In my experience, companies that have grown largely through acquisition have fallen far short of their expectations. The truth is that more than half of all of the companies moving through this process actually destroy shareholder value. Over the last 30 years, I have encountered three primary reasons for this failure.

The First Reason for Failure
The first reason for failure in these cases is that many executives do not understand the importance of achieving appropriate levels of commonality in their processes and systems.  I recently interviewed a CEO on this topic who said that while the executives involved in his company were aware that there were potential gains available from the integration of processes and systems; they were considered minor in light of bigger objectives such as gaining market share. He perceived almost no relationship between an enterprise’s ability to leverage the broader capabilities of a combined enterprise and the capture of additional market share. The Fortune 100 company involved had grown through a multi-decade process of acquisitions and mergers, and had still remained fairly immature in terms of integration. They had common finance and human resource systems, and most of the business processes supported by those systems had been brought into a reasonably aligned position. As a result, the closing of financial books was much faster than the pre-alignment days, and fundamental processes such as the generation of payroll checks and annual activities surrounding performance appraisals and compensation adjustments were fairly uniform. However, the most fundamental processes and systems that comprised the company’s ability to add value were left largely untouched.

The company’s performance as reflected by metrics such as EPS, RONA, and the price of common stock remained lackluster. The company lost ground to both domestic and foreign competitors, and eventually divested itself of most of its vertically integrated operations in order to hold on to profitability. This corporate retreat, moving the burden of effectively managing operations to a supplier base, left the company at significant risk of material shortages, cost escalation, and quality problems. It also made the introduction of new technologies more challenging, and retarded some the company’s most promising opportunities for internal innovation.

Many companies, especially in the industrial manufacturing segments of American business, seem to have concluded that managing the most value-additive processes of their businesses is simply too difficult, and that keeping up with offshore competitors is not possible; hence the current trend toward disintegration. However, the evidence is not yet suggesting a broad improvement as a result of this trend; rather, many of the companies involved appear thus far to merely be holding their own.

The story of vertical integration is certainly an old one, and probably the most famous example was Henry Ford’s original manufacturing operation that literally changed the world. These days, vertical integration in the automotive industry is more often related to reaching forward toward the customer, such as General Motors’ formation of the General Motors Acceptance Corporation (GMAC). Achieving vertical integration through acquisition and merger became a larger feature on the business landscape in America more recently. Examples of late are the merger of Time and Warner in 1989, the purchase of Medco Containment Services by Merck & Company in 1993, and the series of moves made by aluminum manufacturers such as Reynolds to acquire can manufacturers such as BevPak.

The motivations for performing acquisitions and mergers to achieve vertical integration most often center around: assurance of a dependable source of supply, reducing throughput times in the supply chain, achieving lower costs through a shift away from outside procurement toward internal transfer pricing, and satisfying the need for specialized inputs such as proprietary material formulations, custom equipment or internal components, and so on. In addition, many companies who integrate vertically backward through the supply chain find that they can more consistently produce high levels of quality via the commonization of processes and systems throughout the enterprise.

Another CEO I interviewed only a few days later understood the need for commonality and integration very well. This CEO had presided over many acquisitions in the course of his 25+ years at the company, and was able to point to almost flawless expansion without any dilution in company value, hitting accretive value increase targets in most cases within the designated eighteen to twenty-four month window (He also reflected on one acquisition attempt many years ago that failed, and the work that was required to pull that one apart again in order to avert disaster). During the course of my interview, he explained in detail how all new acquisitions in that company were moved very rapidly to the enterprise’s suite of business processes and systems, including finance, human resources, supply chain management, and other critical processes. In finance alone, he pointed out, nineteen separate processes and two supporting information systems were involved. Growing from a single business unit, over the course of three decades this company became the largest one of its kind, and currently operates in more than 20 states. The company used acquisitions and mergers to expand horizontally into adjacent markets, and learned a great deal during those early years about how to filter potential acquisitions and mergers so that effort was expended only in cases where the combination of businesses would support the overall strategy of the business.

These types of acquisitions and mergers, directed toward horizontal integration, are a reasonably common way for companies to move into adjacent markets. Certainly LDDS, which grew to become the second largest long distance telephone carrier in the United States before it was acquired by WorldCom, is a case in point. In these cases, the companies involved usually expect to lower their per-transaction costs by leveraging existing experience and systems assets across a broader market, and further improve financial performance by redundancy reductions and a lower overall asset base. In this way, the expertise, business processes, systems, and other assets of the business are scaled only to the extent necessary to meet the needs of the combined enterprise, and redundant assets are targeted for reduction. The asset base per unit of sales is reduced; hence an improvement in Return on Net Assets (RONA).

The Second Reason for Failure
The second reason for failure is that many company leaders do not know how to go about achieving commonality in their processes and systems. Most of these executives have no idea that the superficial overview of processes and systems so often comprised in the due diligence phase of an acquisition leaves them with only the dimmest view of the opportunities available for improved earnings and growth. However, even when this is not the case there is usually such a dearth of understanding around the discipline of business process re-engineering, lean enterprise concepts, and six sigma quality principles that they have no idea how to remedy the situation.

A couple of years ago, I was asked to accompany the corporate IT executives from one our clients to a business unit in the northeastern part of the United States. Out mission was to see whether we could determine why that division was struggling to perform even the most rudimentary activities, and yielding such poor financial results. When I arrived with my companions, I discovered that there was no adequate documentation of any business process in the division. In fact, as we went through interview after interview, I discovered that I was the only person there who knew how to document a business process in flow chart form, calling out inputs, outputs, responsibilities, and resources consumed. I was even more alarmed when I interviewed manager after manager and found that none of them (with the exception of the division general manager) could articulate any quantitative objectives for their own performance, or the performance of their division.

