Merger Failures Value Destruction And How To Avoid It

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To fully understand merger failures we need to understand the motivation behind M&A activity - which is primarily about the creation of value by exploiting [what is euphemistically referred to as] synergies.


The word "synergy" entered merger vocabulary during the 1960s merger wave, and was used to describe gains from conglomerate mergers that could not be readily identified, but were presumed to be present to explain why the mergers occurred (Mueller & Sirower 2003).

If it were not for the catastrophic rate of merger failures and the destruction of shareholder value and, most importantly, the human cost, then this could be amusing. But to my mind it isn't, it is an appalling indictment of the business world and their advisors that [just as in the world of change management] 70% of all M&A activity fail to realise the intended benefits.

Technically speaking, "synergy" is defined as the increase in the merging firms’ competitive strengths and resulting cash flows beyond which the two companies are expected to accomplish independently (Seth 1990; Sirower 1997).

Bibler’s (1989) definition of synergy is expressed as 1+1=3[!]. He further proposes that the definition should be: “an acquirer’s being able to use its significant strengths to improve the performance of the acquired company, or taking one of the acquired company’s strengths to bolster a weakness of its own”.

In case you feel that I am partial in my view of all these merger failures, I cite the overwhelming evidence of academic and professional studies and reports, to take just one example: Mueller and Sirower (2003) developed a methodology that used the distribution of gains and losses across two samples of firms, and their relationship to one another to test four hypotheses about why mergers occur.

They analysed 168 mergers between large companies from 1978 to 1990 [to include an exploration of merger successes and merger failures].

Their findings reported that little or no support was found for the hypothesis that mergers create synergies or that shareholders of both the acquiring and acquired firms share gains from these synergies.

Instead, they discovered that was considerable support for the respective "managerial discretion" and "hubris" hypotheses, that suggests that mergers are “purely for growth” and at the discretion or for the hubris of top management who have vested power to decide on M&A. [No wonder the merger failures rate is so high!]

Warren Buffett on mergers...

This is what Warren Buffett had to say on the subject of merger success and merger failures [in his 1981 Berkshire Hathaway Annual Report]:

    "Many managers were apparently over-exposed in impressionable childhood years to the story in which the imprisoned, handsome prince is released from the toad’s body by a kiss from the beautiful princess. Consequently they are certain that the managerial kiss will do wonders for the profitability of the target company.

    Such optimism is essential. Absent that rosy view, why else should the shareholders of company A want to own an interest in B at a takeover cost that is two times the market price they’d pay if they made direct purchases on their own? In other words investors can always buy toads at the going price for toads.

    If investors instead bankroll princesses who wish to pay double for the right to kiss the toad, those kisses better pack some real dynamite. We’ve observed many kisses, but very few miracles.

    Nevertheless, many managerial princesses remain serenely confident about the future potency of their kisses, even after their corporate backyards are knee-deep in unresponsive toads."

KPMG Survey - mergers and value enhancment

According to a survey published by KPMG in 2008, the proportion of M&A deals that have reduced value has increased by 50 percent in the two years since their previous survey.

Take a look at their statistics of "Value Enhancement Trends" over the past 10 years:

KPMG Merger Value Enhancement Trends

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Further highlights from the KPMG survey [see link below for full report]

  • The proportion of deals that have reduced value has grown from 26 percent to 39 percent in the two years since KPMGs previous survey in 2006.
  • 80 percent of respondents believed they had exceeded post deal targets, yet deals are not delivering value.
  • Culture remains one of the top post deal challenges with companies continuing to link post deal HR challenges with cultural complexity.
  • "Once again, there is a large perception gap between what corporates think they have achieved in their deals and what has actually been delivered using shareholder value as a measure. An overwhelming 93 percent of corporates believed the deal they had executed had created value for their organization. We are surprised that this gap has not narrowed in the last 10 years in line with rising standards of corporate governance and performance management."
  • "It appears that corporates are still not making an objective assessment of their performance post deal. In such a competitive market it is crucial that corporates track post deal performance and focus on delivering more than the value premium they paid to win the deal."

