue i.e. sequential M&A to learn about a sector as a prologue to

a later larger M&A deal (e.g. a common practice amongst Japanese firms in

cross-border M&As) (Ghauri).

4.3 Preservation and survival

This type of synergy results from the elimination of competitors from a market and to

gain a more dominant position in an industry:

� Affecting competitive dynamics

M&A deals can be used as a weapon to harm the actions of competitor firms.

Here performance is less about the contribution of the target firm to the new

parent, but more in terms of the damage done to the competitor and prevention

of unpleasant challenges in an industry (e.g. Angwin; Ghauri).

Example: avoid price war or affect a competitor’s pricing ability in mutual markets

through acquiring in a competitor’s main market.

A similar motivation is to prevent a private firm from becoming more tradable and

so available to competitors as often seen in the pharmaceutical, biotechnology

and IT industry.

� Overcapacity reduction i.e. purchasing competitors and closing them down to

gain market share or critical mass

� Pricing flexibility i.e. elimination of capacity from the market place allowing an

acquirer to maintain or increase prices in the market thereby improving margins

and cash flows.

� Innovation quenching (Angwin)

The acquisition is intended to suppress rather than develop the competitive

potential of the acquired firm (Ghauri). For instance, buying infant firms and

closing them down prevents any possible takeoff of that firm which could change

industry dynamics. An alternative to closure is to purchase infant firms so that the

acquirer can control the rate of innovation leakage into an industry. Such

acquisitions itself may not result in positive returns, but may be less damaging

than allowing the firm to emerge.



� Competitor actions

The actions of a competitor may induce a firm into engaging in M&A. It is known

that when an industry begins to consolidate there is a rush of other firms to

follow. The motive here is the fear of being taken over (M&A as a defense

mechanism) or the fear of no suitable targets being left for an M&A deal.

� Customer / supplier pressure

Powerful customers or suppliers can force firms making M&A deals. For instance,

in the IT industry Nokia brought pressure on one of its suppliers to purchase a

high tech firm as they wanted aspects of this technology integrated into the

components they were sourcing, but they did not want to purchase the firm

themselves. The supplier, wanting to keep its main client had no choice. It may

not have benefited from the actual M&A but to lose Nokia as its primary customer

would have been a far worse outcome.

� Political persuasion

Governments can bring substantial pressure upon top management to act in a

way which would further the national interest. For instance, in France there has

repeatedly been pressure upon firms to merge rather than accept approaches

from Italian, Spanish and Swiss firms.

� Gaining influence on 3rd party firms

4.4 Managers’ self-interest and prestige

All of the above motives for M&A assume rational managerial motivation based upon

improving firm performance. However, not all motives can be considered rational from

the business perspective:

� ‘Agency’ motive (self-interest, greed motive)

In the context of M&A the agency motive suggests that takeovers occur because

they enhance the acquirer management’s welfare at the expense of acquirer

shareholders (e.g. Angwin; Brouthers).

� Hubris motive (prestige motive)



The hubris hypothesis suggests that managers make mistakes in evaluating

target firms (excess confidence) and engage in M&As even when there is no

synergy potential or other legitimate motive (Berkovitch). Diversification of

management’s personal portfolio, managerial challenge, the increase of the firm

size and prestige, the increase of the firm’s dependence on the management

(empire building) and fashion (Ghauri) are manager motives summarized under

the hubris hypothesis.

The agency problem and hubris motive receive support from studies reporting that

acquirer returns from M&A deals are positively related to the level of management

ownership in the acquiring firm (Berkovitch; refer to chapter 3.4.1).

Considering the increase in shareholder wealth as the primary reason for any M&A and

taking into account that most M&As fail, Berkovitch jumps to the conclusion that many

M&A deals are motivated by agency and hubris. However, the huge variety of motives

different from shareholder wealth creation as the primary motivation for M&A puts some

doubt on that straight conclusion. “If all takeovers were motivated by synergy only, one

would never observe negative gains.” Here, Berkovitch does not take into account that

there are many other issues except the motivation that decide upon M&A financial

success.

4.5 Finance motives

The main motives cited in the finance literature:

� Improving stock market measures (classical motive referred as ‘exploitation’ or

‘synergy’ motive)

� Reducing cost of capital (e.g. through reducing firm risk by stabilizing earnings

due to diversification or buying a listed company)

� Reduction of tax liabilities (e.g. through benefits achieved in cross-border M&As)

� Adjusting the debt profile of the company

� Accessing cash or other financial resources in the target company

� Generate cash flow from the break-up of the target firm (e.g. Megginson)

� Move capital to higher valued uses / Reinvestment of financial resources (e.g.

firms with poor investment opportunities acquire firms with outstanding growth

opportunities; Goergen), in the extreme case: Replace a business with a new one

(respond to market failures)



� Asset stripping

� Speculative transactions driven by the intention to buy shares in companies

solely to resell them at a profit in future.

4.6 Conclusion

The vast majority of M&A literature assumes that M&A deals must improve returns to

shareholders. However, this ignores many other ‘legitimate’ and ‘illegitimate’ motives for

M&A activities and ownership structures other than public companies. The broad set of

motivations presented here now, first, allows a much more subtle assessment of post-

M&A firm performance while the lack thereof was criticized in the chapter ‘Performance

studies’ (refer to chapter 3), second, simplifies a sound review of strategic logic and

reasoning for M&A activity and, third, opens a much broader view on upcoming

integration and transformation difficulties like negative synergies and culture issues.



5 Post-M&A integration and transformation

Independent of the underlying motives for an M&A project, during post-merger

integration many different matters must be carefully blended such as for example

different strategies, brands, product portfolios, production processes, knowledge and

technology, pricing policy, support functions, sourcing and distribution partners,

administrative policies and processes including the management of human resources,

technical operations, marketing activities and customer relationships. Depending on the

level of integration such a blending imposes many difficulties and pitfalls for synergy

realization and for reaching other M&A objectives. The lacking awareness of those

difficulties (fostering positive synergy realization and anticipating negative synergies)

are seen as prominent reasons why M&A projects can be compromised to reach their

goals, in particular when not considered at a very early stage in the M&A project (e.g.

Datta; Haspeslagh). Mace and Montgomery already noted in 1964:

„The values to be derived from an acquisition depend largely upon the skill with

which the […] problems of integration are handled. Many potentially valuable

acquired corporate assets have been lost by neglect and poor handling during

the integration process.“

As a consequence, besides recognizing the strategic logic that predicts value creation

the processes through which the M&A’s objectives come to be realized must be taken

into account and planned in detail. Management must find the appropriate integration

practice (e.g. procedural, physical, and socio-cultural) given the motives and

characteristics of the acquiring and acquired firms (Marks). They must decide how, at

which level and to which degree acquiring and acquired organizations are to be

integrated in the post-M&A period, should foresee the many difficulties and dangers in

the integration process and must be prepared to anticipate culture issues. The already

scarce and often overrated positive synergies should not be considerably impaired by

negative synergies due to integration difficulties. Examples of such negative synergies

might be alienated customers and demotivated sales organizations leading to low

morale and high employee turnover.



