5 Drivers of Success in M&A
Companies should focus on these five key aspects of deal-making to help ensure long-term success for their mergers and acquisitions.
Last year was a banner year for merger and acquisition (M&A) activity around the world. In the first three-quarters of the year, global M&A deals reached US$3.3 trillion and cross-border deals hit $1.3 trillion. In 2019, organizations that are flush with cash may be tempted to continue this trend by jumping on the first promising acquisition opportunity that comes their way. However, a short-sighted approach to deal-making is unlikely to help a company maximize long-term value.
Gartner recently took a look at the practices of companies that we’ve termed “efficient growth leaders”—organizations that have demonstrated consistent long-term growth compared with their industry peers—to learn what they’re doing differently when it comes to M&A. The answer is that they take a more purposeful, bold, and strategic approach to these deals.
Based on our research, here are five things these efficient growth leaders do to achieve consistent success in M&A.
1. Don’t shy away from large, transformative deals.
Some of the most notable megadeals in recent history ended up transforming into a waking nightmare for the acquiring CEO, not to mention the acquiring company’s shareholders, who continue to feel the pain long after that CEO has departed. It’s not surprising, then, that many business leaders’ natural reaction is to pursue a higher quantity of smaller deals in the name of diversification and risk management. Our research found, however, that the businesses with the most successful growth strategies embrace big deals. They recognize that failing to drive growth is the biggest long-term risk of all.
We found that the most successful companies don’t necessarily make more deals than their rivals. In our study, the companies we identified as “efficient growth leaders” engaged in roughly the same number of mergers and acquisitions over a 15-year period as their competitors did. But companies that achieve exceptional long-term growth do place larger bets. In our research, their M&A transactions were 42 percent larger, on average, than those conducted by their peers.
Our efficient growth leaders outgrew their competitors by undertaking large, data-driven risks. They consistently picked the right M&A targets through a strong sourcing pipeline that allowed them to investigate and vet every potential lead. For example, at one U.S. corporation we studied, business-unit heads scored prospective M&A targets against a screening template. The company then compiled and scored the business leaders’ responses to weed out prospective deals that failed to meet the organization’s rigorous screening criteria.
In an environment flush with cash, this type of discipline is a prerequisite in avoiding pursuit of suboptimal targets. Instead of focusing on speedy acquisitions, M&A leaders invest time in researching a wide range of targets to find the prospective deals that best fit their strategy.
2. Take a strategic look at the economic cycle.
Executives often base their M&A strategy on the current state of the economy, moving away from risk-taking in a downturn. There is a certain logic to this approach. During periods of strong corporate performance, management teams naturally want to put their growing cash flows to good use, whereas tough times lead them to conserve cash by cutting spending.
Management teams that feel this approach is sensible should keep in mind that the upside of a bad economy is that desirable M&A targets are often available at very low prices. The efficient growth leaders in our study have demonstrated a penchant for taking advantage of the unique opportunities presented by economic downturns. These businesses’ deals are more likely to occur in periods of slow growth in global gross domestic product (GDP) than the mergers and acquisitions undertaken by their peers.
The companies with the most successful M&A track records over time come up with a proactive, strategy-focused approach to deal selection. They develop objective M&A guidelines for their company and follow those guidelines, independent of the business cycle. Moreover, their finance teams understand the organization’s risk appetite through the lens of capital and liquidity plans. A principled bet placed in a weak economy, as competitors are taking shelter, can have magnified growth effects as the global business environment recovers.
3. Find operational synergies, not just cost synergies.
M&A deals fall into four major categories:
- Horizontal acquisition. Two direct competitors consolidate into one company.
- Vertical acquisition. Two companies that are part of the same value chain merge to consolidate aspects of the production process.
- Product extension. A company acquires a business with products that are related to, but not in direct competition with, their offerings.
- Market extension. A company acquires a business that sells similar products in a different market.
Each of these types of deals has specific advantages, but we found that M&A leaders tend to focus most on vertical acquisitions. The proportion of total M&A spend allocated to vertical acquisitions is nearly 10 percent higher for the efficient growth leaders in our study than for their peers.
One explanation of this statistic is that a vertical merger may be more likely to be successful in the long term. If it can clear legal hurdles, the transition process required to combine the two companies may be smoother. That’s because the companies are known to each other and are already working toward the same end result. It’s usually easier for an organization to expand capabilities, increase operational efficiencies, and create competitive pricing within its existing supply chain.