Moving them toward process commonality in order to gain enough leverage to generate profitability required first of all that the existing business processes be understood, so that we could identify existing performance levels and changes required. At the same time, corporate level objectives needed to be communicated and translated into divisional goals and objectives, flowed down through the business unit in a manner that linked them appropriately from top to bottom. This practice was foreign to the leaders of that unfortunate division, and it was a protracted struggle to move them into alignment. Because this company had moved so rapidly through the acquisition process, paying only cursory attention to systems and almost no attention to process commonization, earnings performance was dismal. Unfortunately, as I discovered over the ensuing year, this had been a pretty common approach over the acquisition-based history of the corporation. It was an ingrained part of the culture of management, and sorting it out was a real adventure. It remains to be seen whether the company will ever gain a real grip on the criticality of getting their fundamental business processes aligned, or whether – like so many others – they will merely attempt to overlay a common information system and hope for the best. It is important to begin with the processes and enable those processes with effective information systems. Approaching the business the other way, with systems leading process execution, is often a dangerous path.

The Third Reason for Failure
The third reason many of these activities fail to achieve expected performance levels is that executives are frequently unable to follow through on the difficult decisions related to post-acquisition and post-merger consolidation. During the course of the interviews I conducted as I prepared to write this book, one of the questions I always asked was: “What, in your experience, have been the top three things to avoid when undertaking a merger or acquisition?” One of the most frequent answers among those CEOs who were most successful was: “Failure to make the tough calls. You can’t appease everyone, and businesses that end up with co-directors, co-CEOs, or co-leaders of any kind are businesses heading for trouble.” The point is that it is best to make tough decisions up front, as the actual business combination is being formulated, and implement them not long after the deal is closed. This is true not only of decisions pertaining to people, but also facilities, equipment, and critical information systems. An air of confidence -not arrogance, or insensitivity, but resolute confidence – and steadiness of direction is an important element of the leadership required to pilot any company through the tumultuous waters of a merger or acquisition.

Few acquisitions have gone as visibly and dramatically wrong as the 1984 acquisition of EDS by General Motors. By virtually all accounts, the attempt to introduce a plain-speaking, no-holds-barred management shakeup at GM failed miserably. Most historians seem to agree that this acquisition, which cost the corporate giant hundreds of millions of dollars, was largely the product of conflicts generated when tough decisions were consistently avoided. Throughout his tenure as a General Motors employee, Ross Perot identified and exposed massive investments in various automation and acquisition projects that were dramatic failures, and repeatedly asked the board of directors at GM to intervene. They consistently refused. Even as he was being bought out and forced to leave, Perot was dumbstruck at the willingness of the board to spend the money they had authorized simply to have him, and his dissention, gone. One excellent account of this phenomenon published as a corporate governance case study, says: “In a press conference held immediately after he signed the buyout agreement, Perot told reporters, “Is spending all this money the highest and best use of GM’s capital? . . . I want to give the directors a chance to do the right thing. It is incomprehensible to me that they would want to spend $750 million on this. I am hopeful that people will suddenly get a laser-like focus on what needs to be done and do it.” Following the announcement of the buyout, and Perot’s press conference, GM stock declined $3, and EDS stock lost $4.50.”

Getting the management of a company to recognize the tough decisions that need to be made, and act on those matters in an effective and timely manner is often difficult. In the turbulent aftermath of a corporate merger or a significant business acquisition, it is especially challenging – and uniquely critical to the company’s success.

Another reason that surfaces, though not as often, is generally poor execution of the due diligence activity (touched on briefly in previous paragraphs). The most common underlying cause for that, in my experience, is an inadequate exploration of processes and systems during the due diligence phase.

To be fair to the executives involved, it is important to understand that mergers and acquisitions are revolutionary rather than evolutionary changes. The level of disruption to both organizations is severe, and there is a psychological toll taken on management and employees alike that can be devastating. The deadlines are aggressive, the sheer tension around the event is high, and there is often a jockeying for position in the new organization. It is very tough to keep one’s eye on the ball in these situations. I am hopeful that the information provided in this article will enable company executives and executives-in-development to foresee those problems, and improve our overall batting average.

The history of mergers and acquisitions in the United States is comprised of a series of five distinct waves of activity. Each wave occurred at a different time, and each exhibited some unique characteristics related to the nature of the activity, the sources of funding for the activity, and to some extent, differing levels of success from wave to wave. When the volume, nature, mechanisms, and outcomes of these transactions are viewed in an objective historical context, important lessons emerge.

The First Wave
The first substantial wave of merger and acquisition activity in the United States occurred between 1898 and 1904. The normal level of about 70 mergers per year leaped to 303 in 1898, and crested at 1,208 in 1899. It remained at more than 300 every year until 1903, when it dropped to 142, and dropped back again into what had been a range of normalcy for the period, with 79 mergers, in 1904. Industries comprising the bulk of activity during this first wave of acquisition and merger activity included primary metals, fabricated metal products, transportation equipment, machinery, petroleum products, bituminous coal, chemicals, and food products. By far, the greatest motivation for these actions was the expansion of the business into adjacent markets. In fact, 78% of the mergers and acquisitions occurring during this period resulted in horizontal expansion, and another 9.7% involved both horizontal and vertical integration.

During this era in American history, the business environment related to mergers and acquisitions was much less regulated and much more dynamic than it is today. There was very little by way of antitrust impediments, with few laws and even less enforcement.

The Second Wave
The second wave of merger and acquisition activity in American businesses occurred between 1916 and 1929. Having become more concerned about the rampant growth of mergers and acquisitions during the first wave, the United States Congress was much more wary about such activities by the time the second wave rolled around. Business monopolies resulting from the first wave produced some market abuses, and a set of business practices that were viewed as unfair by the American public. Even the Sherman Act proved to be relatively ineffective as a deterrent of monopolistic practices, and so Congress passed another piece of legislation entitled the Clayton Act to reinforce the Sherman Act in 1914. The Clayton Act was somewhat more effective, and proved to be particularly useful to the Federal Government in the late 1900s. However, during this second wave of activity in the years spanning 1926 to 1930, a total of 4,600 mergers and acquisitions occurred. The industries with greatest concentrations of these activities included primary metals, petroleum products, chemicals, transportation equipment, and food products. The upshot of all of these consolidations was that 12,000 companies disappeared, and more than $13 billion in assets were acquired (17.5% of the country’s total manufacturing assets).