5.1 What is an adequate level of integration?

There are several possible generic scenarios how a company can be integrated in the

post-M&A phase (Sirower; Duncan), although, hybrid and intermediate forms may exist:

1. The company is acquired as a stand-alone (total autonomy).

2. The company is acquired as stand-alone but with a change in strategy (e.g.

restructuring followed by financial control).

3. The target company is to become part of the acquirer’s operations (e.g.

centralization of key functions).

4. The target and acquirer are to be completely integrated (full integration).

5. The target takes over the acquirer’s existing business and the acquirer is

integrated into the target’s operations (reverse integration).

Schweiger suggests four measures that define intensity of integration:

� Consolidation: The extent to which the separate functions and activities of both

an acquirer and a target firms are physically consolidated into one.

� Standardization: The extent to which the separate functions and activities of both

firms are standardized and formalized, but not physically consolidated.

� Coordination: The extent to which functions and activities of both firms are

coordinated.

� Intervention: The extent to which interventions are made in an acquired firm to

turnaround, for example poor operating profit, regardless of any inherent sources

of synergy.

Level of integration can be defined as the degree of post-acquisition change in an

organization’s strategic, technical, administrative, and cultural configuration. Level of

integration is an important concept in acquisition management because, although high

levels of integration theoretically enhance realization of interdependency-based

synergistic potential, they may also result in realization of negative synergies as a

consequence of increased coordination costs and potential for interorganizational

conflicts (Pablo):



A low level of integration is one in which technical and administrative changes are limited

to the sharing of financial risk and resources and the standardization of basic

management systems and processes to facilitate communication. Where a higher

degree of autonomy is given to the target company it results in a lower level of

complexity in the implementation process, as integration affects a lower number of

employees and business units.

A moderate level of integration includes increased modifications in the value chain as

physical and knowledge-based resources are shared or exchanged. Fuller integration

often results in a loss of power on the part of the target. As a consequence integration

difficulties and cultural issues arise endangering the M&A integration success and, in the

extreme, target employees are more likely to leave the company.

The highest level of integration involves the extensive sharing of all types of resources

(financial, physical, and human), generalized adoption of the acquiring organization’s

operating, control, and planning systems and procedures, and complete strategic,

structural and cultural absorption of the acquired firm.

What are the factors that determine the level of integration that is chosen in acquisition?

a. The degree of integration is defined by the degree to which the realization of

intended synergies depends on the sharing or exchange of critical resources.

The strategic task, thus, requires that links are developed between the

combining firms’ activities and that the organization should be appropriate to

support those links. Based on these considerations management must decide

whether the acquired firm is integrated, for example, at a corporate, divisional

or business unit level (Pablo).

b. From an acquirer’s perspective two key elements in the integration design

decision are the perceived need to exert power and the ability to do so. The

extent of the perceived need to use power will depend upon the degree to

which the target has a vision of essential actions and outcomes in the

acquisition that is compatible with the acquirer’s (Pablo).

c. An acquirer’s degree of tolerance for cultural diversity should be a predictor of

the level of integration that is chosen for an acquisition (Pablo).



5.2 What are the difficulties and dangers during in tegration?

Difficulties and dangers during the integration process are manifold and widely

discussed not only in the M&A literature but generally in the transformation literature.

Here the most often cited issues in the M&A context and those of major relevance for the

pre-M&A phase are discussed. To foster a positive attitude in an often negatively

charged environment success factors are presented instead of a list with frequent

reasons for integration failure (no particular order):

1. Choice of appropriate level of integration

2. Post-merger management of projected positive and negative synergies

3. Speed of integration

4. Communication to internal and external stakeholders

5. Cultural fit and anticipation of culture dissonance

6. Experience with transition structures and transformation management (Reimus)

7. Avoidance of leadership vacuum (Duncan)

8. Choice of top management positions reflecting the values being applied in the

merged firm and the true distribution of power between the former firms (Trauth).

9. All parts of the organization have the knowledge and resources, and give their

commitment for the integration efforts (Epstein).

5.2.1 Under- and overintegration – or the appropriate level of integration

An acquired firm must be aligned to a certain extent to the requirements of the acquiring

company. The accomplishment of integration, however, requires that target-specific

bases of critical resources and skills be kept intact. The organizational task therefore is

the preservation of any unique characteristics of an acquired firm that are a source of

key strategic capabilities. Pablo advises against “fixing things that aren’t broken”.

However, under- or overintegration has been cited as one of the leading causes of M&A

failure (Pablo). The realization of potential synergies can be short-circuited given an

insufficient level of integration, but excessive integration (reconfiguration) can hinder the

development of fruitful conditions (e.g. when executives depart, expertise is lost etc.).

Management of the acquiring firm has the tendency to over-integrate the target firm,

means to completely change the whole setup and the processes. These practices



(besides demotivating the employees) can result in the loss of the firm’s success factors

before the M&A deal (e.g. short decision processes, flexibility and agility in the market,

personal partnership with customers, innovativeness…) (Cliffe). Another common pitfall

is that acquirers make organizational (e.g. cut workforce) or strategic changes to realize

synergies while destroying, for example, the growth or source of innovation of the

acquired firm by doing so.

5.2.2 Post-merger management of projected positive and negative synergies

Acquiring companies must view potential synergies in the light of realization problems:

“When two previously sovereign organizations come together under a common

corporate umbrella, the result is a hybrid organization in which value creation

depends on the management of interdependencies through the facilitation of firm

interactions and the development of mechanisms promoting stability.” (Pablo)

Specifically, management should:

� Have an integration plan in considerable detail on how to implement the strategy

(e.g. integration of sales force, distribution system, information systems, R&D

processes, marketing efforts, reward and incentive systems).

� Examine how different issues impact the success of changes needed in the

acquirer, the target, or both firms and the impact they can have on positive

potential but also negative synergies (value leakage e.g. through reduction in

cash flows and earning during integration period).

� Develop different integration scenarios leading to a series of realistic M&A

evaluation.

5.2.3 Speed of integration

Angwin in his studies argues:

“[…] the first 100 days is when all the critical actions should be launched, as this

is the outer limit of employee enthusiasm, customer tolerance and Wall Street

patience”.

Early wins to convince internal and external stakeholders keep the momentum of

positive attitude while sustained uncertainty, not only amongst employees, is seen as

one of the most corrosive elements of the soundness of post-acquisition integration.



Faster integration may reduce the length of time to experience uncertainty as well as

reduce the effects of the rumor mill.

An organization, Angwin then argues, benefits from well planned and thus shorter

integration periods in several ways:

� Spending less time in a sub-optimal condition

� Less costly readjustments and iterations

� Cuts time for competitors’ reactions to the new organization

� Favorable response of financial markets to quick wins

5.2.4 Communication to internal and external stakeholders

The preparation during the period leading up to the merger announcement is vital to

success since it is critical to present the merger to key constituencies with confidence.