Merger failures and successes and the main reasons - take a look at KPMG's latest bi-annual report entitled: "All To Play For - Striving For Post Deal Success"

Major causes of merger failure are all people related

A survey conducted by A.T. Kearney in 2004 to identify the most critical phase to merger success or merger failures, revealed that 30% of survey respondents emphasised the importance of the pre-merger phase; only 17% indicated that the middle phase presented the greatest risk of failure; while the majority of 53% stressed that the actual implementation phase – often referred to as the “post-merger integration” phase – bears the greatest risk.

Ironically - but perhaps not surprisingly, however, this post-acquisition phase is the most ignored.

    In a study of 40 British companies, Cartright and Cooper (1995) reported that all 40 conducted a detailed financial and legal audit of the company they intended to acquire, but that not even one of these same companies made any attempt to carry out an audit of the company’s human resources and culture to assess the challenges concerning integration of the organization they were acquiring.

A brief review of the business academic studies into the factors impacting merger failures reveals the following:

  • Harey and Newgarden (1969) suggested that the greatest risk of merger failure existed in the area of people issues.
  • Pritchett (1987) warned that the costs of ineffective mergers will be realized in lost talent, lost productivity, and loss of competitive position as a result of distracted employees.
  • Schorg, Raiborn and Massoud (2004) proposed that a “soft” due diligence audit focusing on human resources may also be performed to identify people who are critical to the success of the merger: those whose leaving after the combination would lower the true value of the merger.
  • Bibler (1989) suggested that loss of key people and a resultant loss of organizational effectiveness can occur in acquisitions.
  • merger failures, merger failure, mergers,how to manage change,change management,change managers,change management training

  • Buono and Bowditch (1989) addressed the hidden costs of combining organizations: tardiness; absenteeism; turnover; reduced output; and declining morale, loyalty, commitment and trust of those who remain in the post-combination firm. Other costs, not hidden, include: separation costs; replacement costs; training costs for each replacement worker; and the costs involved with a high level of turnover.
  • Hirsh (1985) estimated that the merging of two companies directly affected one-quarter to one-half of all employees in both organizations.

  • Habeck et al (2000) suggested that most employees will feel some degree of impact in the process, regardless of whether an individual is directly impacted by the merger through loss of employment.

I am indebted to Dr Dominic Fong for the above information as cited in his doctoral thesis: "The role of the psychological contract in affecting employee behaviour under the influence of merger and acquisition: a study of local regional managers in Hong Kong". Curtin University of Technology, Graduate School of Business, Curtin Business School.

Cultural conflicts at the root of failure merger failures

Continuing with Dr Fong's invaluable research, I am quoting extensively below on his research into reasons for and factors impacting merger failures.

I want to make the point and provide the academic research that supports the view that is indicated by the statistics [as illustrated in the KPMG report above].

Clearly, whilst people issues are not the only reasons for merger failures they are a significant and frequently ignored factor.

As Dr Fong says: "One critical factor that befalls a merger is cultural conflicts...."

  • Tetenhaum (1999) describe culture as the heart of a merger integration.

  • Schein (1999) also explains the resentment felt by employees of change by describing culture as stability, in which members of a group want to hold on to their cultural assumptions because culture provides meaning and makes life predictable.
  • According to Habeck, Kroger, and Tram (2000), culture creation starts with the founder or builder, and the employees and managers tend to follow the example of their current leaders. When a leadership exodus occurs upon a merger, the remaining employees feel a loss of their identity in the new organisation and feel they have been deserted when their leaders leave.
  • Weber and Camerer (2000) used laboratory experiments to explore merger failures due to conflicting organisational cultures and found that the differences in culture between merged firms (simulated in a laboratory) lead to consistent decreased performance for both groups of employees after the merger. In addition, they also found evidence of conflict arising from the differences in culture, pointing to a possible source for the high turnover rate following real mergers.
  • Previous studies have also indicated that cultural similarity (or difference) between merger partners has a direct impact on employee stress (Cartwright & Cooper 1993), organisation integration effectiveness (Weber 1996), and post-merger organisational performance (Chatterjee et al., 1992; Weber 1996).
  • When employees perceive their old organisation’s culture is similar to that of a new one or the other merger partner, they feel a “sense of continuity”(Rousseau 1998).