The nature of the businesses formed was somewhat different in the second wave; there was a higher incidence of mergers and acquisitions to achieve vertical integration in the second wave, and a much higher percentage of the resulting businesses resulted in conglomerates that included previously unrelated businesses.  The second wave of acquisition and merger activity in the United States ended in the stock market crash on October 29, 1929, and this altered – perhaps forever – the perspective of investment bankers related to funding these transactions. Companies that grew to prominence through the second wave of mergers and acquisitions in the United States, and that still operate in this country today, include General Motors, IBM, John Deere (now Deere & Company), and Union Carbide.

The Third Wave
The American economy during the last half of the 1960s (1965 through 1970) was booming, and the growth of corporate mergers and acquisitions, especially related to conglomeration, was unprecedented. It was this economic boom that painted the backdrop for the third wave of mergers and acquisitions in American history. A peculiar feature of this period was the relatively common practice of companies targeting acquisitions that were larger than themselves. This period is sometimes referred to as the conglomerate merger period, owing in large measure to the fact that acquisitions of companies with over $100 million in assets spiked so dramatically. Compared to the years preceding the third wave, mergers and acquisitions of companies this size occurred far less frequently. Between 1948 and 1960, for example, they averaged 1.3 per year. Between 1967 and 1969, however, there were 75 of them – averaging 25 per year.  During the third wave, the FTC reports, 80% of the mergers that occurred were conglomerate transactions.

Although the most recognized conglomerate names from this period were huge corporations such as Litton Industries, ITT and LTV, many small and medium size companies attempted to pursue an avenue of diversification. The diversification involved here included not only product lines, but also the industries in which these companies chose to participate. As a result, most of the companies involved in these activities moved substantially outside of what had been regarded as their core businesses, very often with deleterious results.

It is important to understand the difference between a diversified company, which is a company with some subsidiaries in other industries, but a majority of its production or services within one industry category, and a conglomerate, which conducts its business in multiple industries, without any real adherence to a single primary industry base. Boeing, which primarily produces aircraft and missiles, has diversified by moving into areas such as Exostar, an online exchange for Aerospace & Defense companies. However, ITT has conglomerated, with industry leadership positions in electronic components, defense electronics & services, fluid technology, and motion & flow control. While the bulk of companies merged or acquired in the long string of activity resulting in the current Boeing Company were almost all aerospace & defense companies, the acquisitions of ITT were far more diverse. In fact, just since becoming an independent company in 1995, ITT has acquired Goulds Pumps, Kaman Sciences, Stanford Telecom and C&K Components, among other companies.

Since the ascension of the third wave of mergers and acquisitions in the 1960s, there has been a great deal of pressure from stockholders for company growth. With the only comparatively easy path to that growth being the path of conglomeration, a lot of companies pursued it. That pursuit was funded differently in this third wave of activity, however. It was not financed by the investment bankers that had sponsored the two previous events. With the economy in expansion, interest rates were comparatively high and the criteria for obtaining credit also became more demanding. This wave of merger and acquisition activity, then, was executed by the issuance of stock. Financing the activities through the use of stock avoided tax liability in some cases, and the resulting acquisition pushed up earnings per share even though the acquiring company was paying a premium for the stock of the acquired firm, using its own stock as the currency.

The use of this mechanism to boost EPS, however, becomes unsustainable as larger and larger companies are involved, because the underlying assumption in the application of this mechanism is that the P/E ratio of the (larger) acquiring company will transfer to the entire base of stock of the newly combined enterprise. Larger acquisitions represent larger percentages of the combined enterprise, and the market is generally less willing to give the new enterprise the benefit of that doubt. Eventually, when a large number of merger and acquisition activities occur that are founded on this mechanism, the pool of suitable acquisition candidates is depleted, and the activity declines. That decline is largely responsible for the end of the third wave of merger and acquisition activity.

One other mechanism that was used in a similar way, and with a similar result, in the third wave or merger and acquisition activity was the issue of convertible debentures (debt securities that are convertible into common stock), in order to gather in the earnings of the acquired firm without being required to reflect an increase in the number of shares of common stock outstanding. The resulting bump in visible EPS was known as the bootstrap effect. Over the course of my own career, I have often heard of similar tactics referred to as “creative accounting”.

Almost certainly, the most conclusive evidence that the bulk of conglomeration activity achieved through mergers and acquisitions is harmful to overall company value is the fact that so many of them are later sold or divested. For example, more than 60% of cross-industry acquisitions that occurred between 1970 and 1982 were sold or divested in some other manner by 1989. The widespread failure of most conglomerations has certainly been partly the result of overpaying for acquired companies, but the fact is that overpaying is the unfortunate practice of many companies. In one recent interview I conducted with an extremely successful CEO in the healthcare industry, I asked him what actions he would most strongly recommend that others avoid when entering into a merger or acquisition. His response was immediate and emphatic: “Don’t become enamored with the acquisition target“, he replied. ”Otherwise you will overpay. The acquisition has to make sense on several levels, including price.”

The failure of conglomeration, then, springs largely from another root cause. Based on my own experience and the research I have conducted, I am reasonably certain that the most fundamental cause is the nature of conglomeration management. Implicit in the management of conglomerates is the notion that management can be done well in the absence of specialized industry knowledge, and that just isn’t usually the case. Regardless of the “professional management” business curricula offered by many institutions of higher learning these days, in most cases there is just no substitute for industry-specific experience.

The Fourth Wave
The first indications that a fourth wave of merger and acquisition activity was imminent appeared in 1981, with a near doubling of the value of these transactions from the prior year. However, the surge receded a bit, and really regained serious momentum again in 1984.   According to Mergerstat Review (2001), just over $44 billion was paid in merger and acquisition transactions in 1980 (representing 1,889 transactions), compared to more than $82 billion (representing 2,395 transactions) in 1981. While activity fell back to between $50 billion and $75 billion in the ensuing two years, the 1984 activity represented over $122 billion and 2,543 transactions. In terms of peaks, the number of transactions peaked in 1986 at 3,336 transactions, and the dollar volume peaked in 1988 at more than $246 billion. The entire wave of activity, then, is regarded by analysts to have occurred between 1981 and 1990.