During this period, the integration process is formulated and key decisions should be

made in the areas of leadership, structure, and timeline. Unprofessional communication

to employees, clients, shareholders, suppliers and the media fosters uncertainty,

mistrust and rumors. Thus, it is necessary that the companies and their stakeholders

involved understand the advantages associated with the merger.

The communication should generate a culture where employees see the merger as

enabling them to develop the business rather than inhibiting them from progress.

Employees then can concentrate on reaching the objectives of the whole M&A project or

the integration process in particular. Management must define the necessary changes

that will bring a successful transaction. It is important to establish clarity in roles and

responsibilities for those involved in the integration process, versus those in operating

businesses. And, the final authority and responsibility should be communicated on all

levels.

Moreover, the achievements of the integration process and the current status (success,

failures, shortcomings etc.) should be communicated to all employees in order not to

loose their positive attitude, to encourage or to highlight serious deficits (Epstein).

This chapter on ‘communication’ passes into to the subject of ‘culture dissonance’ since

communication is an inherent part of culture and lacking or unprofessional

communication shares the same set of human reactions to culture dissonance.



5.2.5 Cultural fit and anticipation of culture dissonance

For Ansoff citing Machiavelli “[…] resistance to change is proportional to the degree of

discontinuity in the culture and power structure introduced by the change”. Resistance

comprises cultural and social aspects, at both the individual and collective level.

Culture dissonance, which might be real or just perceived, is a major risk for M&A

integration success and thus is widely discussed in the literature and is treated in a

separate but complementary chapter in this work (refer to chapter 6).

5.3 Conclusion

The M&A literature reports that insufficient planning for positive synergy realization and

lacking anticipation of negative synergies are the elementary shortcomings in the M&A

integration context. Cultural problems, disruption of employees, hierarchy changes and

missing incentives for acquiring and acquired firm employees play a key role in these

shortcomings. However, independent of the level of integration efforts to retain and

encourage employees are of vital importance for reaching an M&A’s objectives:

“[…] mangers generally want a company that is fully staffed, with a general

manager and all functional heads and, since it takes three to five years to

develop a good operating team, they want assurance that these key people will

stay on the job.” (Paine)



6 National and organizational culture and culture clashes

Numerous authors have discussed the potential troubles of culture dissonance (culture

clashes) between merging organizations and report culture dissonance to be one major

source of conflict that can undermine potential synergistic effects and endanger a whole

M&A project. Duncan found that 65 per cent of those acquirers who had experienced

serious problems with post-acquisition integration said that these difficulties had been

due to cultural differences. Cultural fit is therefore a vital success factor for international

and domestic M&As. The interesting point is that many studies show that culture is an

important issue even when the firms come from the same country and the same industry

(Ghauri). On the other hand, culture issues are worth to shed light into them since they

can be used as almost uncontroversial alibi for anything that goes wrong with M&As

(Sirower).

6.1 What is culture in the M&A context?

There exist various definitions of ‘culture’, but a classic definition is a “shared set of

norms, values, beliefs, and expectations” which are translated into behaviors. A

‘corporate culture’ includes this shared set but also implies incentive and reward

systems, performance evaluation, chain of command, leadership styles, information and

decision processes, operating procedures etc. (Veiga).

However defined, organizational culture is seen as being important in determining an

individual’s commitment, satisfaction, productivity, and permanence within an

organization. This is because individuals tend to select groups that they perceive as

having values similar to their own while trying to avoid dissimilar others (Veiga).

6.2 Which forms of acculturation exist?

Similarly to the possible integration scenarios (refer to chapter 5.1) Jöns defines different

degrees of acculturation between the acquiring and acquired firm while the degree of

integration and degree of acculturation do not necessarily correspond to each other. This

is due to the fact that the acculturation depends on the way companies manage the

formal (organizational aspects) and informal (socialization aspects) integration process:



1. Integration is characterized by cultural and structural changes on the part of both

partners without a dominant culture.

2. Assimilation is a one-sided process where the acquiring company fully absorbs

the acquired one.

3. Separation means minimal cultural exchange, the acquired company therefore

remains almost unchanged.

4. Deculturation leads to completely new organizational practices and systems that

are different from those of both previous cultures.

6.3 Are cultural stereotypes a real assist or just convenience?

Two statements reflect the conventional understanding of culture we have and how we

normally think about it:

“Surprisingly, the monolithic vision of organizational and national cultures is still

dominant in the strategy field and has tended to use organization-wide or

nationwide classifications (one organization – one culture; one country – one

culture).” (Irrmann)

“Cultural stereotypes are a condensation of reality in that they simplify and over-

generalize the characteristics of a societal group. In the absence of detailed

knowledge and direct experience of a potential merger partner or acquisition

target, stereotypes offer a means of reducing the cognitive complexity of a

decision.” (Cartwright)

Thus, culture should not be considered as something objective and given which a nation

or an organization has. For instance, companies can be characterized by subcultures

linked to departments, professions and other communities. Although some scholars

define national and organizational cultures as separate constructs, others agree that

these two constructs are interrelated and have a strong influence on each other.

6.4 Can culture be ‘measured’?

As culture is intangible, it is a very difficult concept to evaluate. Although the concept of

‘culture clash’ has been widely discussed in the context of M&A, the literature has been

relatively quiet about how to empirically measure this phenomenon:



� Hofstede (1980, in Veiga) introduced a classification concept based on country

indices for ‘Power Distance’, ‘Uncertainty Avoidance’, ‘Individualism’ and

‘Masculinity’ as a way of representing cultural distance between collaborating

companies.

� Veiga et al. present a ‘perceived cultural compatibility’ index (PCC) as a tool for

assessing culture based on interviews with various people “…who live in the

organization and […] could help to uncover the basic cultural essence”. Different

to Hofstede, Veiga et al. focus on the cultures of the single organizations and do

not measure the level of compatibility of two merging national cultures only. They

present 23 items to be considered for their congruence index within and across

national and organizational contexts:

The organization:

1. Encourages creativity and innovation

2. Cares about health and welfare of employees

3. Is receptive to new ways of doing things

4. Is an organization people can identify with

5. Stresses team work among all departments

6. Measures individual performance in a clear, understandable manner

7. Bases promotion primarily on performance

8. Gives high responsibilities to mangers

9. Acts in responsible manner towards environment, discrimination, etc.

10. Explains reasons for decisions to subordinates

11. Has managers who give attention to individual’s personal problems

12. Allows individuals to adopt their own approach to job

13. Is always ready to take risks

14. Tries to improve communication between departments

15. Delegates decision-making to lowest possible level

16. Encourages competition among members as a way to advance

17. Gives recognition when deserved

18. Encourages cooperation more than competition

19. Takes a long-term view even at expense of short-term performance

20. Challenges persons to give their best effort



21. Communicates how each persons’ work contributes to firm’s big picture

22. Values effectiveness more than adherence to rules and procedures

23. Provides life-time job security

A respondent’s overall compatibility score can range from -20 to +20, where -20

signifies the highest degree of unattractiveness. A zero suggests neutrality, i.e.

the respondent perceives no differences between the buying firm’s culture and

the acquired firm’s culture. The calculation customizes each respondent’s

assessment on each item by using their response to the respective value item’s

‘ought to be’ question as a weight.