How can a corporate management team put vertical M&A planning into practice? One company involved in production and distribution developed a gamification model to help executives visualize their strategic M&A pathways. This approach focused their growth conversations on important strategic variables, including the business value chain, geography, and time. From there, senior managers could easily see and analyze the long-term economic tradeoffs inherent in any given deal, such as whether future transactions could stem from the current target.
4. Wisely invest both capital and management’s time.
Our research found that, over the long run, the typical business ends up divesting about half the companies it acquires. By contrast, our efficient growth leaders eventually divest one out of every six acquisitions. M&A deals are too expensive, in terms of both capital and executive time, to take a purely trial-and-error approach.
Companies should approach M&A as a long-term corporate strategy, not a way to get quick portfolio wins. Our study suggests that management teams are best served by focusing their energy on a single large deal in one strategic domain at a time, rather than spreading their attention across multiple simultaneous bets and multiple strategic initiatives.
Predicting how well an acquisition target will fit into the acquirer’s corporate culture is tricky, especially since the acquirer’s own culture might pivot at any time. However, every business pursuing mergers and acquisitions needs to incorporate cultural compatibility metrics into its process for evaluating prospective M&A targets. With the right scoring criteria, a company can make a reasonable estimate of how well each target will mesh with its organization over the long run.
One firm we studied evaluates potential M&A targets using a set of characteristics that are core to its culture—openness to change, importance of learning and development, and risk tolerance. The firm operates in a high-risk, high-reward environment, so it targets acquisitions with high marks in these categories.
5. Don’t “fire and forget.”
Another practice shared by many of the companies we’ve deemed efficient growth leaders is that they continue to monitor the performance of each merger or acquisition long after the deal is closed. Evidence of this practice emerges in different companies’ accounting for goodwill impairment.
Current accounting standards require public companies to perform an annual goodwill impairment test to measure the difference between the purchase price of any M&A deals and the fair value of their acquired assets. Our research found that efficient growth leaders report 30 percent fewer goodwill impairments, and that the impairments they do have are about $300 million less than average.
One reason is that efficient growth leaders tend to have superior value management capabilities. In many businesses, once the executive team has conducted an initial analysis and decided to make an investment, the time they spend tracking performance of the related assets falls off dramatically. This holds true for both organic and inorganic investments. However, our research found that executives within efficient growth leaders track their new investments closely, even long after the initial capital deployment. And lessons they learn by monitoring prior investments feed back into their screening process for making decisions on future M&A deals.
See also:
- The Importance of a Treasury Acquisition Strategy
- Is Your Treasury Organization Ready for an Acquisition?
- Risk Management Pitfalls in Mergers and Acquisitions
- Managing Fraud and Corruption Risk in M&A
Certainly, external economic factors that are outside the management team’s control may cause assets to depreciate in value. Even so, building strong internal processes for managing the sources of value in an M&A transaction will help an executive team minimize any fluctuations in the deal’s fair value.
Before closing the deal, the management team should create a set of leading key performance indicators (KPIs) to measure value capture, including return on capital minus weighted average cost of capital, or cash flow return on investment. After the merger or acquisition is complete, managers need to track the combined company’s performance relative to these metrics, to measure the deal’s value delivery over time. The return on investment (ROI) from this additional analytic capability comes via increased returns on the merger or acquisition itself.
A Perfect Time for an M&A Tune-up
As we seem to be approaching the apex of the global economic cycle, corporate management teams may be tempted to overpay for deals. Not all bad mergers and acquisitions will become the stuff of nightmares, but a company whose approach to M&A is not adequately rigorous may find that its “growth grab” results in a death by a thousand cuts—with poorly planned deals draining corporate growth and shareholder value over the long run. Now, more than at any other stage of the business cycle, companies must make sure they are effectively measuring the value of their M&A practices.
A strategic and purposeful approach to M&A leads companies to undertake higher-value deals and to achieve more consistent success. Executive teams should be laser-focused on finding the best long-term fits for their business, rather than simply going after deals that fill holes in their portfolio. This approach will ultimately reduce the effort they waste on divesting acquired businesses and will minimize their goodwill impairment in the future.
Sustainable growth through acquisitions requires effort, planning, and a focus on long-term strategy. Success is never guaranteed, but it’s easier to achieve with the right M&A strategy.