There are a number of aspects of this fourth wave that distinguish it from prior activities. The first of those characteristics is the advent of the hostile takeover. While hostile takeovers have been around since the early 1900s, they truly proliferated (more in terms of dollars than in terms of percent of transactions) during this fourth wave of merger and acquisition activity. In 1989, for example, more than three times as many dollars were transacted as a result of contested tender offers than the dollars associated with uncontested offers. Some of this phenomenon was closely tied to another characteristic of the fourth wave of activity; the sheer size and industry prominence of acquisition targets during that period. Referring again to Mergerstat Review’s numbers published in 2001, the average purchase price paid in merger and acquisition transactions in 1970, for example, was $9.8 million. By 1975, it had grown to $13.9 million, and by 1980 it was $49.8 million. At its peak in 1988, the average purchase price paid in mergers and acquisitions was $215.1 million.   Exacerbating the situation was the volume of large transactions. The number of transactions valued at more than $100 million increased by more than 23 times between 1974 and 1986, which was a stark contrast to the typically small-to-medium size company based activities of the 1960s.

Another factor that impacted this fourth wave of merger and acquisition activity in the United States was the advent of deregulation. Industries such as banking and petroleum were directly affected, as was the airline industry.   Between 1981 and 1989, five of the ten largest acquisitions involved a company in the petroleum industry – as an acquirer, an acquisition, or both. These included the 1984 acquisition of Gulf Oil by Chevron ($13.3 billion), the acquisition in that same year of Getty Oil by Texaco ($10.1 billion), the acquisition of Standard Oil of Ohio by British Petroleum in 1987 ($7.8 billion), and the acquisition of Marathon Oil by US Steel in 1981 ($6.6 billion).  Increased competition in the airline industry resulted in a severe deterioration in the financial performance of some carriers, as the airline industry became deregulated and air fares became exposed to competitive pricing.

An additional look at the ontology of the ten largest acquisitions between 1981 and 1989 reflects that relatively few of them were acquisitions that extended the acquiring company’s business into other industries than their core business. For example, among the five oil-related acquisitions, only two of them (DuPont’s acquisition of Conoco and US Steel’s acquisition of Marathon Oil) were out-of-industry expansions. Even in these cases, one might argue that they are “adjacent industry” expansions. Other acquisitions among the top ten were Bristol Meyers’ $12.5 billion acquisition of Squibb (same industry – Pharmaceuticals), and Campeau’s $6.5 billion acquisition of Federated Stores (same industry – Retail).

The final noteworthy aspect of the “top 10″ list from our fourth wave of acquisitions is the characteristic that is exemplified by the actions of Kohlberg Kravis. Kohlberg Kravis performed two of these ten acquisitions (both the largest – RJR Nabisco for $5.1 billion, and Beatrice for $6.2 billion). Kohlberg Kravis was representative of what came to be known during the fourth wave as the “corporate raider“. Corporate raiders such as Paul Bilzerian, who eventually acquired the Singer Corporation in 1988 after participating in numerous previous “raids”, made fortunes for themselves by attempting corporate takeovers. Oddly, the takeovers did not have to be ultimately successful for the raider to profit from it; they merely had to drive up the price of shares they acquired as a part of the takeover attempt. In many cases, the raiders were actually paid off (this was called “greenmail”) with corporate assets in exchange for the stock they had acquired in the attempted takeover.

Another term that came into the lexicon of the business community during this fourth wave of acquisition and merger activity is the leveraged buy-out, or LBO. Kohlberg Kravis helped develop and popularize the LBO concept by creating a series of limited partnerships to acquire various corporations, which they deemed to be underperforming. In most cases, Kohlberg Kravis financed up to ten percent of the acquisition price with its own capital and borrowed the remainder through bank loans and by issuing high-yield bonds. Usually, the target company’s management was allowed to retain an equity interest, in order to provide a financial incentive for them to approve of the takeover.

The bank loans and bonds used the tangible and intangible assets of the target company as collateral. Because the bondholders only received their interest and principal payments after the banks were repaid, these bonds were riskier than investment grade bonds in the event of default or bankruptcy. As a result, these instruments became known as “junk bonds.” Investment banks such as Drexel Burnham Lambert, led by Michael Milken, helped raise money for leveraged buyouts. Following the acquisition, Kohlberg Kravis would help restructure the company, sell off underperforming assets, and implement cost-cutting measures. After achieving these efficiencies, the company was usually then resold at a significant profit.

Increasingly, as one reviews the waves of acquisition and merger activity that have occurred in the United States, this much seems clear: While it is possible to profit from the creative use of financial instruments and from the clever buying and selling of companies managed as an investment portfolio, the real and sustainable growth in company value that is available through acquisitions and mergers comes from improving the newly formed enterprise’s overall operating efficiency. Sustainable growth results from leveraging enterprise-wide assets after the merger or acquisition has occurred. That improvement in asset efficiency and leverage is most frequently achieved when management has a fundamental commitment to the ultimate success of the business, and is not motivated purely by a quick, temporary escalation in stock price. This is related, in my view, to the earlier observation that some industry-specific knowledge improves the likelihood of success as a new business is acquired. People who are committed to the long-term success of a company tend to pay more attention to the details of their business, and to broader scope of technologies and trends within their industry.

There were a few other characteristics of the fourth wave of merger and acquisition activity that should be mentioned before moving on. First of all, the fourth wave saw the first significant effort by investment bankers and management consultants of various types to provide advice to acquisition and merger candidates, in order to earn professional fees. In the case of the investment bankers, there was an additional opportunity around financing these transactions. This opportunity gave rise, in large measure, to the junk bond market that raised capital for acquisitions and raids. Secondly, the nature of the acquisition – and especially the nature of takeovers – became more intricate and strategic in nature. Both the takeover mechanisms and paths and the defensive, anti-takeover methods and tools (eg: the “poison pill”) became increasingly sophisticated during the fourth wave.

