Delivering on the Promise: 10 Merger Imperatives by Gerald Adolph, J. Neely, and Karla Elrod

very merger is a big and bold promise. The architects of the merger implicitly declare to the management, employees, shareholders, customers, and business partners that — on the other side of the often challenging, lengthy, and upsetting process of integrating two companies — the combined company will be greater than the sum of its two parts. This result will be worth the sweat and tears it will take to create. Too often, of course, such a promise goes unfulfilled. As Booz Allen Hamilton found in a study of mergers that took place in 1997 and 1998, 53 percent failed to deliver the intended result. Merging two organizations is a mammoth undertaking; managers are inundated with competing priorities and demands, and ample opportunities to go astray present themselves. But even if many mergers have failed in the past, that doesn’t mean yours must. For there is a flip side to that 53 percent failure rate: Almost half of all mergers do succeed. And as the introduction to this book suggests, there is reason to believe that the success rate has increased since the end of the Nasdaq bubble, when speculative frenzy encouraged hasty and ill-conceived mergers. Sure, the AOL and Time Warner merger was a very visible megabust, but many mergers have exceeded expectations. R.J. Reynolds Tobacco Company’s acquisition of the Brown & Williamson Tobacco Corporation has proved a great success, illustrating the new trend of using mergers to reinforce brand coherence. In general, if a transaction is well conceived, then expectations of success are reasonable. Executives should not run scared from the odds of success. Rather, they should see M&A as an opportunity to build their business and distance themselves from competitors who cannot execute as well. How exactly can a management team deliver on the promise? There is no uni-

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versal formula. Every company’s circumstances are different. For example, experience suggests that companies that have paid large premiums should approach merger integration very aggressively. To recover their investment, they need to target early wins and exploit synergies immediately. A hostile takeover, conversely, requires a strategy that focuses on identifying and nurturing capable people. Companies in a takeover need to retain key talent and ensure knowledge capture. Or to take a third case: A high-profile deal with some market skepticism requires the CEO to play a visible role in the integration effort. Planning a merger is the easy part; almost all the risk of failure lies in the implementation. Indeed, of the mergers that failed in our study, more than two-thirds of the failures could be attributed to execution. Management simply didn’t deliver. There is, of course, no one-size-fits-all approach, but Booz Allen has identified 10 critical items, or imperatives, that can help executives keep their M&A on track. These imperatives cover everything from setting the right direction for the merger to successful execution. The first tasks are setting strategic intent, building stakeholder enthusiasm, and gaining internal understanding. The other seven imperatives are associated more with plotting and organizing the execution: forming “one company,” capturing value, energizing the team, stabilizing operations, closing the deal, facing moments of truth, and identifying integration leadership and line management. These 10 imperatives tend to operate in parallel; executives will find themselves juggling most of them at the same time. They cannot simply be checked off the list one at a time, as if at some point in the process you can completely stop worrying about stable operations, or value capture, or stakeholder enthusiasm. This juggling act — and think knives, not merely oranges — is a serious challenge, to be sure, but it is the best way to deliver on the promise of a merger. Stepping Onstage 1. Setting Strategic Intent. The strategic intent of a transaction, when articulated and

fully understood, determines the overall approach to integration. It spells out the rationale for the merger and the goals for the merged company. Is the merger part of a push toward industry consolidation? Is it a vertical integration or an entrée into an adjacent market? Does the acquiring company want to transform the entire organization, absorb the merger partner, or simply attach it and allow it to function independently? Once these questions have been answered — once you have successfully made your case for change — you can translate the strategic logic behind your merger into guiding principles for the merger itself, which will clarify planning objectives and assumptions. Articulating strategic intent allows the organization as a whole to see strategy+business Reader

