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Parmit Chadha

Acquire a new company but leave it alone! Fiddling with its character can have disastrous consequences.

Holding on too hard!

MOST acquisitions don't work.

A recent Harvard Business Review article puts the failure rate at 70-80 per cent. That figure is supported by not one, but several studies over the past few years. In case after case, mergers and acquisitions result in a drop in shareholder value. It doesn't matter whether the companies are large or small, in consumer goods or in technology — the results are the same.

So, why did 1995-2000 see M&A deals totalling over $12 trillion in the US alone (that's right, trillion)? What is it about acquisitions that makes managers continually ignore data and feel that "this time it will be different"? And why do so many fail?

Most acquisitions are driven by slowing growth opportunities in a company's main business. Normally, this is also the time when the business is throwing up a lot of free cash. So, we have the potent combination of slow growth and a lot of spare cash sloshing around in corporate pockets. And no matter what theory says, there is not a chance of the managers returning this cash to the shareholders (can you visualise a red-blooded manager saying he can't manage the cash better than that little old lady who owns 2,000 shares?) At the same time, we have financial analysts poking and prodding — where will future growth come from, what will turnover be in three years, how will you combat the slowdown in your industry, and so on. Inadequate replies to these pesky questions can lead to a fall in stock price, and thereby to the value of stock options.

No wonder that the compulsion to acquire is strong. Not only does it promise to kick-start growth, but also makes the company look aggressive, like a predator in a jungle. Add to this the fact that mergers and acquisitions always look good in an Excel spreadsheet. Synergies appear, costs vanish, growth zooms, and the sensitivity analysis results in a glowing picture of the company a few years down the line.

So what goes wrong? Why do those synergies fail to materialise, and how do those costs creep back in? Most important, what happens to that promised growth?

In my view, this is because the process focuses too much on the results, that is, the numbers like costs and sales, and not enough on the causes — the softer issues like the business model and organisational culture. This is important because the softer issues are what drive the results — change these, and the results are bound to change. And these are always changed — can you imagine an acquisition in which the buyers leave the bought company alone? Almost certainly, there will be a "culture integration" exercise, application of existing metrics to the acquired business, and generally, a force fitting of the new business into the existing business model. Soon, the factors that made the acquired company different are removed — why should the results stay the same?

Here's a real life example. A major FMCG player, which dominated its market, was present essentially in the premium segment. Facing severe competition from low-priced brands, it decided to enter the economy segment. After due deliberation, it acquired a regional, low-priced brand. This was to be its beachhead in a large-volume, low-margin business. All the data was rigorously analysed — financials, cost structure, and so on and everything looked good.

Also, the new brand would fill a gap in the existing portfolio. Overall, the acquisition seemed certain to deliver value.

Unfortunately, a regional company operates very differently from a mainstream, national one. Begin with overheads. A low-cost factory shed HQ turned into a centrally air-conditioned office in central Mumbai. Next, instead of a flat distribution structure, the new brand was put through the existing, multi-layer, high cost distribution system. Train travel by managers turned into air travel. Then, the consumer profile was changed. The original business was very clear about its customers — price-conscious consumers in a specific region. This consumer base was maintained through low media spends — now, there was `brand-building' through TV. When all this was added up, the costs allocated to it were, obviously, far higher than it could take. As allocated costs went up, the already low margins turned negative. This threw up red flags all over the (existing) accounting system, and the price was increased. The result was what can be expected when a price-led brand increases price unilaterally — a quick descent into oblivion.

It's not that the acquisition could not have worked. It could, if the bought business had been left alone. The problem was not the fact that the new brand had low margins, but that it was force-fitted into a high-cost system. The mainstream business model was designed for high margins and sophisticated, brand-led consumers — it just could not handle a low-margin, price-led consumer-based brand.

A far better approach would have been to treat it as a separate business, with different metrics, overheads and cost structures. Also, if you are not comfortable with the existing consumer base (which presumably is why you tried to change it), why buy the brand in the first place? This would be a venture capitalist approach, which is anathema to most business heads.

If you are looking to integrate the acquisition, first ask yourself the key reason the acquisition looks so attractive. Next, ponder over whether this reason would continue to exist after you have changed its business model to suit yours.

(The writer is a Chennai-based management consultant. Karate-gy is a proprietary term for strategic exercises conducted by Paradigm Management Knowhow.)

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