The third characteristic in this category of “other unique characteristics” in the fourth wave was the increased reliance on the part of acquiring companies on debt, and perhaps even more importantly, on large amounts of debt, to finance the acquisition. A significant rise in management team acquisition of their own firms using comparatively large quantities of debt gave rise to a new term – the leveraged buy-out (or LBO) – in the lexicon of the Wall Street analyst.

The fourth characteristic was the advent of the international acquisition. Certainly, the acquisition of Standard Oil by British Petroleum for $7.8 billion in 1987 marked a change in the American business landscape, signaling a widening of the merger and acquisition landscape to encompass foreign buyers and foreign acquisition targets. This deal is significant not only because it involved foreign ownership of what had been considered a bedrock American company, but also because of the sheer dollar volume involved. A number of factors were involved in this event, such as the fall of the US dollar against foreign currencies (making US investments more attractive), and the evolution of the global marketplace where goods and services had become increasingly multinational in scope.

The Fifth Wave
The fifth wave of acquisition and merger activity began immediately following the American economic recession of 1991 and 1992. The fifth wave is viewed by some observers as still ongoing, with the obvious interruption surrounding the tragic events September 11, 2001, and the recovery period immediately following those events. Others would say that it ended there, and after the couple of years ensuing, we are seeing the imminent rise of a sixth wave. Having no strong bias toward either view, for purposes of our discussion here I will adopt the first position. Based on the value of transactions announced over the course of the respective calendar years, the dollar volume of total mergers and acquisitions in the US in 1993 was $347.7 billion (an increase from $216.9 billion in 2002), continued to grow steadily to $734.6 billion in 1995, and expanded still further to $2,073.2 billion by 2000.

This group of deals differed from the previous waves in several respects, but arguably the most important difference was that the acquisitions and mergers of the 1990s were more thoughtfully orchestrated than in any previous foray. They were more strategic in nature, and better aligned with what appeared to be relatively sophisticated strategic planning on the part of the acquiring company. This characteristic seems to have solidified as a primary feature of major merger and acquisition activity, at least in the US, which is encouraging for shareholders looking for sustainable growth rather than a quick – but temporary – bump in share price.

A second characteristic of the fifth wave of acquisitions and mergers is that they were typically more equity-based than debt-based in terms of their funding. In many cases, this worked out well because it relied less on leverage that required near-term repayment, enabling the new enterprise to be more careful and deliberate about the sell-off of assets in order to service debt created by the acquisition.

Even in cases where both of these features were prominent aspects of the deal, however, not all have been successful. In fact, some of the biggest acquisitions have been the biggest disappointments over recent years. For example, just before the announcement of the acquisition of Time Warner by AOL, a share of AOL common stock traded for about $94. In January of 2005, that share of stock was worth about $17.50. In the Spring of 2003, the average share price was more like $11.50. The AOL Time Warner merger was financed with AOL stock, and when the expected synergies did not materialize, market capitalization and shareholder value both tanked. What was not foreseen was the devaluation of the AOL shares used to finance the purchase. As analyst Frank Pellegrini reported in Time’s on-line edition on April 25, 2002: “Sticking out of AOL Time Warner’s rather humdrum earnings report Wednesday was a very gaudy number: A one-time loss of $54 billion. It’s the largest spill of red ink, dollar for dollar, in U.S. corporate history and nearly two-thirds of the company’s current stock-market value.”

The fifth wave has also become known as the wave of the “roll-up“. A roll-up is a process that consolidates a fragmented industry through a series of acquisitions by comparatively large companies (typically already within that industry) called consolidators. While the most widely recognized of these roll-ups occurred in the funeral industry, office products retailers, and floral products, there were roll-ups of significant magnitude in other industries such as discrete segments of the aerospace & defense community.

Finally, the fifth wave of acquisitions and mergers was the first one in which a very large percentage of the total global activity occurred outside of the United States. In 1990, the volume of transactions in the US was $301.3 billion, while the UK had $99.3 billion, Canada had $25.3 billion, and Japan represented $14.2 billion. By the year 2000, the tide was shifting. While the US still led with $2,073 billion, the UK had escalated to $473.7 billion, Canada had grown to $230.2 billion, and Japan had reached $108.8 billion. By 2005, it was clear that participation in global merger and acquisition activity was now anyone’s turf. According to barternews.com: “There was incredible growth globally in the M&A arena last year, with record-setting volume of $474.3 billion coming from the Asian-Pacific region, up 46% from $324.5 billion in 2004. In the U.S., M&A volume rose 30% from $886.2 billion in 2004. In Europe the figure was 49% higher than the $729.5 billion in 2004. Activity in Eastern Europe nearly doubled to a record $117.4 billion.”

The Lessons of History
Many studies have been conducted that focus on historical mergers and acquisitions, and a great deal has been published on this topic. Most of the focus of these studies has been on more contemporary transactions, probably owing to factors such as the availability of detailed information, and a presumed increase in the relevance of more recent activity. However, before sifting through the collective wisdom of the legion of more contemporary studies, I think it’s important to look at least briefly to the patterns of history that are reflected earlier in this article.

