Mergers and acquisitions are booming. Worldwide deal flow reached $2.7 trillion in 2005, based on preliminary figures, a 38-percent increase over 2004. This is the highest level since 2000, the record year for M&A activity.

Industry consolidation is at the heart of the trend, driven by globalization, deregulation, and technological shifts. "Mergers and acquisitions are the primary way industries consolidate," said Wharton Professor Harbir Singh, during a recent session of Wharton's Mergers and Acquisitions program. Singh has been researching mergers and acquisitions for more than 2 decades.

Consolidating industries now account for more than 50 percent of the US GDP, from financial services, to oil and gas, to cement and steel. "This is driven by forces that are larger than individual companies," he said. "People say managers have become more acquisitive, but acquisitions are being driven by industry consolidation."

Success Factors

Yet the M&A track record is still dismal. According to most studies, only about 40 percent of all deals are successful; some estimates put the figure as low as 25 percent. What can be done to make mergers and acquisitions more successful? Among the insights Singh offered were:

• Learn from the past: Many companies that have extensive experience in mergers and acquisitions don't learn from their past experience. Companies need to create feedback loops to capture the learning from their past deals. Singh's studies on the banking industry found that only about 40 percent of companies actually draw upon past experience in setting up new deals. Often managers dismiss their own experience or the experience of others as irrelevant. "Managers say: It doesn't apply in this case because we are in a different industry," he said. "We are in denial. If the feedback loop shows that the company is not very good at integrating acquisitions, that might indicate that the company needs to allocate more time and resources to integration."
  
  
• Ensure accountability: "If you don't work out the accountability, the people who deliver the deal are not responsible for post-acquisition performance, so they will be overly optimistic," he said. "You will only be aligned in your expectations if accountability is maintained." GE and Cisco have good accountability from the top to the bottom. One company that Singh worked with felt that its M&A processes were ineffective, but he found the basic processes were solid. The problem was accountability, and that undermined its success.
  
  
• Bring business experience to the deal table: One way to strengthen accountability is by ensuring that there is continuity of teams from pre-acquisition to post-acquisition. The deal process should be designed to bring together deal makers and the line managers who will run the business. "Bring both sides to the table, the deal experience and the business experience, " Singh said.
  
  
• Prepare carefully: Research has shown that cross-border acquisitions are actually more successful than domestic ones. "This is surprising because of the increased complexity of cross-border deals, but there may also be a higher level of preparation than for domestic acquisitions," Singh said.
  
  
• Focus on integration and culture: Planning needs to look beyond numbers and cost cutting to understand integration. "If you lay out a plan for exactly how you expect the combined company to create value, that is a great way to surface some of the human issues involved," he said. "It is possible using your integration system to understand what deals you should do or not do." Companies need to think carefully about the strategic and cultural fit between the two companies. "If your values are completely incompatible, that is a walk-away condition," he said.
  
  
• Move quickly, but with discipline: There is a bias for action, because companies that move too slowly may miss out on opportunities. But without careful analysis, there is increased possibility for mistakes. Companies with a well-developed M&A function can move quickly with rigor. Wachovia, for example, developed a disciplined system for scanning and identifying banks very quickly to buy them before purely opportunistic acquirers. "You often don't have the luxury of time to do a full-blown strategic analysis," Singh said. "A disciplined acquirer with a well-developed M&A function can be more strategically informed in the same amount of time as an opportunistic acquirer." Companies that wait too long may ultimately become takeover targets themselves. "You have to be prepared to move fast and to get the strategy right," he said.
  
  
• Don't overbid: Assess your "walk-away" price, and walk away when you reach it. Many managers get caught up in the negotiating process, and prices are driven to astronomical levels, making success unlikely. "If you overpay, it doesn't matter how good your integration plan is," Singh said. (We'll consider this issue in more detail in a future article.) "Each transaction has to be create value in its own right," he said. "The only exception is when the transaction is a stepping stone to other value-creating transactions. There is not a whole lot of room there. That is the way to create value."

Sources of Competitive Advantage

To create value from acquisitions, companies have to increase their competitive advantage in some way. How do they do that? Singh said competitive advantage in a deal results from three primary sources: improving the company's position in the industry, neutralizing competitors, or leveraging capabilities. By analyzing the impact of the deal on each of these sources of advantage, the acquirer can better understand whether the deal creates value and how.

For example, how did the Daimler Chrysler deal improve its advantages in the industry? While it gave the combined company global scale and a broad footprint, the mismatch between a mid-priced and luxury company did little to improve its capabilities. Customers didn't pay a lot of attention to the deal, so the company's competitive position was not improved. If anything, Daimler's image was eroded. It also did little to neutralize competitors, and they took advantage of the distraction to outmaneuver the company.

By laying out the impact on three sources of advantage for the target, acquirer, and combination, the value (or lack of value) created by the deal becomes much clearer. This analysis also helps to clarify strategies and integration plans that are needed to realize this value.

Understanding the Dominant Logic of the Deal

In addition to considering advantages, companies need to be clear about the dominant logic of the deal and how it creates value. Where is the main action in the transaction? Singh identified three primary logics that shape deals and determine how value is created from them:

• Cost reduction: A cost-based strategy typically would use scale and scope to reduce costs as a result of the merger or acquisition. "Cost controls are a more reliable way to get value from an acquisition." The focus would be on opportunities for synergies and other opportunities to reduce costs.
  
  
• Market power: The acquisition may give the company power over price, but the only way to have this power is to own some proprietary assets (such as know-how, plants, and reputation). In the case of Pfizer and Warner Lambert, the merger was driven by the drug Lipitor, which was a key asset for the company. "In a market power situation, you have to be sure you protect and enhance the assets that drive the market power," Singh said.
  
  
• Game changing: By acquiring wireless assets ahead of competitors, Verizon saw the game moving toward wireless. It used acquisitions to change the game. This allowed the company to get out in front of other competitors. "Game changing is high risk, and the returns have to justify the risks," Singh said.

Assessing sources of advantage and the dominant logic for the deal can help to keep managers focused on how the deal creates value. This leads to better decisions on which deals to pursue and strategies for after they close. "The Daimler Chrysler guys were smart. What happened?" Singh asked. "In my view, what happened was they applied the wrong decision framework. You can be smart, but if you apply the wrong decision framework, you get the wrong decision. You have to look specifically at how you create competitive advantages and what are the competitive disadvantages that might occur. If you have the right framework, you can sort this through and come up with better deals."

Related Courses

• Mergers and Acquisitions
  
  
• Strategic Alliances: Creating Growth Opportunities

• Wharton Executive Education
  
  
• The Wharton School

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