Chapter 8: Making Acquisitions

Overview

Modern business leaders are optimistic about strategic acquisitions, but their optimism seemingly is not rooted in reality. Depending on whose research is cited, 50 to 80 percent of acquisitions never deliver the anticipated benefits. Michael Porter’s study of 33 large U.S. corporations between 1950 and 1986 indicated that those companies eventually divested more than half of their acquisitions in new industries and more than 60 percent of their acquisition in entirely new fields.^[1] Research by Mercer Management Consulting revealed that most deals fail to deliver shareholder value greater than average industry performance: Between 1987 and 1991 only 43 percent outperformed the industry average for total shareholder return. That figure rose only to 48 percent during the boom years 1992 through 1997. When broader criteria are applied, such as the attainment of financial, strategic, and operational synergies, failure rates are estimated to exceed 80 percent.^[2]

Some of the biggest deals have produced the worst outcomes, with the AOL–Time Warner merger being a recent example. In most cases the real beneficiaries appear to be the investment banks, which earn big fees for arranging these marriages and harvest still more fees for breaking up the ill-suited partners.

Acquisitions are driven by many legitimate business purposes: to achieve profit growth, achieve advantages of scope or scale, acquire complementary skills or resources, enter a new market, or capture an important technology, distribution arrangement, or competency. However, they often fail to deliver the promised gains. Could these disappointing results be due to faulty pre-deal due diligence? Due diligence mostly concentrates on measurable “things” such as the valuation of inventory and contracts, financing options, balance sheet impacts, existing labor agreements, supplier contracts, and product and distribution issues. If due diligence is at fault, perhaps that is because it fails to account for the human capital of the acquired entity. Traditional financial valuation methods fall short in this regard. The human capital of the acquisition target seldom is evaluated or addressed until after the deal is closed.

Reasons for the failure rates also are found after the deal, when problems of integration first appear. In fact, the most frequently cited reason for the lack of success is failure to integrate. By integration we mean the harmonization of structures and processes and the alignment of two organizations with common goals.

A survey of financial executives—individuals who have a great deal to say about acquisitions—indicates that almost half of all chief financial officers (CFOs) view human capital as at best only moderately important in acquisition pricing (Figure 8-1). Perhaps this reflects the fact that the motivations for acquisitions usually center on gaining economies of scale, dominating markets, or filling a gap in a product line. When financial executives look ahead, however, they report that human capital will become increasingly important in acquisitions. Perhaps the rationale for acquisitions is changing. Perhaps human capital will become the reason for future acquisitions as pursuits of scale and the like take on a less central role.

Figure 8-1: How Financial Executives Rate Human Capitol in Acquisition Pricing, Source: Human Capital Management: The CFO’s Perspective (Boston: CFO Publishing Corporation, 2003), 29.

In light of the superficial attention paid to human assets, is it any wonder that so many costly and organization-wrenching deals produce disappointing results? Acquirers would get better results if they paid serious attention to the human capital of target companies, its value, and its potential for integration. That attention should be given before a deal is made and again as soon as the deal closes and integration looms.

^[1]Michael E. Porter, “From Competitive Advantage to Corporate Strategy,” in Cynthia A. Montgomery and Michael E. Porter, editors, Strategy. Boston, MA: Harvard Business School Press, 1991), 226.

^[2]M. L. Marks and P. H. Mirvis, “Managing mergers, acquisitions, alliances: Creating an effective transition structure,” Organizational Dynamics, no. 28, 2000, 35–47.