Casting a view backward over this long history of mergers and acquisitions then, observing the relative successes and failures, and the distinctive characteristics of each wave of activity, what lessons can be learned that could improve the chances of success in future M&A activity?  Here are ten of my own observations:

1. Silver bullets and statistics. The successes and failures that we have reviewed through the course of this chapter reveal that virtually any type of merger or acquisition is subject to incompetence of execution, and to ultimate failure. There is no combination of market segments, management approaches, financial backing, or environmental factors that can guarantee success. While there is no “silver bullet” that can guarantee success, there are approaches, tools, and circumstances that serve to heighten or diminish the statistical probability of achieving sustainable long-term growth through an acquisition or merger.
2. The ACL Life Cycle is fundamental. The companies who achieve sustainable growth using acquisitions and mergers as a mainstay of their business strategy are those that move deliberately through the Acquisition / Commonization / Leverage (ACL) Life Cycle. We saw evidence of that activity in the case of US Steel, Allied Chemical, and others over the course of this review.
3. Integration failure often spells disaster. Failure to achieve enterprise-wide leverage through the commonization of fundamental business processes and their supporting systems can leave even the largest and most established companies vulnerable to defeat in the marketplace over time. We saw a number of examples of this situation, with the American Sugar Refining Company perhaps the most representative of the group.
4. Environmental factors are critical. As we saw in our review of the first wave, factors such as the emergence of a robust transportation system and strong, resilient manufacturing processes enabled the success of many industrial mergers and acquisitions. So it was more recently with the advent of information systems and the Internet. Effective strategic planning in general, and effective due diligence specifically, should always include a thorough understanding of the business environment and market trends. Often times, acquiring executives become enamored with the acquisition target (as mentioned in our review of third wave activity), and ignore contextual issues as well as fundamental business issues that should be warning signs.
5. Conglomeration is challenging. There were repeated examples of the challenges associated with conglomeration in our review of the history of mergers and acquisitions in the United States. While it is possible to survive – and even thrive – as a conglomerate, the odds are substantially against it. Those acquisitions and mergers that most often succeed in achieving sustainable long-term growth are the ones involving management with significant industry-specific and process-specific expertise. Remember the observation, during the course of our review of fourth wave activity, that “the most conclusive evidence that the bulk of conglomeration activity achieved through mergers and acquisitions is harmful to overall company value is the fact that so many of them are later sold or divested.”
6. Commonality holds value. Achieving significant commonality in fundamental business processes and the information systems that support them offers an opportunity for genuine synergy, and erects a substantive barrier against competitive forces in the marketplace. We saw this a number of times; Allied Chemical is especially illustrative.
7. Objectivity is important. As we saw in our review of the influence of investment bankers vetoing questionable deals during second wave activities, there is considerable value in the counsel of objective outsiders. A well-suited advisor will not only bring a clear head and fresh eyes to the table, but will often introduce important evaluative expertise as a result of experience with other similar transactions, both inside and outside of the industry involved.
8. Clarity is critical. We saw the importance of clarity around the expected impacts of business decisions in our review of the application of the DuPont Model and similar tools that enabled the ascension of General Motors. Applying similar methods and tools can provide valuable insights about what financial results may be expected as the result of proposed acquisition or merger transactions.
9. Creative accounting is a mirage. The kind of creative accounting described by another author as “finance gimmickry” in our review of third wave activity does not generate sustainable value in the enterprise, and in fact, can prove devastating to companies who use it as a basis for their merger or acquisition activity.
10. Prudence is important when selecting financial instruments to fund M&A transactions. We observed a number of cases where inflated stock values, high-interest debt instruments, and other questionable choices resulted in tremendous devaluation in the resulting enterprise. Perhaps the most illustrative example was the recent AOL Time Warner merger described in the review of fifth wave activity.

Many of these lessons from history are closely related, and tend to reinforce one another. Together, they provide an important framework of understanding about what types of acquisitions and mergers are most likely to succeed, what methods and tools are likely to be most useful, and what actions are most likely to diminish the company’s capability for sustainable growth following the M&A transaction.

This recent wave of mergers and acquisitions has prompted businesses to get scale fast and place themselves in a position to reap considerable benefits from “first mover advantages.” Speed to market is a critical competitive differentiation in all businesses, regardless of their size and industry classification. Going it alone can slow you down and very often it turns out to be one sure way to get left behind. This article is the first in a series of resources that offer a working guide to help you effectively chart your way, from initial discussions to integrating the operations, through the many different steps involved in successful business combinations. Specifically you will learn:

* What to look for

* Things that could go wrong

* What to do

* How to do it successfully

Different companies will have various motives when deciding to pursue an acquisition, divestiture, joint venture, or strategic alliance plan. The decision is usually driven by key business fundamentals such as broader competitive product line, access to strong distribution channels or new markets, sharing of scarce talent, lower unit cost position via the elimination of common costs, economies of scale, better market positioning with a stronger brand recognition, and faster speed of entering a market versus doing a start-up. In the case of divestiture, the motivation to sell may be due to poor financial performance of the company or, if the business is a subsidiary or division, it no longer fits strategically with the future direction of the company.

Having decided that the company must participate in mergers, acquisitions, divestitures, joint ventures, or other strategic alliances to achieve short and long-term goals, it must then ensure that all transactions fit within the corporate strategic plan. Too often in the past companies who use business combinations to stray too far away from their core business strategy have a tendency to fail in their effort to execute on the promise of the deal. If the company has a clear sense of where it wants to go and the missing elements of its strategy that is needed to win, then finding companies who bring these missing strengths to bear on serving the market is an essential ingredient for success.

A merger occurs when one company is legally absorbed into another and the surviving company takes over all of the assets and liabilities of the absorbed company. There cannot be any separate transfer of assets or liabilities to other third parties and a certificate of merger must be filed in the state where the new business will incorporate. The absorbed company shareholders are not “bought out” and therefore the merger is, in essence, treated as a stock transaction for federal tax purposes. The shareholders of both of the merged companies exchange their original stock for new stock in the surviving company. The company’s board of directors and shareholders must approve the merger.

* Acquisitions can occur in two ways:

* Buy the assets of the company

* Buy the company’s shares from the stockholders

Under the acquisition scenario, the shareholders of the company being bought can, in most instances, take their money and “ride off into the sunset.” The terms of the payment can be either in cash or stock of the purchase (which is as good as cash for publicly traded companies). The acquisition is different from a merger in that the selling shareholders do not own stock in a new, combined enterprise. The buyer can select targeted assets or liabilities to take and others to discard which the seller must accommodate. For example, the buyer does not have to assume the debt of the company being bought–although in most cases they do.