6.5 What is the result of perceived culture dissona nce?

The impact of culture dissonance on the M&A project, the organizational structure and

the employees’ behavior is frequently discussed in the literature. “Lack of trust, lack of

competence, unwillingness to cooperate, unacceptable behavior, bureaucratic system

…” are just a few attributes often named when ‘partners’ interact in M&A projects. Such

phenomena are not exclusively restricted to M&A projects but to any sort of cultural

interaction in business contexts such as team building, buyer-seller interaction and

transformation projects in general. Irrmann and Jöns report in their extensive study the

most often perceived consequences of cultural dissonance in M&A projects cited by

employees:

� Non-cooperation

� Information retention

� Lack of competence

� Organizational silence

� Competitive atmosphere within the company

� Mistrust among employees

� Increased bureaucracy

� Higher degree of hierarchy, bureaucracy and authority

� Avoidance of responsibility

� Bypass of hierarchy

� Stress and uncertainty due to potential layoffs

� Lower job satisfaction and commitment



In the light of these perceived culture issues it becomes obvious that acquiring

companies must view potential synergies in the light of realization problems. However,

those perceived changes in structure and behavior must not solely be attributed to

culture dissonance but must be seen in the overall context of integration difficulties.

6.6 How can one understand culture dissonance?

Considerable differences in corporate cultures as, for example, according to Veiga’s

congruence index might impose serious culture clashes during and even after the M&A

integration process. Irrmann argues that the often cited ‘culture clashes’ mainly arise

from communication dissonance and communication absence between acquiring firm

and target as a result of two types of failures: the ‘linguistic pragmatic failure’ and the

‘business pragmatic failure’.

The first one is grounded in differences in:

� Accepted cultural forms of discourse

� Message content and medium of communication

The second one is grounded in different interpretations of:

� The appropriate decision-making process

� The divergent vision of the appropriate business strategy to adopt

� The economic role of the acquired firm

Beside culture dissonance it is the uncertainty surrounding acquisition events that

causes executives and employees to defend positions they may have taken years to

build. If employees feel uncertain about their personal situation, corporate goals may not

matter so much to them (Jöns). M&As are “surrounded in an aura of conquest” where

employees and managers eventually have to break their bond with the way things were

and conform to the culture of the buying firm:

“Once a big fish in a small pond, acquired key people may feel a strong sense of

alienation with their new proximate group, inferior in status to the acquiring top

managers, and/or unappreciated by them […] known as the ‘superiority

syndrome’.” (Veiga)



Post-M&A studies on the Daimler-Chrysler deal (Epstein) reported the emergence of a

collective political and ideological resistance at the target to collaborate when Daimler

top managers communicated the two-level strategy of the now combined firm where

Daimler ought to be the premium brand and Chrysler ought to be the “medium-to-low

quality” brand. Together with the ‘distance to home country’ problem this ideological

resistance led to the fact that Daimler-Chrysler remained a two-company firm until

divestment of Chrysler. Mr. Hubert of Daimler-Chrysler half a year before divestment of

Chrysler declared:

“We are absolutely happy with the development of the merger, we have clear

understanding: one company, one vision, one chairman, two cultures.” (Ghauri)

Such ‘Wir-gegen-die’ psychology is often observed, if no clear new strategy and vision

are communicated and both partners do not value and respect the achievements of the

other. A much more subtle example is given in Reimus where an acquired firm had to

move into the buildings of the acquiring firm resulting in non-cooperation and mistrust.

6.7 What can be learned for practice to anticipate culture dissonance?

6.7.1 Avoid insurmountable integration problems

In terms of selecting a compatible target, Larsson and Risberg note that organizations

tend to prefer to invest in neighboring territories or those with which they have the

closest economic, linguistic and cultural ties (‘more like us’ tendency). While differences

can lead to greater acculturation stress and integration difficulties, cultural differences do

not necessarily result in negative outcomes. Cartwright et al. argue that cultural

differences at the national level do not have such a negative impact as differences at the

organizational level in domestic M&As, because there is a greater awareness and

appreciation of national cultural differences and a greater tolerance for multi-culturalism.

Larsson and Risberg (in Barmeyer) even show that M&A transactions where companies

face both corporate and national culture differences have a higher degree of

acculturation (creation of a joint corporate culture) than domestic firms with similar

corporate cultures.

The objective fact that cultural differences exist, however, does not necessarily imply

that the acquired employees will resist any post-merger consolidation attempts.



Many investigators agree that culture dissonance is likely to be more pronounced in

cross-national M&As than in domestic ones since such M&A deals bring together not

only two firms that may have different organizational cultures, but also two firms whose

organizational cultures are rooted in different national cultures (Duncan). This results in a

greater possibility of incompatibility between the acquirer and the acquired (Veiga).

Researchers studying M&A have proposed the selection of similar partners for the

merger to avoid culture dissonance. However, many studies show that although merging

similar organizations does not in general reduce resistance and integration problems

(Liu). Not to forget that the issue for acquirers is not solely whether the cultures are

similar or different but whether the changes necessary to support the strategy of the

combined firm will clash with either culture.

6.7.2 Be aware of potential cultural dissonance

The awareness of national and organizational culture issues is seen as being

fundamental already in the target screening phase for potential M&A projects. An

underestimation of the cultural factor in pre-M&A phase is fatal, because the merging of

companies is a merging between different human beings. It is humans that create, follow

or divert rules and structures of companies, and that make sure that companies live,

function and make benefits. It is their ideas, strategies, thoughts and decisions that are

transformed into action and they contribute to the success or failure of a company.

How to anticipate culture dissonance and managing transformation during the integration

process is a topic not discussed here in detail. When an acquirer fears strong cultural

resistances from a target it can engage interventions such as discussions, intercultural

mirroring workshops, gathering employees from both companies, organizing reciprocal

visits at worksites, work on future common values that will characterize the new group to

moderate the resistance. The creation of a new corporate entity that integrates the

positive aspects of each culture helps to avoid conflicts. For practice, Irrmann suggests

that investing in the development of intercultural communication skills, language skills

and cultural intelligence could be a more fruitful approach for managers than the quest

for cultural fit between merging organizations.



Research shows that the perception of the partner’s credibility and trustworthiness are

central success factors from the very beginning of M&A projects, while perception is

largely rooted in the interpretation of the repeated interactions between the partners.

The importance of creating “a climate of mutual trust by anticipating problems and

discussing them early with the other company” is reported by Paine. Mutual respect and

communication is, for example, enhanced by two-way transfer of knowledge having a

positive motivational and early acceptance effect on the employees of both firms

(Duncan).

