Why do firms carry out mergers and acquisitions, and how can the difficulties involved be overcome?
In October this year, the British government approved a merger between two major television companies, Carlton and Granada. The £4 billion deal, which creates a single ITV company for the whole of England and Wales, was welcomed enthusiastically both by investors and by the managers of the two troubled companies , who have steadily lost audience share and advertising revenue to new rivals such as BSkyB, and lost money following the collapse of their ITV Digital venture. However, it remains to be seen whether the new partnership will succeed in turning around the companies' fortunes, or whether, like many past corporate marriages, it will end in unhappiness and divorce.
The merging of two companies into one is not a recent idea - there were "waves" of corporate mergers back in the 1920s, the 1960s and the 1980s (Fairburn and Kay 1989) - but the enormous scale on which companies have swallowed each other up over the past decade far exceeds what has gone before. The total worldwide value of mergers and acquisitions in 1998 alone was $2.4 trillion, up by 50% from the previous year. However, research suggests that a large proportion of mergers and acquisitions do more harm than good to companies and their shareholders: Mercer Management Consulting (1997) concluded that "an alarming 48% of mergers underperform their industry after three years" , and Business Week recently reported that in 61% of acquisitions "buyers destroyed their own shareholders' wealth".
Why do so many firms choose to participate in mergers and acquisitions, and why do so many of these subsequently go wrong? In this essay, I will attempt to answer these questions, and examine what steps companies can take in order to prevent acquisitions from ending in failure.
The reasons for mergers and acquisitions
One of the most common arguments for mergers and acquisitions is the belief that "synergies" exist, allowing the two companies to work more efficiently together than either would separately. Such synergies may result from the firms' combined ability to exploit economies of scale, eliminate duplicated functions, share managerial expertise, and raise larger amounts of capital (Ravenscraft and Scherer 1987). Carlton and Granada hope to save £55 million annually by combining their operations. Unfortunately, research shows that the predicted efficiency gains often fail to materialise following a merger (Hughes 1989).
'Horizontal' mergers (between companies operating at the same level of production in the same industry) may also be motivated by a desire for greater market power. In theory, authorities such as Britain's Competition Commission should obstruct any tie-up that could create a monopoly capable of abusing its power - as it did recently in preventing the largest supermarket chains from buying the retailer Safeway - but such decisions are often controversial and highly politicised. (In the case of Carlton and Granada, the government imposed strict safeguards to prevent the combined firms from unfairly raising the price of TV advertising. ) However, some authors have argued that mergers are unlikely to create monopolies even in the absence of such regulation, since there is no evidence that mergers in the past have generally led to an increase in the concentration of market power (George 1989), although there may be exceptions within specific industries (Ravenscraft and Scherer 1987).
In some cases, firms may derive tax advantages from a merger or acquisition. However, Auerbauch and Reishus (1988) concluded that tax considerations probably do not play a significant role in prompting companies to merge.
Corporations may pursue mergers and acquisitions as part of a deliberate strategy of diversification, allowing the company to exploit new markets and spread its risks. AOL's merger with media giant Time Warner, for example, saved it from being affected quite so disastrously as many of AOL's Internet competitors by the 'dot com crash' (Henry 2002).
A company may seek an acquisition because it believes its target to be undervalued, and thus a "bargain" - a good investment capable of generating a high return for the parent company's shareholders. Often, such acquisitions are also motivated by the "empire-building desire" of the parent company's managers (Ravenscraft and Scherer 1987).
Why mergers and acquisitions fail
Sometimes, the failure of an acquisition to generate good returns for the parent company may be explained by the simple fact that they paid too much for it. Having bid over-enthusiastically, the buyer may find that the premium they paid for the acquired company's shares (the so-called "winner's curse") wipes out any gains made from the acquisition (Henry 2002).
However, even a deal that is financially sound may ultimately prove to be a disaster, if it is implemented in a way that does not deal sensitively with the companies' people and their different corporate cultures. There may be acute contrasts between the attitudes and values of the two companies, especially if the new partnership crosses national boundaries (in which case there may also be language barriers to contend with).
A merger or acquisition is an extremely stressful process for those involved: job losses, restructuring, and the imposition of a new corporate culture and identity can create uncertainty, anxiety and resentment among a company's employees (Appelbaum et al 2000). Research shows that a firm's productivity can drop by between 25 and 50 percent while undergoing such a large-scale change; demoralisation of the workforce is a major reason for this (Tetenbaum 1999). Companies often pay undue attention to the short-term legal and financial considerations involved in a merger or acquisition, and neglect the implications for corporate identity and communication, factors that may prove equally important in the long run because of their impact on workers' morale and productivity (Balmer and Dinnie 1999).