In today’s fast changing markets, more and more companies across multiple industries are concluding that it is reasonable to join with other companies to enter and grow new markets. Alliances can take place between two competitors, a company and its vendors, or even two companies operating in different market spaces. Sometimes an alliance allows a firm to expand without actually taking on more employees–an important phenomenon for small businesses. The opportunity to handle additional growth without major hiring can have a positive impact on profitability and cash flow. These alliances can be structured as partnerships or be set up as new corporations. The structure is determined by the goals and objectives of the parties as well as tax advantages and liability concerns.

JVMergerHelper is one of the best places on the Internet to find guides, tools, and templates to help you with sample letters and agreements, tips, guidelines, rules of thumb, real world examples, step-by-step instructions, presentations. Use them to quickly grasp the key essentials needed to win. This particular resource addresses the elements of a business combination or joint venture transaction by targeting the tools and templates into seven parts:

* Finding the Right Target Company

* Structuring the Transaction

* Preparing Solid Transaction Documents

* Valuing the Business

* Doing Effective Due Diligence

* Negotiating and Closing the Deal

* Combining the Businesses

* Presenting the Deal Effectively

Business combinations are not easy to execute and they most often don’t live up to their expectations. There have been several studies done on business combinations announced in the last 20 years and in well over 60% of the cases the synergy was not realized. When synergy doesn’t materialize the acquiring company ends up damaging shareholder value because premiums paid to take a significant equity stake in a target company are not recouped. However, by understanding a company’s motives for doing business combinations, how the decision fits in with their overall corporate strategy, and the careful identification of the characteristics of an ideal target, the chances of success can be greatly increased. In addition, using proven successful tools and templates goes a far way in helping to make sure your company is one of those in the winners circle.

Mergers and acquisitions are a prominent phenomenon in business. It provide additional growth and profit opportunities. Entrepreneurs also often use it as an exit strategy and it is crucial in determining their ultimate success and financial independence. Unfortunately things do not always go smooth in the execution of mergers and acquisitions and sometimes it is a complete failure.

Rationale Behind Mergers and Acquisitions

In general a company sees a merger and acquisition as an opportunity to improve their competitive edge and financial well-being. The rationale behind mergers and acquisitions includes the following:

• Realizing shareholders value. The management of companies is measured on the improvement of the shareholders value. Entrepreneurs on the other hand want to make a substantial material gain after they successfully built their companies.
• Broadening of markets. The growth potential of companies are enhanced through additional niche markets and a wider geographic spread.
• Increased efficiencies. Economies of scale can be gained from an increase in the size of the operations and through the better control of operations (e.g. controlling a larger portion of the supply chain).
• Access to resources. Competitive edge is enhanced through better access to finances, raw materials, skills and intellectual capital.
• Manage risks. Risks can be decreased through the diversification of the business and by having a choice of supply chains (e.g. manufacturing and procurement in different countries).
• Listing potential. The public offering of the shares of a business is enhanced through an increase in turnover and profitability.
• Political necessity. Countries have different legal requirements (e.g. in South Africa there are certain Black Economic Empowerment (BEE) regulations that companies need to adhere to).
• Speculative possibilities. Companies often buy another company just to sell it in the near future or to strip the company and sell portions of it.
• Additional products, services and facilities. Patented products and additional warehousing and distribution channels enhance the service levels and offering of a business.

Why Do Many Mergers and Acquisitions Fail?

Mergers and acquisitions fail for various reasons. The failure can be before the physical merger and acquisition take place, during the implementation process or during the running of the new merged entity. Potential failures are due to many factors, including:

• Negotiations failure. No agreement is reached between the parties due to factors such as different cultures, expectations and risk profiles.
• Legal issues. The competition laws of various countries often prohibit transactions that are considered to be anti-competitive.
• Implementation problems. Systems (especially IT) are often not very compatible and difficult to merge.
• Financial failure. The expected turnover and return on investment have not been achieved and/or the liquidity and solvency of the company are at risk.
• People failure. Cultural differences, hostility from personnel and resignations can cause serious problems.
• Planned strategic objectives are not achieved. This include the achievement of synergies such as increased efficiencies and market penetration.
• Risk management failure. The risks (e.g. legal, business, financial and operational) of the merged entity are unacceptably high.

Success Criteria for a Successful Merger and Acquisition

A successful merger and acquisition can be measured against two major factors:

• Shareholders value increase. A sustainable increase in shareholders value should be achieved over time.
• Synergies materialized. The achievement of expected synergies such as more efficient operations, increased profitability and an increase in market share.

Improving the Odds of a Successful Merger and Acquisition

Companies can increase their chances of successful mergers and acquisitions by proper planning, by working within a pre-defined methodology and by managing the whole merger and acquisition as a project. Specific detail that need to be managed properly include the following:

• Strategy. Mergers and acquisitions form part of the broader company strategy and it should be thoroughly thought-through and planned.
• Due diligence. Risks (e.g. legal, business, financial and operational) are analysed in a due diligence process. This process should be carefully planned and executed.
• Synergies. The planned synergies should be spelled-out and attention must be given to its achievement.
• Costs. Expenses can easily skyrocket during the merger and acquisition process. Expenses must be budgeted for and then be monitored.
• Expectations. False expectations by various groupings often lead to disillusionment. All expectations should be discussed and clarified with all relevant parties.
• Transparency. Proper communications and openness (where relevant) with employees, customers, suppliers and other business partners are advisable. Rumors (quite often unsubstantiated) that are not quickly nipped in the bud can cause a lot of damage to morale and role-players can look for alternative opportunities.
• Systems. The merging of systems (especially IT) should be planned and executed with utmost care or it can cause the downfall of the new merged entity.
• Keep interest. Top management commitment is essential. Their involvement (when required) can substantially enhance the chances of success.
• Keep eye on ball. A merger and acquisition is a means to an end. Companies often fail to see it in perspective and other critical aspects of the business are then neglected.
• Change management. The success of any merger and acquisition is quite often dependent on the successful merger of two different business cultures. In addition to this people often have resistance to chance and experience some form of trauma in the process. Professional change management can make the difference between a highly successful merger and acquisition or the failure thereof.
• Trusted advisers. Mergers and acquisitions are often a once-off experience for many companies. In this situation, as well as where companies do not have sufficient and qualified people to handle all aspects of a merger and acquisition, they should hire competent outside advisers. These advisers can include attorneys, auditors, business consultants and change management facilitators.