6.8 Conclusion

Cooperation will not magically occur unless incentives and rewards are created that will

induce changes in behavior. In the extreme, key employees and managers who are

crucial to the business as a stand-alone may leave in anticipation of these problems

(talent exodus). On the other hand, some cultural differences may even facilitate

assimilation. For example, the acquired managers and employees may anticipate more

opportunities for themselves, and may also hold the buying firm in high regard,

perceiving it to be a high prestige firm, a world-wide leader, a firm that protects the

environment etc. (Veiga).



7 Success factors, reasons for failure and risks

The success factors, reasons for failure and risks presented here is according to the

topics discussed so far. Additionally, results from direct interviews and surveys of key

informants are presented.

A firm that takes over another firm makes two assumptions. The first is that the acquiring

firm can extract more value from the same assets than the current owners. The second

assumption is that the value extracted will be more than the market price paid for the

assets. The fact that this assumption is often erroneous is the core reason why many

acquisitions fail as profit enhancing tool. Consequently, the price premium, the

realization of synergies and the strategic logic are in the focus here.

7.1 Financial overextension and price premium

An acquisition premium is the amount the acquiring firm pays for an acquisition that is

above the pre-acquisition price of the target company. Or in other words, it is the price

pre-acquisition shareholders would not have to pay when investing in the firm to be

acquired.

In the M&A literature, the acquisition premium represents the expectation of synergy in a

corporate combination. According to this explanation, acquirers pay a premium because

the expected value of the combined companies is greater than the expected value of the

sum of the independent parts. An acquisition premium thus must be understood as an

up-front payment for some uncertain stream of additional payoffs sometime in the future.

The acquirer needs to value the improvements when they are reasonably expected to

occur.

Warren Buffett in the Berkshire Hathaway 1982 Annual Report summarizes the

problematic in a few words:

“A too high purchase price for the stock of an excellent company can undo the

effects of a subsequent decade of favorable business developments.”

Or, as Sirower declares in his book ‘The Synergy Trap’ in a more sloppy way:

“The acquisition game is best described as a game with some distribution of

payoffs and an up-front price to play the game.”



According to a KPMG study (2000), 83% of recent deals failed to deliver shareholder

value and an alarming 53% actually destroyed value. While this study was already cited

when discussing post-M&A performance (refer to chapter 3) the more important result in

this context is that the report concludes that underperformance is the outcome of

excessive focus on “closing the deal” at the expense of focusing on factors that will

ensure its success and that the pricing decision becomes completely detached from any

synergies that may be realizable.

Garrette in his study argues already in 2000 on the Daimler-Chrysler deal:

“Daimler Benz is said to have acquired Chrysler in order to strengthen its

presence in North America and to enter lower segments of the automobile

market. […] This move was justified by the fact that earlier attempts […] to

expand their product lines through internal growth had proved extremely difficult.

However, […] the price paid by the acquiring firm is such that it is unlikely that

[…] this acquisition will ever become profitable.”

Cartwright argues in a more pragmatic way. Even if the market price fully reflects the

future profit stream of the acquired assets, then there is no scope for profit from the

acquisition. In a perfectly competitive market, bidding firms that complete a merger or

acquisition will not obtain abnormal returns, even if they are completely successful in

exploiting anticipated relatedness with a target, since the value of relatedness will be

reflected in the price of a target, and thus distributed as abnormal returns to the share

holder of acquired target firms (Sirower). Assuming that assets are priced at their fair

value, the only way to earn excess returns is if there exist limits to competition such that

assets do not get bid up to their fair value. Other opportunities for profit arise in situations

where assets do not have a market price, as is the case with private firms or divisions of

multi-unit companies.

However, the uncertainty in the valuation of future income streams remains as an

important issue in takeovers. The complexity of the modern firm complicates easy

analysis. The assets of interest may be difficult to identify and may be overvalued or

undervalued for some time. This may especially be the case where the value of the

target is largely tied up in intangible assets such as people and knowledge.



7.2 Realization of synergies

From a traditional synergy motive perspective managers in acquisitions have to

accomplish what shareholders cannot accomplish on their own. This means that

synergies must be realized to an amount that lies above the price premium paid for that

synergy potential. But history shows that expectations rarely reflect realizations

(Cartwright). When one considers that the acquisition premium implies certain

requirements of performance improvements and calculate the probability of achieving

these improvements, one can predict the probable losses to shareholders of acquiring

firms (Sirower). One has to recall that realized synergies are actual improvements in

combined performance above what the two firms were already expected to accomplish

independently (Cullinan).

A study by Sirower, summarized in his book, ‘The Synergy Trap’, found that of 168 deals

analyzed, roughly two-third of all companies studied too often think they can generate

synergy faster and in greater amounts than is really possible. In the M&A literature,

authors widely agree that the most frequently encountered causes for insufficient

synergy realization are (Palmatier; Schweiger):

� Synergies that are either not present or exaggerated by the buyer.

� Synergies that cannot be effectively realized due to integration difficulties

As already argued when discussing performance studies (refer to chapter 3) formal

merger consideration (pre-M&A and due diligence) still begins and ends far too often

with the analysis of financial indices only (such as stock price, earning, tangible and

intangible assets, investments, assets, liabilities, revenues/expenses, accounting and

budgeting practices etc.) instead of reviewing also strategic logic, valuation of synergy

potential and detailed planning of synergy realization, organizational fit and the ability to

merge cultures (Epstein). In particular, management fails to think through integration and

synergy realization at the very beginning of an M&A project having no detailed

conception and action plan on how value should be generated (Cartwright; Palmatier).

The literature has not yet addressed exactly how much synergy or performance gains

would be generated if the various integration problems did not occur (Sirower).



Further, researchers have not yet offered propositions regarding the prediction of when

problems are more likely to occur and how managers may react when these problems

persist.

Additionally, one has to consider the temporal nature of synergy as an important factor

limiting the value of performance improvements. Synergies tomorrow are not as valuable

as synergies today. For example, synergies expected at some point in the future give

competitors more time to compete them away before they even occur (or e.g. the

synergies like knowledge and patents get obsolete with time). If synergies are expected

to come from short-term increasing sales they must emerge from cross-selling

opportunities. Cross-Selling opportunities exist, however, mostly not to the extent

expected. Performance improvements on the other hand may take years to develop. It is

well known that realizing operating synergies (e.g. economies of scale) or

standardization and coordination of business processes can take several years and can

turn out to be extremely complex and difficult management tasks with huge conflict

potential. But given the required performance improvements embedded in most

acquisition premiums, the gains need to begin immediately, otherwise value will be

destroyed. If these improvements occur “far down the road”, they may have little value

(Schweiger).