    Robust empirical results do support the negative effect of cultural difference perceptions on post-merger organisation identification (Logan & Mikes 2002; van Knippenberg et al., 2002), but will positively influence employees’ identification with their pre-merger organisation.

    • The attributable cause is that cultural differences between the merger partners produce more misunderstanding and conflicts between them.
    • This results in the polarization between employee groups and increases the “us against them” tendency, consequently, employees would be more likely to stick to their old social group membership.

  • Cho (2003). The post-merger operating efficiency will, hence, be in jeopardy without extra integration effort.
  • Habeck, Kroger & Tram (2000) believe that culture is as much a values driver of an organisation as its assets, products, customers, and even the individual capabilities of its people.
  • Bibler (1989) suggests that cultural incompatibility is the single largest cause of merger failures to achieve projected performance, of the departure of key executives, and of time-consuming conflicts in the consolidation of businesses.
  • According to Bibler (1989), the difficulty of blending two organisations lies in the fact that each group tends to see the world through its own biased cultural filters, which he refers to as “familiarity blindness” or “cultural trance”, and this cannot be overemphasised as a cause of merger failures.
  • Schein (1999) proposes that grief and bereavement are emotions associated with radical culture change and sees the danger of an identity crisis on the part of those being acquired, even if their jobs are not threatened.
  • Another implicit message for cultural conflicts is the impact of any leadership exodus (Habeck, Kroger & Tram 2000).
  • Bell (1988) reports that between 1982 and 1984, almost half the 150 executives in the biggest takeover targets got out within a year and most left because they did not like the way their new bosses did things.
  • Levinson (1970) believes this can result in an identification crisis for employees. He describes how management goes to great lengths to integrate people as members of the corporate family, to encourage them to identify themselves with the organisation, and to see it as their own. But when a merger takes place, the stronger the identification, the greater the possibility that employees will feel they have been deserted when their leaders leave.

Articles & Resources

  • 9 Steps to prevent merger failures

    "Execution-related failures can be avoided. To do so, you need to establish a program integration team early in the process that can respond to the execution risks inherent in all transactions."

    "We call these risks the 'nine deadly sins.' Understanding them is a critical first step toward a successful merger."

  • Mergers and corporate cultures

    "Culture clashes can be a surprisingly large stumbling block in creating profitable mergers...a recent study sponsored by the Society for Human Resource Management and conducted by Towers Perrin that was titled 'Making Mergers Work.'"

    "In the study, HR professionals listed incompatible cultures as among the biggest obstacles to success in mergers and acquisitions."

    "The companies may go in and do due diligence, look at all the financial matters, but it’s really the cultural and people issues that can mean the demise of a successful merger."

  • Mergers and culture

    "It is widely recognized that cultural differences between the partners of a merger are one of the most common reasons for failure in mergers."

    "This may happen during pre-merger negotiations or during post-merger integration. Despite all Due Diligence, the two partners of a merger fail to form a new successful unit that is able to exploit all synergies."

  • Mergers and HR issues

    "Numerous studies confirm the need for firms to systematically address a variety of human resource issues and activities in their merger and acquisition activities."

    "This article proposes a three-stage model of mergers and acquisitions that systematically identifies several human resource issues and activities. Numerous examples are offered to illustrate the issues and activities in each of the three stages."

GRAPHIC - How to Manage Change During a Merger Integration - Bain & Co

GRAPHIC - A Strategic Guide to Merger Integration - Bain & Co

REPORT - Change Management in Merger Integration - Bain & Co

A very personal perspective...

What really bothers me is the way the system currently works for remunerating all of the professional advisors who provide services to the corporate world.

These people get paid via a combination of time sheet based fees and "by results" i.e. the securing of the deal - which so often is linked to a percentage of the value of the deal, so the bigger the deal - the bigger the fee... [you can see where this is leading].

