The Acquisition Peril, Part I-Why Is Postmerger Integration So Difficult?

Don Shay and Sandra Burnis*

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cquisitions in the government services industry con-

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tinue unabated, according to Houlihan Lokey Howard & Zukin. The McLean investment banking firm reported in February 2004, "In the past 12 months, technology and defense contractors have completed

For many government services firms, acquisitions figure prominently in the strategic growth plan. This is especially true of midsize firms feeling the squeeze-too small to be a prime contractor, yet bridling at a subcontractor role. For others, access to cleared workers defense/intelligence customers is a key driver of acquisitions.

Regardless of the strategic merits, studies consistently find that 60-70percent of deals actually diminish shareholder value. The Insiderasked Don Shay and Sandra Bumis, experts in merger integration, to identify why the postmerger part of most deals is trying and ojienfaits. Part II. in October, will look at how to stay out of trouble.

Deals Are Disruptive Disruption

(and

company. Within two months after the deal's announcement, 29 of the top 30 TNS managers had departed, causing substantial turmoil. PSInet's woes continued as their acquisition of Metamore led to their bankruptcy a year later. Most companies recognize that effective communications are critical to capping this uncertainty.

nearly 200 acquisitions, more than all the deals in 1998 and 1999 combined." While acquisitions continue to be a key element in many government services firms'

Is Costly), Deals

typically don't go bad because of flawed strategy. They fail because deal economics demand higher returns from the combined entity at the same time that a set of disruptive events and changes, both real and perceived, is imposed on both companies. Once a

growth strategies, this practice is not without peril. Consider, for example, a study by noted M&A expert Mark Sirower. He found that "2/3 of 168 deals surveyed experienced significant value destruction." Reported M&Arelated hiccups in firms such as CACI, Titan, and ManTech sug-

As [customers] wonder about service deterioration, changes in sales relationships, loss of influence, and. changes in pricing, they become more vulnerable [and] competition ... will turn up the heat.
deal is announced, most companies tell employees and customers it's business as usual. The reality is far different. Employees of both companies recognize that change is inevitable, and absent concrete information from management, rumors abound. Distraction is inevitable too. As a result, productivity suffers as employees spend time wondering about the deal's implications. As uncertainty erodes morale, it is not unusual for headhunters to descend on the best employees, cherry-picking those with critical skills and customer relationships and placing them with the competition. Consider PSInet's acquisition of TNS, the transactiod network However, their communications tend to promote the strategic and financial benefits of the deal without directly addressing the issues of most concern to employees, customers, and others. Consider Dyncorp's acquisition by CSC, as described by Mike DeBruhl, then Dyncorp's senior vice president of human resources and member of the integration team. DeBruhl told the authors that "although integration planning began soon after the letter of intent was signed, communications about issues most
to employees-as
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gest a level of acquisition indigestion not inconsistent this finding. The source of these difficulties may be multiple and compound, such as inadequate due diligence, unexpected changes in the marketplace, and underestimation of the difficulties of integration. The financial outcomes are often revenue shortfalls, higher than expected integration costs, and shrinking margins. What is it about acquisitions that makes them so tough to pull off? What problems do companies typically face when they embark on a "growth by acquisition" strategy? And what are the implications for government services firms? with

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deal's strategic drivers-were ready for distribution at deal close. In addition to concerns

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'Don Shay, fonner Partner In charge of PwC's Washington, DCmerger integration group, was a founder of the firm's post merger Integration praclice. Sandra Bumis helped lead _Integration of two major acquisi-tions for cable and W' Iess. To~r, they assist flnns,lncludlng govemment rvIces companies, tIJrougIJthe process ot integrating acquisitions.

September 2004

2004 Panda Publishing, LLC.

The Acquisition

Peril, Part I-Why Is Postmerger

Integration

So Difficult?

continued from P1

employees wanted to know to whom they would report, whether programs would be consolidated, , consequence about job security, and about the abilirv to apply for other jobs." As a of the firm's inability to on these issues, Declearlv communicate

What Can You Do?

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and attendant

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6. Keep SCOI'l'_ In addition to measuring financial results, crack whether transition plans are meeting their objectives on schedule, 7. Rr..ard rllC integrators. Transition management is generally not recognized as a discrete and valued activity by either firm's measurement and reward system. Track fJrogress and reward successes with meaningful financial and psychic rewards,
8. Appr(!ciah' cultural differcllcPS and

Bruhl estimates that up to 25 percent of Dvncorp's key managers left. Customers will also have reasons for concern, As they wonder about service deterioration, changes in sales relationships, loss of influence, and changes in pricing, they become more vulnerable to advances from the competition. The competition senses this and will turn up the heat, In one instance, the sales force of a hightech company going through a substantial merger found that its toughest competitor had provided key accounts with memos describing the merger as a disaster that would lead to sub-par service and a slowdown in innovation, New sales slowed as customers waited to gauge the impact of the merger. The field sales force had to spend a substantial amount of time on damage controL Change Has Unanticipated Costs. There is a subtle irony that when acquisitions are made, management is expected to

key stakeholders on issues that matter most to them. Make decisions qukkEy. 2.
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If certain employees are key, make sure that golden handcuffs are in place for them. If access to key customers is critical, safeguard and nurture these relationships during the initial period of uncerrainty,
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3,. Time is I!ltht> essence. As soon as permissible, involve mldlevel managers from the acquisition in planning for initiatives that will create new value. This will help soothe some of their concerns.
4. Prioritixe
0/1