Managers, suddenly deprived of authority and promotion opportunities, can be particularly bitter: one survey found that "nearly 50% of executives in acquired firms seek other jobs within one year". Sometimes there may be specific personality clashes between executives in the two companies. This may prove a problem in the case of Carlton and Granada: Carlton's chief executive Charles Allen and Granada's chairman Michael Green, who will have joint responsibility for running the merged company, have been likened to "ferrets in a sack".
Strategies for a successful acquisition
Why are so many organisations apparently unable to overcome such difficulties? A merger or major acquisition is often a unique, one-off event in the lifetime of a firm; companies therefore have no opportunity to learn from their experience and develop tried-and-tested methods to ensure that the process is carried out smoothly. One notable exception to this is the financial-services conglomerate GE Capital Services, which has made over 100 acquisitions during a five-year period (Ashkenas et al 1998). Through this extensive experience, GE Capital has learnt four basic lessons:
Other authors, however, question whether aiming for total integration of two contrasting company cultures is necessarily the best approach. There are, in fact, four different options for reconciling cultural differences: complete integration of the two cultures, assimilation of one culture by another, separation of the two cultures (so that they are maintained side by side), or deculturation (eventual loss of both cultures). The optimal strategy may depend upon the degree of cultural difference that exists between the organisations, and the extent to which each values its own culture and identity (Appelbaum et al 2000).
Tetenbaum (1999) suggests an alternative set of "seven key practises" to assist with a successful merger or acquisition:
Although there are many different opinions on precisely what causes so many mergers and acquisitions to fail, and on how these problems can be avoided, there are certain points that most analysts appear to agree on. It is widely accepted, for instance, that the 'human factor' is a major cause of difficulty in making the integration between two companies work successfully. If the transition is carried out without sensitivity towards the employees who may suffer as a result of it, and without awareness of the vast differences that may exist between corporate cultures, the result is a stressed, unhappy and uncooperative workforce - and consequently a drop in productivity.
With this in mind, it is important that a clear 'integration plan' is in place, and that it is overseen by a dedicated manager with the experience and interpersonal skills to calm employees' anxieties and reconcile cultural differences. Preparation for the transition should begin as soon as possible, preferably before the deal has been signed, and any necessary changes should be implemented as quickly as possible to avoid stressful uncertainties that can damage morale. Open and honest communication throughout the process is vital in retaining the trust of employees.
Even when following these principles, there may be situations in which a tie-up between two companies could never be made to work effectively, because there are irreconcilable differences in corporate culture or because the drawbacks of a merger would outweigh any potential benefits. Although it is obviously impossible to predict with certainty the outcome of a merger or acquisition before it takes place, thorough preparation can definitely help, and companies should not be afraid to abandon plans for a tie-up if there is evidence that it is unlikely to be a success.
Most importantly, any decision to carry out a merger or acquisition should consider not only the legal and financial implications, but also the human consequences - the effect of the deal upon the two companies' managers and employees. It is upon them, ultimately, that the fate of the newly-merged company will depend.
Appelbaum, Steven H., Gandell, Joy, Jobin, Francois, Proper, Shay, and Yortis, Harry (2000), "Anatomy of a merger: behavior of organizational factors and processes throughout the pre- during- post-stages", Management Decision, Vol. 38, Numbers 9 and 10
Ashkenas, Ronald N., DeMonaco, Lawrence J. & Francis, Suzanne C. (1998), "Making the Deal Real: How GE Capital Integrates Acquisitions", Harvard Business Review, Vol. 76, Issue 1.
Auerbauch, Alan J., and Reishus, David (1988), "The Impact of Taxation on Mergers and Acquisitions". In Mergers and Acquisitions, edited by Alan J. Auerbauch. University of Chicago Press.
Balmer, John M.T., and Dinnie, Keith (1999), "Corporate identity and corporate communications: the antidote to merger madness", Corporate Communications: An International Journal, Vol. 4 Number 4 1999.
BBC News online articles: "What now for Safeway suitors?" (27 Sep 2003), "TV bosses: two ferrets in a sack" (3 Oct 2003), "ITV merger gets the go-ahead" (7 Oct 2003).
Fairburn, James A., and Kay, John A. (1989), Mergers and Merger Policy. Oxford University Press.
George, Kenneth (1989), "Do we need a merger policy?". In Mergers and Merger Policy (see above).
Henry, David (2002), "Mergers: Why Most Big Deals Don't Pay Off", Business Week, October 14, 2002.
Hughes, Alan (1989), "The Impact of Merger: a survey of empirical evidence for the UK". In Mergers and Merger Policy (see above).
Ravenscraft, David J. & Scherer, F.M. (1987), Mergers, Sell-offs and Economic Efficiency. Washington, DC: The Brookings Institution.
Tetenbaum, Tony J. (1999), "Beating the odds of merger and acquisition failure: seven key practices that improve the chance for expected integration and synergies", Organizational Dynamics, Autumn 1999.
This was originally written as a university Business Studies essay