Summary A merger and acquisition is normally one of the most important strategies that a company will embark on. Unfortunately many mergers and acquisitions are failures (or at least in some aspect). One of the best ways to increase the chances of success is to plan properly for a merger and acquisition and to see it as a project and manage it in such a way. A merger and acquisition typically has all the important characteristics of a project – it is multidisciplinary, has specific objectives, is once-off and has time and budget constraints.

Have you discovered that achieving cost related synergies in mergers and acquisitions (M&A) is like looking for the Lost Dutchman’s gold mine? Most companies looking for them never realize their sought-after treasure:

• 39% of companies entering into merger and acquisition activity indicate at the outset that they are attempting to reduce the combined direct operating costs through the merger of the two companies. Of that 39%, only 35% of them achieve their goal.
• 9% of companies entering into merger and acquisition activities indicate at the outset that they are attempting to reduce indirect and overhead costs for the combined enterprise. Of that 9%, only 39% achieve their goal.

However, the fact that most fail doesn’t mean the task is impossible; it means the task is difficult, and most are not adequately prepared.

Today’s companies have the greatest opportunity in history to achieve cost-related synergies. The advents of computers, telecommunications, and the Internet have made businesses incredibly transparent. Three of the most discretely quantifiable and controllable cost synergy elements in today’s companies are:

• Moving to a shared service model and reducing staffing redundancies. This is especially true in areas such as Human Resources, Finance, Customer Service, and Information Technology
• Achieving procurement leverage through greater volume in purchases and consolidation of suppliers to produce discounts, lowering material costs
• Rationalization of facilities and capital equipment following the closing of the deal. This boosts the utilization of fewer resources, and eliminating those which are less capable and/or less well suited to the long term strategy of the company

These, and many more areas of opportunity, should be clearly identified and evaluated during the Due Diligence phase of the M&A process. If there are so many clear opportunities for today’s companies to achieve cost-related synergies when they merge or do an acquisition, why do so few of them materialize? Successful C-level executives from some of the biggest companies in the world, with extensive backgrounds in M&A activity, cite these reasons:

• 1. Lack of clarity around the reasons for the merger or acquisition
  2. Lack of effective metrics for the success of M&A transactions
  3. Poor governance; a general lack of accountability among executives over three to five years following the transaction
  4. Insufficient time and attention to detail in due diligence and integration
  5. The dynamics of the business environment; some business strategies simply don’t hold up over time.

In order to capture the expected cost-related synergies in merging companies (whether the merging results from company mergers or company acquisition), management must do these things:

1. Address all thee areas of the business – leadership, processes and systems. Failing to address leadership aspects such as organization structure, performance measures, and alignment of goals can be deadly. Equally debilitating to profitability is failing to understand the fundamental business processes of the companies involved. Without that insight, consolidation efforts don’t yield expected results. In addition, companies who do not focus on getting commonality in their data and information systems find that things like consolidating purchases are far more challenging than expected.
2. Move as quickly as possible toward commonality between the companies involved. Those who are most successful in M&A are those who bring acquired businesses quickly and effectively onto a common platform of fundamental business processes and information systems. Use that action to retain and more fully utilize the most capable processes. At the same time, use the broader information and skills of the combined enterprise to seize additional opportunities without growing infrastructure. When you fail to do so, it allows acquired business units to remain more autonomous for longer, stretching out the time to break-even from their M&A transactions. It will take your company longer to do everything from closing the financial books to redistributing work among business units.
3. Be willing to make the tough calls - especially related to leadership, staffing, and facilities consolidations. The inability of management to make tough calls on consolidation was reported to be “significant-to-severe” by more than 75% of senior M&A managers. Another “top five” response was management hubris / unwillingness to recognize problems. C-level M&A executive interviews also show that “double-boxing” (the practice of putting two people in a single “box” on the organization chart) following M&A transactions is disastrous. It is important to understand which executives will be in leadership positions following the transaction. Do not take the path of least resistance in these situations in order to avoid offending someone.
4. Communicate! One C-level executive I interviewed recently said: “You can’t over-communicate.” Effective communication stems the flow of rumors. It gets a consistent message out to the troops. It keeps everyone focused on the appropriate sources of information. It reinforces the newly merged management structure, and eases the concerns of all stakeholders – from the management team to customers and shareholders. It also helps to reduce the attrition rates among key management and staff members. Another executive said: “We always had a motto that went: ‘8 times, 8 ways.’ We felt that a message wasn’t communicated effectively unless the employees heard it eight different times through eight different channels.” Those channels included e-Mail, direct one-on-one communications, newsletters, press releases, and so on. Topics surrounding cost reduction, such as the consolidation of facilities, staff reductions, and reorganizations always bring about an extraordinary of unrest and uncertainty. The work force and the customer base are both affected. Quelling rumors and getting everyone on the same page requires continuous, accurate communications
5. Plan the integration activity in detail ahead of the announcement. Then execute the plan. The level of detail in planning around integration activity is rarely adequate in M&A transactions. Companies fail to delve deeply enough into the business processes and supporting information systems of targeted acquisitions. They never really understand how to align them. If your company follows that path, the integration team will encounter nasty surprises. Those surprises will occur when the time comes to share information and move into shared service operations to reduce overhead costs. When the announcement is made, companies should already understand four things: 1) Their business strategies, 2) the initiatives that will be implemented to achieve combined financial operating targets, 3) the specific actions that will be taken at what times, and 4) which executives are accountable for the completion of each of these actions.

Capturing cost related synergies in M&A transactions isn’t rocket science, but it is hard work. It involves paying close attention to detail in processes and systems. It entails making tough consolidation related calls. It requires resolute leadership to adherence to company-wide process and system standards. M&A management, like any other form of leadership, is not for the faint of heart. However, the benefits of getting it right are enormous.