In a recent article for BusinessWeek, Mark Johnson discusses mergers and acquisitions and how to increase the probability of success. Johnson points out the familiar statistic that 80% of acquisitions fail to create value for the acquiring company; the reason, Johnson hypothesizes, is that firms fail to realize what they are buying. In Johnson’s words:
“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.”[i]
Johnson outlines that two types of acquisitions can occur:
1) Acquisition of resources – The acquiring firm is essentially purchasing technology, capabilities, etc., that are then integrated into the acquiring firm’s existing business model. Cisco Systems (a Walker client) is noted as following this path.
2) Acquisition of a business model – The acquiring firm is purchasing the business model of the target; in this case, the acquisition is generally kept separate from the acquiring firm. Resources (capital, for example) of the acquirer are leveraged to help jettison the growth of the purchased firm. Best Buy’s purchase of Geek Squad is given as an example.
This premise is interesting and makes sense; we would offer some additional observations to add to the analysis:
1) What about customers? Critical to understanding the aspects of the business model as addressed by Johnson (i.e., customer value proposition, profit formula, resources, processes) is how customers fit into that model. For example:
a. How loyal are the customers to the organization? We have found customer loyalty (that is, the likelihood for the customer to continue to purchase coupled with the level of commitment of the customer toward the firm) to be a strong predictor of future business success. Understanding the extent to which customers are loyal to the acquisition target is key to understanding the long-term viability of the firm’s profit model (and, therefore, the valuation of the firm at large).
b. What revenue flight risks exist within the organization? Suppose you are interested in acquiring a firm that has an excellent product; if the firm has had some service issues of late that has caused some level of degradation of customer loyalty, should you proceed with the purchase? There is no one-size-fits-all answer. For example - if the product is unique (that is, few competitive alternatives exist), customers are likely trapped in the short run, which means that the purchasing firm will likely have to invest aggressively from the onset; moreover, this approach carries risk – if a new entrant comes into the market, there could be great revenue flight. At a minimum, this could have a significant impact on the price of the acquisition.
If, on the other hand, plenty of competitive alternatives exist, it may make more sense to not complete the acquisition. Regardless of the outcome, the acquiring firm cannot make an informed decision without knowing the level of loyalty among the customer base and how the firm’s revenue aligns with the loyalty profiles.
c. How distinct are the customers relative to the acquiring firm’s customer base? Is the product or service provided by the acquired firm designed to offer new offerings to your existing customers, bring distinct (and new) customer segments to the firm, or some combination of the two? Consider the Walker Growth Matrix:
Simply put, this matrix decomposes four growth strategies into customer type and product/service offering components. This matrix can be helpful in identifying what type of growth we can expect the acquired company to provide.
Understanding this can help in the valuation of the acquisition, as it tells us how much wholly new revenue vs. incremental revenue to expect. In order to reliably estimate this, you need to understand your current customers as well as what needs (met and unmet) exist among the target firm’s customer base.
2) How complementary are the cultures? Johnson does make that case that understanding the culture is key to understanding the extent to which the two businesses can be effectively integrated – for example, an entrepreneurial culture will likely be suffocated if the acquiring firm is more structured/disciplined (the difference between being “disciplined” and “staid” is often in the eyes of the beholder).
Understanding the culture, combined with an understanding of the loyalty of the employee base of the acquired firm, will help to determine whether to fully integrate the acquired company or to keep it as a stand-alone entity. In addition, understanding the employee loyalty will also provide insight as to the likelihood that the firm will be able to continue to generate success – if the firm has been successful but the employee loyalty is low, then there is a heightened likelihood that the best days may be behind it due to the probability of post-acquisition employee defections. While that isn’t necessarily a reason to not consummate the deal, it again would likely have some influence on the tangible value of the firm. Do you see a theme emerging here?
Tying all this together, the advice we would offer on the topic of mergers and acquisitions to customer-focused firms is fairly straightforward:
1) Don’t lose your sense of self – If you are a customer-focused firm, seek to acquire like-minded companies. While it is possible to successfully acquire a firm that is not customer-focused, the effort to achieve successful integration will be immense, and failure could have adverse impact on how customer-focused your current customers perceive your organization.
2) Remember what you are buying – If the customer base of the target is a key aspect of the acquisition (and it absolutely is unless you are acquiring a specific technology that has not yet been introduced to the market), then take the time and make the necessary investment to optimally understand how loyal those customers are.
3) To integrate or not? – Examining the culture of the acquired firm (including the loyalty of its employees) can provide effective cues to whether or not an absorption acquisition model should be preferred over a stand-alone entity model.
4) Loop back after the acquisition – Regardless of which integration model you pursue, don’t forget to loop back after a reasonable period of time to see how customers and employees are feeling about the success of the acquisition. Use this information to quickly address any problem areas and to reinforce the importance that both customers and employees play in the long-term success of the firm.
Considering these aspects, in conjunction with the excellent guidance provided by Mark Johnson, will help increase your overall probability of a successful acquisition.
Mark A. Ratekin
Senior Vice President, Consulting Services & Resource Management
[i] Johnson, M. W. (2010, May 26). How to Succeed at M&A. Retrieved June 7, 2010, from Bloomberg Businessweek: http://www.businessweek.com/innovate/content/may2010/id20100525_156769.htm?link_position=link16