Fallacies of Cost Synergies in M&A
Anirvan Sen ??
Business Builder | Creator of the ‘PROMISE of a Business’ Ontology | CEO Mentor | M&A Strategist | Buy-and-Build | Author | Board Advisor
Unless you are pursuing a consolidation, acquiring a competitor, or are involved in adjacency acquisition, chances are that a fair amount of synergies for your acquisition are new-value generating synergies. These synergies can be created through revenue, innovation, or operating model activities. In fact, your acquisition thesis is likely to be heavily hinged on how you can usher in significant growth for your company over extracting cost synergies. And as you know, the biggest part of any cost synergies is related to headcount reduction.?
Regrettably, a large number of acquirers end up focusing only on cost synergies. This is partly due to the fact that revenue synergies are much tougher to extract in the real business world compared to the excel spreadsheet calculations and partly because management teams are short on expertise to manage the intangible nature of new value creation.?
The problem with focusing only on cost synergies alone is that it can severely impair the acquired organizational capabilities and can lead to disastrous results.
There are also huge fallacies surrounding cost synergies in an M&A integration.?
Let us explore the topic further.
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Limited Data
Cost synergy projections are primarily based on data that is received during due diligence, data that is obtained from public and third-party sources, and the intuitive thinking of the M&A team. The main purpose of the cost synergy projections is to assess the feasibility of an acquisition. It is one of the main factors used to create a favorable business case. It is, however, directional at best as it is primarily made based on spreadsheet analysis and a generic headcount reduction percentage.
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Competitive Advantage
Another critical part of an acquisition is to learn about how the acquiring company manages its competitive advantage in the market. Unless it is a consolidation acquisition where the primary focus is to get economies of scale or a tuck-in where the only part of interest for the acquirer is the product, the acquiring company does not need to pay much heed to how the competitive advantage was created. But in all other cases, the acquiring company must learn the competitive advantage configuration of the acquired company in order to leverage and create new value. Due to anti-competition rules, it is almost impossible to learn about the competitive advantage configuration. It is only when the transfer of ownership is done that it allows people to get unfettered access to information.
Many companies embark on significant headcount reduction on day one (day of change of ownership). Employing a slash-&-burn approach to these cost synergies can seriously damage a company’s competitive advantage configuration. Without fully developing an understanding of the configuration, acquiring teams do not know the ability and influence that each employee has on the configuration. While companies get to extract a few hundred thousand dollars through headcount reductions, the negative impact may run into millions if done senselessly.
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Human capabilities
Like the previous section, cost synergy analysis is almost done devoid of consideration for their actual business and operational capabilities. Most often only their functional position in the organization is used for high-level evaluation. Obviously, as you can imagine, employees of small and medium-sized enterprises end up performing activities that go far beyond their functional positions in an organization. These activities get assigned to them as per their capabilities and potential. It is not unusual to see a lot more well-rounded individuals working in smaller companies compared to functional depths in large corporates.?
These capabilities often contribute significantly to building and maintaining the competitive advantage of an organization. It is not unusual to see an employee of an HR function have a significant understanding of the talent market. This can be vital for the technology, digital, and innovation world. The compensation and benefit of these individuals may look attractive for cost synergies but delays in hiring and that too, for critical resources can spell doom for many small and medium-sized enterprises.
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Tangible calculations
The whole pre-deal process is steeped deep in documented planning and evidence. Everything is tried to be put in well-articulated and quantifiable structures. Headcount, process, technology, strategy, governance, and communication are all laid out with details and numbers. Every decision made must be substantiated with documented evidence. A clinical and structured approach is the only reality of an M&A transaction prior to the change of ownership. Amidst these tangible and structured approaches, all softer and intangible elements tend to get lost.
The most suffered elements in an M&A include culture, people behavior, leadership perception, employee engagement, and most importantly, new value creation. While we have spoken about people-related aspects in the prior sections, new value creation can only take place when collaboration is combined with access to information and innovation.?
The earliest time that these three elements can be brought together is after the change of ownership takes place. What that means is in the period leading to integration, limited access to information and selective interaction kills any chance of innovation. Organizations must wait till the ownership changes, and full access to information and personnel is made available. It is at this stage that organizations can confidently create roadmaps for new value creation and convert many assumptions and intangibles into a tangible forecast for the first time.
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Conclusion
The rush to realize cost synergies can inadvertently cause more damage than benefits in an M&A integration. There are significant fallacies that exist on how acquiring organizations in general, approach an acquisition.
Cost synergies are an intrinsic part of an acquisition. They are hugely important to drive financial considerations linked to acquisition decision-making. They are also the greatest point at which an acquisition journey can get started.
But that’s where the over-dependence on cost synergies must end. Cost synergies must be viewed as a starting baseline of acquisition and as strategically directional. Organizations actually should find new synergy avenues through new growth opportunities, innovations, collaboration, and operating models. Cost synergies must be evaluated through a competitive advantage lens before they are implemented.
Overall, cost synergies must not be used as a crutch to justify an acquisition. Cost synergies are an extremely vital tool for an M&A. With the right usage, they can bring significant benefits to organizations. Incorrectly used, they can lead to damages and lost value of millions of dollars.?
It is easy to make people redundant but do not forget that it takes years to build capabilities. And to create competitive advantage, eons.
End of the article
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Expert in family enterprise, alternatives, mergers | LinkedIn Top Voice | Avestix (SFO) | Family Business Audiocast | RAS Capital Partners | Salomon Brothers | Columbia Business School - 10x BOD | led $1B directs
2 年Nice article Anirvan Sen