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the immediate priorities in integrating systems, people, and processes, and it gives the leadership team marching orders. This process must include managers from both companies, not just the acquirer. The merger will not succeed unless both sides understand and support the vision of the merged company. The purchase by R.J. Reynolds (RJR) of Brown & Williamson (B&W) in 2004 for $2.6 billion is an excellent instance of a clearly articulated strategic intent yielding a smooth, successful acquisition. Following a restructuring effort that took $1 billion of costs out of its operations, RJR’s acquisition of B&W offered $600 million in synergies and the ability to refocus its product portfolio resources on key brands with growth potential — specifically, Camel and Kool. The company made intensive efforts during this process to communicate the intent, and the possible combined value, to those who would become employees from both organizations. When joined together, the two components — RJR, the second-largest U.S. tobacco company, and B&W, the third-largest — became Reynolds American Inc. (RAI), a much more potent challenger to Altria Group Inc.’s Philip Morris USA division. Since the merger, the company has systematically captured best practices across functions, including approaches to managing retail, proprietary methods for collecting consumer information, and general and administrative cost management. In February 2006, RAI’s stock hit $105, up from $30 two years before, shortly before the merger. 2. Building Stakeholder Enthusiasm. In the wake of a merger announcement, it’s easy to become consumed by the tumult within the organization, but managers cannot neglect any of the company’s stakeholders. They must rally the enthusiasm of the two companies’ internal stakeholders, as well as the future company’s shareholders, customers, suppliers, and regulators. Multiple decisions must be made about what to say, when to say it, and to whom. These decisions must be made quickly and clearly as part of an overall communications strategy to build stakeholder enthusiasm. Part of that strategy must include assuaging stakeholder concerns, both about the short-term impact of the merger — a dip in share price might be countered with estimates about earnings a year hence — and about the long-term implications for a jittery business partner, who might fear a rise in prices. This process will be made all the easier if the strategic intent has been clearly articulated. Thinking you can rely only on official press releases and bulletins to tell your story to the outside is a surefire mistake. Stakeholders will scrutinize everything you say and, just as certainly, everything you do. Service disruptions and price increases send a clearer message to customers and regulators than the best and most expensive PR campaign. Focus first on those stakeholders, particularly customers, who are critical to success and whom you are most at risk of losing. Reach out to them directly and individually. For those stakeholders who stand to benefit, regularly demonstrate 32

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progress; for those who will be negatively affected by the merger, mitigate fears by using both advocacy (explaining the purpose for the merger and its benefits for them) and inquiry (learning more fully about their concerns and the reasons the merger has triggered resistance). You may discover, through these conversations, that the opponents of the merger are concerned about only one small detail (that you can fix) or that they have valuable information about problems that must be dealt with for the implementation to succeed. You needn’t wait until the merger is a fait accompli before beginning your communication campaign. We spoke to the CEO of an Australia-based building products company who began laying the merger groundwork among stakeholders long before he had even identified a merger partner. As he pursued discussions with potential targets, he was simultaneously educating his board and shareholders on the forces pushing the company to seek a merger. The CEO correctly saw this exercise as “earning the right to do a deal.” 3. Gaining Internal Understanding. After everyone understands the strategic intent of a merger, but before the two organizations can actually get down to the nitty-gritty of integration, a firm internal understanding of what each side brings to the table is needed. This analysis should be as granular as possible, pulling together historical budgets, organization charts, compensation and benefits data, and IT systems. The merger planning groups must determine which processes the two companies actually have in common and which differ before they can design the integration of people and assets. Internal understanding also calls for leaders to think through fundamental business model differences. For instance, when U.S.-based Bunge Ltd., an agribusiness company, bought its French competitor Cereol in 2002, it had to reconcile two very different business strategies that might not have been immediately apparent. Both companies dealt in soybeans, oilseeds, and other grains to make margarine, flour, cooking oils, and animal feed, but one focused on making money through the trading of these commodities, while the other’s business model relied on production of commodities. A clear-eyed understanding of this difference and its implication for the integration allowed the two managements to recognize the difference, to treat the different legacy brands differently at first, and to fold their operations together coherently and efficiently. Balance and Rhythm 4. Forming “One Company.” The one-company imperative involves the real heavy

lifting of the integration. Whereas the first three of our critical imperatives were generally involved in setting the right direction for the merger and putting it on solid strategy+business Reader

