What Are You Really Acquiring?

Let's start using "big crayons" to simplify our understanding of why M&A transactions go wrong.  Did we know what we were really acquiring?

Success is a complex equation. Failure is not.  We're going to need high management retention, high customer retention, good cultural fit, perfect market timing, the right speed of assimilation, and of course it all comes down to the softest of them all, execution.  Any of these alone could spell disaster.

Many say valuation can overcome most pitfalls of acquisitions: "Hey, even if we don't realize half of the forecasts we are putting on the table, the deal still makes sense."   Others cite the benefits of autonomy.  Cisco excels at bringing newly acquired businesses into its empire by doing just enough to foster the new asset.  The aim is to avoid  compromising the business model that made the target so attractive.
On Businessweek.com, Mark Johnson captures this dynamic nicely, recommending that business executives go deeper into their business model planning.
How to Succeed at M&A - Bloomberg Businessweek Strategy & Innovation Blog

All too often, mergers and acquisitions fail dismally. That, says Innosight's Mark Johnson, is because executives don't understand what they're really buying....When one company buys another, what it's really purchasing is the target company's business model—its customer value proposition, its profit formula, its resources, and its processes.   - Mark Johnson, BBW

His big crayons draw out two paths to success:
(1) "Leave it alone" and augment the target's business model
(2) "Extract" the value that propels the acquirer's business model. 

I believe that leadership is essential to success in either case.  This is because it is necessary to overcome the resistance of the acquiring company.  By clearly setting the parameters for success along this dichotomy, the business champion sets the stage for realizing value.

Planning in the "leave it alone" case will focus attention at the senior and mid-manager level on acknowledging that there is value separate and distinct from the acquiror.  The front line employees must be motivated to find innovative ways to contribute to the new entity's success.  Johnson describes this as a push rather than pull model.

"Best Buy's Brad Anderson expressed this idea succinctly when, referring to the Geek Squad deal, he said, 'Geek Squad bought Best Buy, not the other way around.'  Anderson knew that the new model would produce growth and transformation for the company, but he also knew that the low-margin, high-volume, retail mentality of Best Buy could easily suffocate the high-touch, high-margin service orientation of Geek Squad. He let Geek Squad pull from Best Buy what it needed to thrive. At the time of acquisition, Geek Squad had 60 employees and was booking $3 million in annual revenue. Today, working out of 700 Best Buy locations across North America, Geek Squad's 12,000 service agents clock nearly $1 billion in services and return some $280 million to the retailer's bottom line." - Mark Johnson, BBW

Facing an "extraction" scenario, leaders must be decisive with their planning.  What is and what isn't valuable are the key questions.  This requires as much understanding of the acquiring company's core capabilities as it does the target's.  Further, how do you measure success?  Without clear guidelines that are pushed down into the implementation phase, the target's value will disintegrate rather than grow. Valuation is probably most important in this scenario.  There may be no salvage value in the operation if the target's business model is picked apart.

Shell bets on ethanol in $21 billion deal with Brazil's Cosan

http://www.reuters.com/article/idUSTRE6101TW20100201

Reuter's shares a good overview of the magnitude of the ethanol (sugar biofuels) industry in this article. Through a joint venture, Shell is leveraging its downstream capabilities of gas stations and jet fuel distribution. Their partner, Cosan, is publicly traded on the NYSE and is the worlds largest ethanol & sugar company.

While industry critics cite the increasing price of sugar as a resistance to ethanol's growth as a major fuel source, Shell is showing a huge commitment with this deal. The JV includes a call option at year 10!

For M&A in Brazil, especially private equity players, consolidation and the growing involvement of major players is a positive trend. Perhaps as these companies compete, they will divest non-core businesses (such as Cosan's port operation). Increased professional management and decreased family ownership is also encouraging.

Using Ethnography to make Smarter Investments

How might ethnography be used in making investments? According to some excellent insights from consultants at Jigsaw Research in London, more and more businesses are using social science methods to drive business innovation and learning. Does it translate into a transactional setting? Rest assured, when allocating large amount of capital to invest in a business, professionals will covet any tool that can sharpen their understanding of value.

Ethnography takes a holistic approach to examining a phenomenon, particularly a culture. Anthropologists approach their subjects with broad objectives. They iterate on models and refine them as they go. This parallels the due diligence process in investing. In due diligence, the wider the scope, the better; the more in-depth, the more likely you are to uncover something that might just cost you millions down the line.

Investing in corporations is effectively betting on the future cash flows that the employees can drive from the assets of the business. In many ways it is actually the culture that you are purchasing. Without understanding the flow of value that comes from power centers within the culture, buyers are at a huge disadvantage. As such, they may be misled their findings during due diligence.

Standard due diligence in M&A is extremely direct and focused, perhaps too so. Potential buyers take information that is available (management reports, public information, contracts, purchased background searches on execs). They talk to the people who are made available (top managers, reference customers). They go on site, collecting more financial, tax, and contractual information.

If they’re lucky during due diligence, buyers will get a brief glimpse using the holistic lens of the ethnographers in a couple of instances. They’ll walk through the production or distribution facility. Also, in the group interviews they may be fortunate enough to gain a window into the relationships upon which so much of business is based.

To mitigate the impact of the culture on a particular investment however, there are several certainties to fall back on. For the most part, the financial reports will preserve a reality of history. Does the historical context of those results promise to be reasonably consistent with the future results of the business? Triangulation from industry sources, customers, plus sales & marketing teams offers a competitive context for future success, too. Lastly, when in doubt, go with certainty: well written, long-term contracts will make almost any business intrinsically valuable.