Why Do Acquisitions Fail?

Hostile TakeoverCredit: Kevin Krejci, CC by 2.0, FlickrM&A (Mergers and Acquisitions) sound exciting. Hearing the latest “inside scoop” about a company that has acquired another leaves you in awe at the victor.  Well, maybe not always.

I’ve spent several years working in the Strategic Alliances Group for a local technology company.  I have headed several acquisitions during my tenure.  Below is a list of strategies that I have observed.  Some have work, some haven’t.

The Problem

The industry, a group of individuals affiliated in a market sector, announces publicly that one party won while implying another party somehow lost.  This win/loss dynamic is fueled by reporters in the news industry desperate to get attention as a “go to” source and analysts in the industry trying to hype their image as an industry “specialist” to improve the investment firm’s ability to draw in new capital for their brokerage accounts. Both reporters and analysts are sales reps, either selling their credibility or selling other miscellaneous services or products they offer in addition to their flashy soap box services.

In addition to the public stigma of being acquired, most buying companies invest heavily in the acquisition process both in time and money with senior management involvement, due diligence research cost, and legal/accounting fees.  Most failed acquisitions that I have researched failed not at the acquiring process, but at the integration process.  The primary reason for these failures is huge investments to acquire and limited funds (or commitment) to integration or market implementation.

After an acquisition, there is always a huge push by a Board of Directors to show shareholder value.  This thirst for a quick news, good news, “shareholder boner”, to be able to tout progress to shareholders leads to ugly directives to senior management shortly after an acquisition.  The directives come in the form of a BOD member complaining to senior management about the huge hit in profits they are about to announce due to recent acquisition costs and a need to increase profits the following quarter.  With quarterly bonuses on the line, most executives won’t risk being fired for overspending during the integration period after the acquisition is announced.  The BOD member’s comments drive management to slow down the pace and cost of integrating the newly acquired trophy (brand, product, service). This dynamic of pumping up the excitement by external players and then slow deflating the momentum by management with lack of integration capital is the cause of most failed acquisitions.

A Merger

Merging TogetherCredit: Tim Brown, CC by 2.0, FlickrA merger is an acquisition where the buying company is sugar coating the transaction.  There might be brand issues, vendor issues, or senior management issues that the buying company wants to handle after the acquisition is completed. They don’t want the stigma of a take-over to hinder or delay their purchase.  Many times there are employment agreements established with senior management in an attempt to grease the skids of the acquisition with anticipation this tactic will improve the transition process.  It doesn’t.   Additionally, there are customer loyalty issues or channel sales issues to take into consideration.   The philosophy being the details of each hurdle can be worked out after the strategic deal is finalized, but rarely does the transition go smoothly post sale when individual agendas may be impacted.

Buy vs. Build

A product set/brand can be built or bought.  You might know of HP acquiring Compaq, Bank of America acquiring Fleet Bank, or Chrysler acquiring Fiat several years ago.  Building a product or brand takes time.  In a fast growth industry time equates to market share.  This rush to be the biggest-fastest strategy often fails. Buying a brand to acquire customers rarely works.  Buying a brand and leveraging your distribution channel does.

A sales channel can be built or bought.  Building or expanding a sales channel often requires a lot of human capital and marketing costs. Buying a sales channel does not mean purchasing a distributor, it means moving more of your product through a strategic partner, one affiliated within your industry sector.

Acquisition Strategies That Work

Pump & Dump - A local investment group buys a small business and hires a seasoned team of sales professionals to increase customer sales over a short period of time such as 2-3 years. With increased sales volume and generating expanding profits over previous years, the local investor group having successfully pumped up the company metrics searches to dump the company to a company or investment group with access to a larger capital pool for future growth. This strategy works when the small business is less than 1M in sales, has a unique product, the original sales model was weak, the company is tightly owned by a small group of investors, and the investors have relationships in the industry.

The Roll-Up - A local bank develops 4-5 branches as did Indian Head Bank in NH several years ago.  A regional bank decides to build up their deposit base by acquiring new markets by purchasing a successful local bank as did Fleet Bank when they acquired Indian Head Bank.  A national bank decides to spread its wings into a new region and purchases a regional player as did Bank of America when they acquired Fleet Bank a few years back.   This strategy works as each player has their own Information Technology, Accounting, and Human Resource departments at their corporate office.  Since only one HQ office is needed to drive these functions going forward there are cost savings in combining the two companies.

Pull Through – A company is successful with their current product line and has a well developed sales channel. They purchase a product line/brand from a small company and move the product through their sales channel. This strategy works well when there is a clearly defined customer need and a known sales channel primed to sell to the customer base.

An Example

The most successful acquisition I ever worked was a Pull Through model.  We identified a need in our customer base for a software tool to automate their payments processing.  We clearly identified over 2,000 business clients that could use such a tool.

One day while at a client site, I was asking an accounting manager if they had such a need. She said yes and showed us the tool they were using that was developed by a small company in the mid-west.  A phone call to the company about their product led to an on-site visit.  While at the company, I noticed they only had 3 employees – all brilliant software developers but none excited to make cold calls and felt sales was a necessary evil to support their passion.  We met several times to share perspectives on the industry.  At one meeting I asked if they were interested in developing any sort of “Strategic Alliance” with us and they thought the idea sounded exciting.

As my knowledge of the market expanded, at one point over a dinner I asked if they wouldn’t mind sharing their annual sales volume and they mentioned their sales volume had been consistently around $400,000 a year for the past 3 years.  I had done some competitive research previously and identified there were few players in this market niche.  Over dinner one night the term “Strategic Alliance” evolved to a conversation about their interest in a potential “merger”.

After further due diligence, our company acquired the rights to their software 2 months later for $500,000 and offered each of them lucrative 2 year employment agreement.  Also the programmers were wondering if they could avoid having to relocate as part of the deal.  We agreed they could remain in their current office environment working remotely to our corporate office.  Without the burden of having to hustle business, they continued to develop new enhancements to the product.  After the transaction was finalized, I personally managed the process of moving the product to market through our own internal channels.  I utilized our existing Inside Sales team to market the product to the 2,000 existing clients that we already had a relationship with and were previously identified as needing such a tool.   In the first 180 days following the acquisition, we generated over $600,000 in sales for the product shedding over $400,000 in net profit.  Additionally, we cross sold an additional $300,000 in sales in implementation, training, and custom programming services that we packaged with the initial software sale.  The additional services provided another $150,000 in net profit.

Was this acquisition successful? 

In Summary

I believe the best acquisitions are those where you have a clearly defined path to retrieve your capital investment.  The CEO and Board of Directors agreed.