Although the credit crunch has, for the time being, slowed the frenzied pace of merger and acquisition activity, there are still some very interesting deals going on that tell us a lot about why firms choose to acquire some businesses and sell off others.
Co-op, Northenden Road, Sale
For example, the Co-op has just bought Somerfield for £1.5bn, giving them a combined share of about 8% of the grocery market in the UK, still far behind the “big four” of Tesco, Asda, Sainsbury and Morrisons, but now a long way ahead of the next biggest, Waitrose. At the same time, the Spanish bank Santander agreed to buy the Alliance and Leicester for about £1.2bn. By contrast, the Economist newspaper recently reported that sell-offs have been growing steadily to over 12,000 globally last year, citing examples such as General Electric (GE) selling off its home appliances division and the Royal Bank of Scotland trying to find a buyer for its insurance business. Why do firms do this? Just the management time and legal costs are huge, so what advantages do they seek when, as academics refer to it, they adjust their portfolio?
Well, it’s a long and complicated story and much of this activity destroys rather than creates shareholder value, but research in this area points to some key lessons both about the motives for merger and acquisition activity and what makes some work and some fail.
Firstly, firms buy other firms for one of two main reasons. Either they are trying to be more competitive in their existing market or they are trying to enter (or leave) a market. The Co-Op/Somerfield deal is an example of the former as they hope that the new, enlarged, Co-Op will have more economies of scale than the two separate firms. That’s an important consideration in a market where size matters and you are competing with much larger and stronger players like Tesco. As an example of the latter reason, behind the GE disposal lies their analysis that they can make more money investing in their other businesses (such as medical technology or jet engines) than they can with relatively low-margin washing machines and the like. With shareholders breathing down their neck, getting the best return on investment is top priority for conglomerates like GE.
So, whatever the reason behind a merger, acquisition or disposal, what is it that makes some work and others fail? A little while ago, I was asked to research this in the specific context of the medical technology sector and spent several months interviewing CEOs who had been through successful and not so successful deals. It turned out that there were lots of lessons to be learned, but none of them seemed specific to that industry. Rather they were general lessons that applied to most firms. In total, I identified 20 lessons for CEOs and the need to get so many things right helps to explain why many mergers don’t make money.
These 20 lessons were described elsewhere (see further reading), but perhaps the two key lessons were about synergy and culture. Mergers or acquisitions work best when they create synergy, so that the combined business is stronger than the parts. This is most likely to occur when the two merging firms are different and complementary rather than similar and overlapping. And to be turned into profit, synergy needs to be supported by complementary cultures. Too often, the basic values and beliefs of two sets of employees can conflict . When that happens, culture clash can reduce, rather than enhance, effectiveness.
So, what seems like a mysterious wheeling and dealing between highly paid executives (and often better paid lawyers) is in fact driven by a commercial logic. Whether trying to compete more strongly or trying to enter or leave a market, merger and acquisition activity is an important part of corporate strategy. And its only the beginning, because then the hard work of making mergers work begins. Finding synergy and managing cultures can take months and years. As if often said, mergers and acquisitions are a little like marriages: the wedding is the easy part.
- Lessons for CEOs from the consolidation of the medical device and diagnostic industries by Brian D. Smith, in International Journal of Medical Marketing. Available free as a PDF from the author: firstname.lastname@example.org
- 'Desperately seeking synergy' by M Goold and A Campbell, in Harvard Business Review
- 'Culture Couture', by Brian D Smith in Pharmaceutical Marketing. Available free as a PDF from the author: email@example.com