7.3 Negative synergies

While the term ‘negative synergies’ often is related to an internal firm perspective

considering integration, culture and communication difficulties (refer to chapter 6) the

outside perspective is mostly neglected (Epstein). Questions how integration difficulties

or endangered synergy realization might impact customers and other stakeholders arise

in this context:

� What is the influence on customer satisfaction and long-term innovation

capabilities when closing factories or subsidiaries or laying off of redundant

employees?

� How can a firm anticipate customers’ uncertainty about future quality, support

and service and general relationship?

� With which means can a firm prevent confusion of customers through a product

offering that can not longer be overseen?



� What dangers arise when channel partners are changed?

Critical to synergy in general is to leverage the realization potential without additional

costs. As an example, costs of managing an external relationship to a supplier may be

replaced by internal coordination costs. Or the gains from a more complete product

portfolio might be offset by the dilution of the sales force.

Summarizing, while synergy sometimes is explained as one plus one equals three, it

seems that a much better explanation is one plus one equals 2.1 (Sirower).

7.4 An example on the difficulties of synergy asses sment and realization

Cloodt in his studies argues that technological learning is expected to be a key

determinant in creating and sustaining a competitive advantage for industries that are

mainly knowledge driven. These opportunities increase when a firm is exposed to new

ideas based on differences in technological capabilities between the acquiring and the

acquired firm. The unification of two related knowledge bases can provide opportunities

for synergies in future innovation and shorter innovation lead-time while reducing

redundant R&D efforts.

However, a few difficulties can rapidly be identified even with very obvious synergy

potentials:

� Some degree of differentiation in technological capabilities between the two firms

may enrich the acquiring firm’s knowledge base and create opportunities for

learning. However, technological knowledge and engineering capabilities that are

too similar to the already existing knowledge of the acquiring company will

contribute little to the post-M&A innovation performance (James).

� The challenge for companies is not just to acquire knowledge bases but also to

transfer and integrate them in order to improve the post-M&A innovation

performance. The integration of a knowledge base that is of a relatively large size

can disrupt existing innovative activities and render the different integration

stages more complex, more time consuming and full of risks (DiGuarda).

As a result synergies are often overestimated while in fact an M&A leaves fewer

resources for the actual innovative endeavor until the knowledge base is

integrated.



Studies of knowledge transfer across (and within) firms show that in the early

stages, the perception of the partners’ trustworthiness, competence, and

professional status are determinant factors in the decision to transfer knowledge

or not (Irrmann). If this perception is damaged in the course of overall integration

difficulties the transfer of knowledge and the corresponding realization of

synergies might be seriously endangered.

� Knowledge depreciates and loses its value over time. The rate at which the value

of knowledge depreciates is likely to vary across industries but it is especially

high in technology intensive industries. For companies in high-tech industries

even quite recent knowledge dating a couple of years or months already

becomes less valuable or obsolete and thus this knowledge plays a positive role

only a limited period of time after an M&A has taken place.

Concluding, a firm’s absorptive capacity for knowledge transfer and integration and the

right degree of differentiation in technological capabilities put severe limitations onto

synergy realization. The valuation of intangible assets as knowledge and technology in

the light of synergy potential might prove to be even more difficult.

7.5 Strategic logic

‘Bad motives’ (e.g. excessive confidence, agency and hubris, external pressure) are

obvious reasons why a firm might not reach performance targets. A prominent reason

reported by Epstein for M&A failure in this context is that the availability of target firms

determines the strategy of the acquiring company. Such illegitimate strategic logic might

be induced by a competitor’s action spreading the fear of no suitable targets being left

for an M&A deal.

Thus, the strategic vision of a company should clearly articulate an M&A rationale that is

centered on the creation of long-term competitive advantage. Whether and how much

synergy exists in a particular acquisition is likely to be a function of the strategic

objectives driving a deal.

While ‘integration’ or ‘culture issues’ often are reported as the main reason for an M&A

project to fail or not to reach the required performance, insufficient strategic logic

interestingly is hardly considered as a reason for failure (Epstein). Thus, a central

question arises here: To which extent does an insufficient strategic logic endanger M&A



success or to which extent difficulties can be attributed to the integration problematic

itself?

At first glance, rather simple questions like the following might be straightforward to

answer:

� How big is the overlap in products and territories with the target firm?

� How similar are the markets between the combined firms based on their

customer groups?

� How complementary are the production processes between the combined firms

based on their required resources?

However, according to Palmatier and Ghauri an acquiring firm has only a partial

knowledge of customers, products, and channels and has a biased perspective

(asymmetric information). As a result, estimation of strategic fit and synergy potential,

choice of integration level and anticipation of negative synergies based on uncertain or

even incorrect information can subsequently cause major integration difficulties and can

indeed cultivate culture dissonance.

A study on post-M&A integration by Ravenscraft and Scherer (in Datta) supports these

findings. They conclude that, on average, acquiring firms have not been able to maintain

the pre-merger levels of profitability of the targets. They argue that an acquiring firm

does not know enough about the potential of the company it is buying and consequently

can unconsciously destroy success factors of the target firm.

7.6 Interview studies

Beside these most prominent reasons for M&A failure discussed above Lucks in his

interview studies reports various other reasons for failure or dangers for synergy

realization that were reported by management and key employees (in no particular

order):

� Management, key people and employee departure

� No participation of middle management during strategic planning, due diligence

and integration



� Double burden of managers, dilution of management attention onto the main

business

� Underestimation of acquisition (legal, advisory, due diligence) and integration

(conflict resolution, standardization, IT) costs

� Missing internal and external dedicated people

� No consideration of expectation of partner firm

� No clear assignment of competencies

� Unprofessional communication (partners, employees, shareholders, media,

customers etc.)

� Bounded rationality (M&A being an overly complex task that cannot be fully

captured anymore)



8 Alternatives to mergers and acquisitions

In order to pool assets, combine resources and exploit synergies, firms can either

permanently merge their operations within a new legal entity through an M&A project or

they can choose to collaborate on well defined and limited areas of business while

retaining their strategic and legal autonomy through forming an alliance, a co-operation

or a joint venture. Both strategies make it possible to capture business opportunities that

neither partner could pursue alone.

Alliances, co-operations and joint ventures are very different in nature. However, they

are all feasible alternatives to industry concentration through mergers and acquisitions

since they can produce some of the effects that could also be obtained from merging

partner firms. They can be an attractive move to expand and capture valuable

capabilities without running the high risk of failure and without having to pay the premium

attached to an acquisition. These alternatives make it possible to avoid the culture and

organization shock to a certain extent by proceeding step-by-step and by gradually

adapt to the partner. From such a perspective, they provide not only an alternative to

M&A deals but also can be a first step toward a merger during which partners can learn

about each other and uncertainty can be reduced.

Alliances, co-operations and joint ventures also share a similar set of motives as do

mergers and acquisitions projects (refer to chapter 4). However, the literature indentifies

a few additional specific motives for such common business activities, in particular the

possibility to:

� spread costs and risks across partner firms,

� collaborate with a less rigid arrangement allowing for fast formation and break

up (e.g. to react to highly volatile demand or to react to rapid changes in

product technology),

� collaborate in a project- or business-specific manner with the option for an

enduring business relationship.