transition lnitiatioe

based

produce a level of income from the combined entity sufficient to offset the premium paid, Yet the very act of acquiring imposes an under-recognized set of hard and soft costs associated with change, The hard costs, such as severance pay and lease termination penalties, are generally recognized by the due diligence team. Less understood and anticipated are the less tangible costs, such as lower productivity, disruption, the loss of key employees, and foregone revenues as customers withhold orders, There is also the opportunity cost of management's Waterhouse's time, which now must be devoted to integration issues. Price merger with Coopers & Lybrand consumed thousands of hours of senior partner time around the world to resolve the myriad issues raised by the merger, and earnings suffered as a result,

value. and focus management's attention on a small number of initiadves, Involve the management of the acquisition in s~Hing priorities. Putting (Joints on the board early boosts morale-and 'Wall Street loves to see early successes.
5. O"ga1!i~(' your transition around 111(' heJ ;lli/;afiI'l's teams

the reasons why they exist, and establish a plan for molding culture to fit the firm's long-term strategy. Take steps such as making role models out of individuals who exhibit desired behaviors and rewarding them as an important early task.
9. Mah' acquisition
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inugrorion a

eompe/('I/ce. Create a small,

experienced SWAT team to help guide integration planning and execution, a pracnce rhat successful integrators as diverse as Cisco and \Vachovia have adopted .

that will create value, not Just around various business functions.

Culture

Isn't Soft; It's Hard. Cultural to

been much less than expected ... the EDS culture was so focused on sales that a lot of Kearney's clients felt EDS offerings were being pushed down their throats." (See the article on page 1 of this Insider for a comment on A.T. Kearney today.) Cultural issues also emerged in the CSC/ Dyncorp acquisition, Mike DeBruhl noted that Dyncorp's of management, culture was entrepreneurial so decisions were swift. and agile. Dyncorp didn't have many layers

differences are often a key impediment

merger integration, Indeed, as one firm attempts to overlay its mode of operation on another, opportunities for disaster abound, Rosabeth Moss Kanter described such a disaster when EDS acquired A.T. Kearney, saying, "The plan was that Kearney's work helping companies overhaul operations would lead to computer-services business for EDS and vice versa, but the synergy has

2 GOVERNMENT SERVICES INSIDER

September 2004 I 2004 Panda Publishing, LLC,

The Acquisition Peril, Part I-Why Is Postmerger Integration

When acquired by the much larger CSC, conflicts in operating style emerged. CSC was perceived as more bureaucratic because decisions took much longer as they flowed through more management layers. This played out duririg the bid process, where key Dyncorp managers became frustrated with what they viewed to be CSC's ponderous layers of review and resigned. When cultural differences are not understood, or are ignored or trampled, resignations and declines in operating effectiveness are inevitable.

So Difficult? continued from P2

Typically, the deal is closed and a division manager is given the responsibility for managing the integration but isn't provided the tools or the support needed to carry out this critical task. The problem is that integration is not an everyday undertaking. And it's stressful, demanding, politically challenging, and ripe with opportunities for failure. When firms make acquisitions, they need to devote the same level of attention to integration planning that they give to the process of identifying and structuting deals. If integration planning and execution do not become core competencies, the track record of M&A failures will remain unchanged. Is There Hope? Despite a spotty M&A track record, acquisitions are still a favored vehicle for obtaining above-average growth. Although it is commonly acknowledged that deals fail more often than they succeed, the attractiveness of growth by acquisitions remains compelling. The question must then be, If creating shareholder value through acquisitions is so attractive, yet so difficult, what specific steps can be taken to shift the odds? This will be discussed in Part II next month. (See page 2 for a preview of some of the solutions.j a

Yet speed, while critical, is not sufficient. If the underlying intent of the deal is to combine the capabilities of a target with those of the acquirer to create value, then this must be the focus of the transition teams. Unfortunately, this conflicts with the natural inclination of many acquiring companies to organize transition planning by function. This focus is misdirected. Deals are about much more than functional integration; they are about combining the skills and capabilities of two companies in such a way as to create more value than either company was able to create independently. This may be accomplished through cost reduction, but value is also created through revenue enhancement, which almost always calls for cross-functional teams. For example, if a primary benefit from an acquisition is the cross-selling of product to one another's customers, this 'is much more than a sales issue. Product managers, R&D, IT, and other contributing functions should be involved, and this is best done by a crossfunctional team. Companies Integration Don't Treat Acquisition As as a Core Competency.

Speed of integration is the single most important differentia between the success and failure of an acquisition.
Transition Plans Are Prepared Too Late and Aren't Focused on Value Creation. Three surveys conducted every other year between 1996 and 2000 by PricewaterhouseCoopers consistently found that speed of integration is the single most important differentia between the success and failure of an acquisition. The underlying reason is straightforward. First, deals are disruptive and disruption is costly, so make decisions quickly, communicate openly, and reduce the length of the time of uncertainty. Second, deals are about value creation, so the more quickly management can complete integration, the more quickly incremental value will be generated.

companies attempt to grow via acquisition, they devote substantial effort to the strategy-identifying and qualifying targets, evaluating their strategic fit, conducting rigorous due diligence, and structuring the deal. Yet seldom do companies apply the same level of thought and rigor to the process of nurturing the integration.

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September 2004

I 2004

Panda Publishing, LLC.