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footing, the one-company imperative lies in the realm of design and execution. The challenge of creating one company from two formerly independent, and often competing, organizations is a daunting task. To pull it off and deliver on the merger’s promise, you must keep up the momentum and begin actually implementing the changes deemed necessary through the internal understanding imperative. The one-company imperative is where the philosophy of the new company begins to take shape. Necessary changes involve the organization, systems and processes, and business management of both cultures. This is when management decides how many people the merged company actually needs, what physical locations need to be eliminated, which business partners will be kept, and which systems can be combined. Leadership itself must be melded, incentive structures combined, and cultures harmonized, perhaps balancing entrepreneurial zeal with structure and control. 5. Capturing Value. There will be enormous pressure to demonstrate clear progress during the first year or two of the merger. The key here is to set a time line for the right mix of short- and long-term synergies: fast and fierce enough to keep the faith of external stakeholders by continually demonstrating value capture in line with the previously articulated strategic intent, but not so aggressive that you sap the new organization of morale, talent, and energy, which would sabotage the merger. Typically, you have six to 12 months to start delivering short-term results to your stakeholders in the most obvious areas, such as savings from eliminating redundancies. When Caremark Rx announced in 2003 that it would purchase Advance PCS for about $5.6 billion in stock and cash, it predicted savings of $125 million in the first year of the merger. As far as short-term value-capture promises go, that was a pretty big one — and pulling it off was trickier than it first looked because the two companies had subtle but significant differences in their business models. Caremark managed pharmacy plans aimed directly at employers, whereas Advance PCS managed pharmacy plans for the health plans themselves. The success of the merger hinged on management’s ability to realize cost savings from two businesses that seemed to be serving the same customer, but actually weren’t. So where exactly does the transition team start looking for these short- and long-term synergies? Start with the facts: Create solid evidence based on the internal understanding described in imperative 3. This will allow comparisons of the two organizations, and will reveal the ways in which they can best complement each other. Once questions have been answered — such as what synergies should be tackled, who in the organization will be responsible for tackling them, what they will cost to implement, and what the P&L impact will be — the next step is creating an infrastructure to capture that synergy. This might mean designing a new organiza34

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tion chart for the merged IT department or human resources team. This kind of redundancy-based synergy is important and may dominate the early stages of value capture. But don’t forget, this is the obvious low-hanging fruit. If you are going to continually deliver on the merger’s promise and truly unlock the new company’s potential, you must push transition teams to look for creative ways to improve the way business is done. If the one-company imperative elucidates the new company’s philosophy, the value capture imperative is the nuts and bolts, involving the mechanics of folding together infrastructure and processes. 6. Energizing the Team. The greatest integration challenge you may face will be building an energized and enthusiastic team that draws from the best of both organizations. (The choice of team members, of course, will be based on a firm internal understanding of what the two sides offer.) Without such a team, you have zero chance of delivering on the merger’s promise. Value capture will be unattainable. The immediate problem, however, is that after the merger has been announced, employees at all levels and at both companies will be consumed with questions and anxieties about their individual futures. “What are my career prospects? What are the financial upsides?” In short, “What’s in it for me?” To expect people to react differently is unrealistic. It’s a problem that must be faced head-on because until you’ve allayed their concerns, they will not buy into your vision of the new company. True buy-in occurs only when employees understand clearly what they are being asked to do and what their opportunities are if they choose to stay. Buy-in is a cascading process, so the selection of the senior leadership team is an all-important step in creating a line of command and communication. Do not underestimate the power of the daily dialogue between supervisors and employees. Not only are these relationships an avenue through which to build enthusiasm and excitement, they are also a critical way to defuse the kind of rumor and gossip that can paralyze a work force. If employees must constantly read the tea leaves to divine truths about the company’s future that they believe their supervisors are unwilling to state openly, they will become very anxious. We’ve seen situations in which the casual assigning of office space brings entire departments to a halt. 7. Stabilizing Operations. In the midst of merger-related pressures, distractions, and conflicts, it’s easy to lose sight of your primary responsibility: keeping the wheels on the wagon. After all, there’s not just one company still to run. There are actually two, and if their operations grind to a halt during integration the future of the merger is bleak indeed. Head off the problem by asking two basic questions: Where are the risks to continued business stability? And what can we do to address these risks — at least on a contingency basis? strategy+business Reader