Beside these evident advantages of such alternative business activities there are also

some shortcomings due to the inherent setup of those. Any rationalization pursued with



those alternatives will be limited in scope and effectiveness because of some

characteristics that distinguish them from mergers and acquisitions:

� All decisions must be made by consensus among the p artner firms.

One of the parties cannot force the other to accept any particular solution. And

even if one of the partners dominates the alliance, it would be unwise for it to

enforce too many of its own decisions against the wishes of the partner. Such a

behavior would very likely lead to the collapse of the alliance. This ‘multiplication

of decision-making centers’ (Garrette) makes it considerably longer and more

complex (if not paralyzing) to decide on controversial issues as e.g. innovation

and product development, eliminating redundant assets, rationalizing product

lines etc.

� Alliances and co-operations are temporary in nature and must remain

reversible.

By definition it has to be possible to terminate alliances without putting both

partner firms at risk. One of the basic justifications for choosing alliances over

more permanent forms of organization is exactly that they can be undone

relatively easily. As a result achieving economies of scale is rather difficult

because it makes terminating the alliance practically impossible.

Garrette et al. argue that for firms seeking to achieve economies of scale, a

complete merger will allow for a greater rationalization than alliances. This

reasoning, however, remains questionable in the light of limited synergy

realization reported in the literature and the many difficulties during integration in

M&A projects discussed so far.

� Risk of learning and skill/technology transfer

A study by Garrette et al. shows that a vast majority (75%) of inter-continental

alliances are formed mainly to benefit from complementarity, while intra-

European alliances, on the contrary, predominantly seek to benefit from

increased economies of scale (84%).

If one of the partners uses the alliance or co-operation to progressively capture

the knowledge contributed by the other the initial complementarity of the alliance

is eroded away by the learning taking place between the firms. Then, the entire

‘raison d’être’ of the partnership disappears. As learning is usually not



simultaneous and reciprocal one of the partners becomes able to operate on its

own while the other continuously depends heavily on the partnership.

In such cases, it is not unusual that the partner that has succeeded in acquiring

all the necessary skills terminates the partnership while keeping the formerly

common business running on his own. Such learning phenomenon is unusual

with scale alliances since both partners have very similar skills and little to learn

from each other such that no major competencies are transferred:

Fig. 8.1: The outcomes of scale and complementary alliance regarding skill

transfer (Garrette).

Some countries, such as the People's Republic of China and to some extent

India, require foreign companies to form joint ventures with domestic firms in

order to enter a market. This requirement often forces technology and knowledge

transfers to the domestic partner.

Summarizing, managers should consciously balance the reasons for and against an

M&A deal and consider alternatives. Beside alliances, co-operations and joint ventures,

a strategy’s objectives eventually can be achieved by internal investments. As an

example, Dickerson et al. (in Ghauri) show that company growth through acquisition

yielded a lower rate of return than growth through internal investment.

However, starting a new business from scratch does not impose the disadvantages of

M&A projects on a firm but brings with its own difficulties.



9 Reasoning of M&A activity in an early project pha se

Independent of the motives for an M&A project, the acquiring company must evaluate

whether both firms are proper choices as merger partners and the right fit to fulfill the

strategic vision. No set of questions could fully capture a phenomenon as complex as

M&A. However, as a summary, the following guideline shall represent all merger and

acquisition matters discussed throughout this work in a condensed form to prevent

managers from one-sided and poorly thought-through decisions and common dangers

putting a high risk to the M&A project.

Without plausible response to these fundamental questions on strategic logic and some

preliminary integration matters, acquirers are on their way to losing the acquisition game

from the beginning even before the due diligence or even the integration starts to

happen:

9.1 The acquiring company’s strategy

� What are your company’s competitive gaps (weaknesses, strengths) and

challenges (threats, opportunities) in a given market?

� Is your company’s strategy independent of M&A as a strategic option and

independent of acquisition candidates available on the market?

9.2 M&A motives

� How can a merger and acquisition support your company’s strategy?

� Which types of motive are considered: exploitation, exploration, preservation or

survival? Rational or irrational?

� What is the relevance of an M&A for the implementation of the overall strategy?

� To which class of M&As does the project belong: horizontal, vertical,

conglomerate or congeneric?

9.3 Strategic fit between target and acquiring firm

� Does the target company improve the acquiring firm’s competitive advantage?

� Which attributes does a target company need to fit into the strategy?



� What is the degree of diversification: focus-increasing or focus-decreasing?

9.4 Sources of synergies and price premium

� What are the stand-alone expectations of acquirer and target?

� What types of synergy potential exists?

- modular, reciprocal or sequential?

- complementarity or similarity?

- cost, revenue, intangibles?

Schweiger et al. assess synergy potential depending on the strategic objective for an

M&A (Fig. 9.1):

Fig. 9.1: Linking strategic objectives and synergies (Schweiger).

Value assessment:

� Where will performance gains emerge in detail as a result of the M&A?

� How big are these gains?

� What is the time-frame for realization? Does the value of synergies depend on

time?

Risk assessment:

� What is the severity of non-achievement to M&A objectives?



� What is the probability of non-achievement?

� What is the degree of control and detectability to these risks?

Measurement:

� How is the progression of the project measured?

� How is M&A project ‘success’ and ‘failure’ defined?

9.5 Integration, transformation and culture

� What are the major integration necessities in the target and in the acquiring firm?

� Which integration efforts are required: consolidation, standardization or

coordination?

� What is an appropriate level of integration to realize the synergies defined?

� Which integration scenarios do exist?

� What are the milestones of the implementation plan?

� Who are the key managers and employees responsible for the implementation?

� Which are the critical success factors of the target company? Are they preserved

or diminished by the pursuit strategy? Which actions are taken to prevent

destroying these success factors?

� What incentives exist to foster M&A integration for acquiring and acquired firm

management and employees?

� Does the target company fit the national and corporate culture of the acquiring

company?

9.6 Costs and negative synergies

� How big are the efforts and investments needed for synergy realization and

integration?

� What are the impacts of the M&A project on internal and external stakeholders

and on the core business?

� Which strategic considerations and integration processes might undermine

synergy realization or even create negative synergies?



� Does cultural difference between target and acquiring firm foster or hinder post-

M&A integration?

� What additional investments will be required to anticipate negative synergies or

resolve conflicts?

9.7 Competition’s reaction

� Which competitors are affected by the pursuit M&A?

� How will those competitors respond?

� How will the response concern the M&A project’s objectives?

9.8 Alternative business collaborations

� Which objectives and performance gains cannot be realized with alternative

investments?

� Which risks and costs could be prevented by alternative business collaboration?

� What are the ratios between gains and risks, gains and costs for M&A and

feasible alternatives?