Senior executives are also remunerated via relatively short-term incentives - which of course are never, ever linked to any downside that the company may experience as a result of, and during, their "stewardship" - as we have relatively recently witnessed in the banking sector.

This, in my view, is a very unhealthy combination as it combines the short-term vested very personal interests of people who are responsible for the interests and welfare of many stakeholders, with professional advisors who have a potentially massive short-term advantage for "pushing the deal" - and absolutely no linkage with the outcome of their "professional" advice and the likelihood of taking their deal into the 70% of merger failures. To be reflective for 30 seconds: life is not actually a "a zero sum game" - we are all inter-connected...

Don't get me wrong - I like earning money - lots of it! "Greed is very good" - just as long as it works for everyone involved in the deal...

All this is very reminiscent of the "bad old days" [in the UK at least] where so called financial advisors were highly incentivised to sell inappropriate life insurance and pension schemes via heavily "front-end loaded" commission deals.

I would welcome the day when professional advisors and senior executives have a significant part of their large remuneration linked to the medium term [i.e.3-5 years] shareholder value they created - cos I somehow feel that might go a long way to redefining the whole concept of "synergy" - oh and incidentally reducing the percentage of merger failures.

Excuse the lateral thinking for a moment - but can you imagine civil engineers or construction companies or the people who build nuclear power stations - working on the same basis - where a 70% failure rate was accepted? Can you? So why on earth should the world of business be any different?

Why does this bother me? Quite simply, because of the very considerable, unnecessary, and totally avoidable human cost.

Oh, and before you ask, yes I frequently link my fees to outcomes. I like it that way - cos I get paid more!!

How to avoid these risks of merger failures...

Having established that there are so many merger failures that do not deliver the promised benefits and increases in shareholder value and explored the people and cultural aspects, what can we conclude?

    "Any proposed merger where directors have failed to identify and quantify the impact on those people most affected by it carries a high risk of failure.

    The numbers may make sense but have the political and cultural factors been assessed?"

There are several reasons why this is often not addressed: first and foremost because the focus is on getting the deal done; secondly the incentive of fat fees for the advisors, thirdly because a corporate culture is hard to see (especially if you are in it) and this is compounded by the fact that there is often more than one culture, and finally because it is hard to talk about.

And yet…. the price of failure comes extremely high!

Don't take my word for it, hear what respected Harvard professor John Kotter has to say about the impacts of change.

Strategic Planning & Cultural Analysis

I have developed a diagnostic process called EEMap©.

See here for an overview of the EEMap process

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This process allows a company to test the impact of a proposed business initiative or venture on those people most affected by it, to identify why it may fail and to establish precisely what has got to be done to make it a success.

This tool can be applied to a proposed merger as part of a HR due diligence process, to identify and assess the cultural issues that will be encountered and to thus to assist with the avoidance of merger failures.

The tool is sufficiently flexible and scalable to be adapted, modified or enhanced to meet a specific requirement.

Principal benefits are that it is low tech and simple to understand and apply, it involves staff at any or all levels and enables them to articulate difficult issues in a non-confrontational way, and it can be undertaken quickly and before large sums of money are irrevocably committed to the proposed merger.

There are three phases to the EEMap process:

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(1) Situation Analysis – that defines a cultural frame work for the company and will also identify all of the significant subcultures within the company that will assist or resist progress towards the business objectives of the proposed venture.

(2) Gap Analysis – plots the positions of key entities within the company and highlights the gaps between this and where the directors say or think the company is, and where they want to be.

(3) Resolution – shows the tasks, steps and processes that have to be undertaken. All implications, issues and exposures are analysed, categorised and prioritised across all functional areas impacted by the proposed venture.

Further resources

Business Culture - the effects of your culture on change management

Organisational Culture - Determines how your people will respond to a change initiative

Programme Planning - The pre-programme review and planning process

Key factors to address BEFORE embarking on a change intiative

Change Management Risk Assessment

Change Management Implementation

Change Equation - INPACT Assessment

Leadership Qualities - Creating a Change Culture

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