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Quest Diagnostics wrestled with these questions as it worked to integrate a series of small acquisitions. Each deal involved a complex, time-sensitive network of laboratories, couriers, and doctors that would quickly disintegrate and disperse to competitors if they did not continue to operate smoothly. Quest met that challenge and kept all those individual networks running while it worked through its integration. When considering how to maintain stable operations, you must focus on three primary areas: internal business processes, organizational control, and problem resolution. The key is to establish stable interim processes and controls, as well as mechanisms for resolving problems, so no debilitating interruptions in service or staff defections occur. Integration decisions may take some time, but issues such as delegation of authority, payroll, workload conflicts, and pricing must be resolved immediately — if only temporarily — for the organization to function. There might be a merger going on, but everybody still needs to know who their boss is. Especially in the first crucial weeks of a merger, you need an “early sensing” ability that sniffs out problems before they grow intractable. Are the products getting placed on the shelves? Is the sales force covering all the stores? Is the parking lot half empty? Identify key metrics that provide a “canary in the coal mine,” and unrelentingly monitor and report progress on these. We’re familiar with one CEO — the head of an Australian conglomerate with extensive M&A experience — who appoints “risk management czars” to identify and address threats to business stability. These czars are independent of the business units and report directly to him. 8. Closing the Deal. The last mile of the merger-negotiation marathon is exhausting and fraught with minutiae, legalities, and hard, sometimes emotional decisions. Yet closing the deal as quickly as possible is critical. A long, drawn-out process can sap the strength of employees, disrupt current operations, and, of course, delay management’s ability to deliver on its promise. Key to closing the deal will be gauging when and in what sequence — or even whether — some questions are answered. Although many of these last-minute details will be technical, don’t be surprised by human foibles. We’re familiar with one highly visible merger that was unexpectedly thrown into doubt because the seller’s CEO was suddenly worried that any layoffs might jeopardize a hoped-for political appointment. Three common areas can delay a merger: unfinished business such as securing merger financing, shareholder approval, and investor filings and notifications; regulatory clearances and processes; and unfinished integration planning. The key is to keep people focused on financing, filings, and regulatory details. Of course, the initial memorandum of understanding will set the broad param36