Dyer evaluates alternatives according to five criteria: type of synergy potential, ratio

between intangible and tangible resources, amount of redundancy, market

uncertainty, and intensity of competition for resources (Fig. 9.2):



Fig. 9.2: Evaluation of alternative business collaborations according to the criteria

‘type of synergy potential’, ‘ratio between intangible and tangible resources’, ‘amount

of redundancy’, ‘market uncertainty’, and ‘intensity of competition for resources’

(Dyer).

Taking into account all these matters the all-dominant questions are:

� Can the acquiring firm extract more value from the target firm than the current

owners?

� The value extracted will be more than the price paid for the assets?

Picot illustrates in a qualitative and simple example how managers should see their

merger and acquisition evaluation in a summary (Fig. 9.3):



Fig. 9.3: Determination of net value of a merger and acquisition deal in the light of

acquiring and target firm value, synergy value, transaction costs, value of alternatives,

price and price premium paid (Picot).



10 Conclusion

The overall conclusion from hundreds of studies is that most mergers and acquisitions

fail to achieve superior financial performance but have a modest negative effect on the

long-term performance of acquiring firms. According to a KPMG study in 2000, 83% of

deals failed to deliver shareholder value and an alarming 53% even destroyed value.

Sirower in his book ‘The Synergy Trap’ argues: “So many mergers fail to deliver what

they promise that there should be a presumption of failure.”

Despite decades of research, what impacts the financial performance of firms engaging

in M&A activity remains largely vague, unexplained or full of contradicting evidence – in

particular from a strategic management perspective. A research stream is best

characterized to be mature when (1) a substantial number of empirical studies have

been conducted, (2) these studies have generated reasonably consistent and

interpretable findings, and (3) the research has led to a general consensus concerning

the nature of key relationships (Palich). The M&A performance literature fails to satisfy

the last two criteria. That fact is troubling since no significant and generally valid success

factors for M&A deals that drive the success can be extracted.

Haspeslagh and Jemison in their studies have argued that “nothing can be said or

learned about acquisitions in general”. It would be unfortunate if this were the only

wisdom one could offer managers gambling with shareholder resources. Altogether it

seems that managers must still suffer from an overdependence on intuition due to

missing significant results from research on M&As and the many conflicting findings

reported in the literature.

The present work uncovers two major shortcomings of most and even today’s M&A

performance studies that might reason the widely reported vagueness and lacking

evidence: methodology of the studies and their M&A motive assumption. Regarding

methodology, most researchers have studied M&A performance on populations of deals

with little regard to the characteristics of those deals, for example vertical vs. horizontal

M&As, level of integration, size of deal, culture concerns etc. In particular, strategic logic

and insufficiencies thereof have been widely neglected. However, context is important

since specific matters of dissimilar types of deals may not generalize very well. As a

consequence, it does not astonish that these studies could not extract significant

success factors and argue on downsides of mergers and acquisitions being of value for



practitioners. Concerning motives, the vast majority of studies assume that M&A deals

must improve returns to shareholders. However, this ignores many other ‘legitimate’ and

‘illegitimate’ motives for M&A activities beside synergy realization and that managerial

actions could be in the best interest of the firm and still may not result in improved firm

value from that transaction.

Based on the deficiencies of performance studies on generally valid strategic success

factors, the present work offers then a more complete overview on M&A motives in an

early project stage reviewing the research literature and consultant surveys and

incorporating expert interviews and manager surveys. The broad set of rational and

irrational motivations presented, first, allows a much more subtle assessment of post-

M&A firm performance, second, simplifies a sound review of strategic logic and

reasoning for M&A activity and, third, opens a much broader view on upcoming

integration and transformation difficulties like negative synergies and culture concerns. A

framework is presented then to assess an M&A project and its characteristics on an

individual basis to increase the likelihood of success. No guide or checklist could fully

capture a phenomenon as complex as M&As since they involve the interaction of a large

number of target and acquiring firm variables. However, the sporadic nature of M&As

and their dissimilarity from mangers’ regular experience make a condensed framework

as presented throughout this work a valuable tool that shall prevent managers from one-

sided and poorly thought-through decisions and common dangers putting a high risk to

the M&A project and the acquiring firm. Without plausible response to fundamental

questions on strategic logic and some preliminary integration matters, acquirers are on

their way to lose the acquisition game from the beginning even before the due diligence

or even the integration starts to happen. It is not that mergers and acquisitions cannot

succeed - but there are many barriers to be overcome and pitfalls to be avoided:

A firm that takes over another firm makes two assumptions. The first is that the acquiring

firm can extract more value from the same assets than the current owners. The second

assumption is that the value extracted will be more than the price paid for the assets.

The fact that these assumptions are often incorrect is the core reason why many merger

and acquisition projects fail as profit enhancing tool.

Insufficient synergy realization is mainly caused by synergies that are either not present

or exaggerated by the buyer, or, by synergies that cannot be effectively realized due to

integration difficulties. A study by Sirower found that of 168 deals analyzed, roughly two-

third of all companies studied too often think they can generate synergy faster, in greater



amounts and with less additional costs than is really possible. In particular, management

fails to think through integration and synergy realization at the very beginning of an M&A

project having no detailed conception and action plan on how value should be

generated. Independent of the underlying motives for an M&A project, during post-

merger integration many different matters must be carefully blended such as for example

different strategies, brands, product portfolios, production processes, knowledge and

technology, pricing policy, support functions, sourcing and distribution partners,

administrative policies and processes including the management of human resources,

technical operations, marketing activities and customer relationships. Depending on the

level of integration such a blending imposes many difficulties and pitfalls for synergy

realization and for reaching other M&A objectives.

Formal considerations in a pre-M&A phase on the other hand still begin and end far too

often with the analysis of financial indices only instead of reviewing also strategic logic of

target firm selection, valuation of synergy potential and detailed planning of synergy

realization, anticipation of negative synergies, considerations of additional human and

monetary resources required for implementation, knowhow management, assessment of

organizational fit between target and acquiring firm, preservation of the target firm’s

success factors, the ability to merge two organizational or national cultures and the

consideration of feasible alternative business collaborations beside M&A.



Acknowledgement

First of all, I would like to thank Prof. Dr. Georg Von Krogh for giving me the opportunity

to complete my master thesis at his chair in Strategic Management at ETH Zurich. In

particular, I thank his PhD student Matthias Stürmer for the supervision of my thesis, for

his helpful and careful discussions and for his guidance.

I would like to express my appreciation to Mr. Thomas Kehl as the head of the strategic

business unit MatChar at Mettler-Toledo AG and to Mr. Urs Jörimann as the head of the

marketing and product management department for providing me the great chance to

carry out my studies and my master thesis during my position as product and marketing

manager. I very much appreciated that you took charge of my work and I acknowledge

the generous financial funding of Mettler-Toledo AG.

Finally, I would like to give my very special thank to my girlfriend Victoria for another

important support while completing my thesis and during my whole studies – your love,

your understanding and your impulsive power! I would not have accomplished my

master degree as fast and as successful without you. Thank you very much!



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