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eters of the merger, but be aware that there is often plenty of room for last-minute maneuvering. Different companies approach these negotiations in various ways, depending on their unique set of regulatory, competitive, and merger-specific issues. 9. Facing Moments of Truth. For a merger to succeed, it’s critical to recognize those big decisions that lie ahead for the new company, which will help determine the organization’s strategic course and its implementation effectiveness after the merger or acquisition. All the planning in the world doesn’t actually make a difference until you can actually make these tough choices. We call these decisions “moments of truth.” Oftentimes, these decisions involve very emotional issues, such as the location of a new headquarters or which factories will be closed or which corporate name will be retained. We have found that the strategic intent of a merger frequently provides a pretty clear answer for these decisions, but one that is unpalatable to some stakeholders. One company shut down and resurrected a particular plant three times before finally killing it off for good. It was a frustrating process that wasted time, diverted attention, and sapped the strength of executives. No matter what the decision, these moments of truth require senior managers to rise above the biases that run counter to the strategic intent of the merger. When senior managers confront these moments of truth, they must manage them in a way that lives the strategy. It’s remarkable how difficult it is for some to see bias. One company, although it had historically been focused on cost containment, decided to acquire a highgrowth company to accelerate revenue growth. Fair enough. But management couldn’t rise above its cost containment focus; it applied those sensibilities to the new company. You can probably guess the result. Existing employees of the acquired company got the message and started jumping ship; before long manufacturing had taken a 40 percent nosedive. 10. Identifying Integration Leadership and Line Management. No integration will work unless the right transition teams are in place and the right leaders are placed at the helm of each team. The nature of the transition teams’ processes and operations depends on the nature of the merger and the organization’s culture; a centralized culture, for instance, will give its transition teams very different decision rights than its decentralized counterpart would. But most integration efforts have the same assortment of teams: design or value creation teams, task teams, and transaction teams (as well as a dedicated team to ensure that the businesses keep running). Value creation teams focus on the future organization and how to transition from the current state. Task teams, by contrast, are almost solely focused on the execution of integration. The transaction team, meanwhile, focuses on closing the deal. These are demanding posts, and you’ll want your best people in place. But there strategy+business Reader

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needs to be a trade-off between integration duties and normal day-to-day responsibilities. We’ve seen high performers given significant integration duties while being expected to continue their normal line responsibilities. The results are usually the same: physical and mental exhaustion leading to compromised performance. Don’t burn out your best performers. As the progress of these teams is tracked, eventually you’ll face a tough and critical decision: When to let day-to-day line management take over operations from the transition teams. If you try to hand line management the reins too early, the business won’t function — but if you wait too long, the line managers might not buy into the new enterprise. Pulling It All Together

Merger integration is not easy, and in many cases can seem a hopelessly complex task. But we believe the 10 critical imperatives discussed here show that the process can be broken down into bite-sized components and managed. Half of all mergers may fail, at least so says current conventional wisdom, but that does not mean that yours must. As we argued at the start of this chapter, an ability to execute difficult mergers can effectively differentiate your company from competitors and win customers, talent, and shareholders. You can deliver on the promise of a merger — and perhaps even exceed it. +

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Booz Allen Hamilton’s Work in Mergers and Restructurings

With substantial experience in transactions of all sizes, including those of many household-name organizations, Booz Allen Hamilton provides merger and restructuring services to companies across a broad range of industries. In the past few years, the firm has supported hundreds of acquisitions and restructurings. Our premerger, post-merger, and restructuring services are built on the combined skills and intellectual capital of Booz Allen’s more than 17,000 employees on six continents. In mergers and restructurings, the firm’s work falls into seven broad categories. Service Areas

• Pre-agreement: Develop the strategic rationale for a deal as well as candidate screening, negotiation, due diligence, business case development, regulatory approval, and other support. • Post-agreement merger integration planning and implementation: Capture post-deal value through integration planning, deal approval and integration execution, benchmarking, and other efforts. • Restructuring and turnarounds: Assist underperforming companies, including stabilization of financial and operating performance. • Joint ventures and alliances: Develop strategic rationale for an alliance, defining screening criteria and governance architecture. • Divestitures and spinouts: Capture post-divestiture value, including the identification of objectives and market dynamics. • Corporate venturing: Advise and set up an organizational and governance structure between companies including technical/management capabilities. • Privatizations and buyouts: Support one-time corporate finance events including leveraged and management buyouts, IPOs, and privatizations. strategy+business Reader

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To learn more about the firm, visit Booz Allen’s Web site at www.boozallen.com, and for more information about the Mergers and Restructuring team, visit www.boozallen.com /mergers or send an e-mail to [email protected]. To learn more about the best ideas in business, visit www.strategy-business.com, the Web site for strategy+business, a quarterly journal sponsored by Booz Allen.

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