Checking too quickly and focusing too narrowly can
be a recipe for disaster. Successful acquirers take a different approach: the
disciplined prioritization and organization of a number of fundamental—but
often neglected—principles. Call it strategic due diligence. By Michael May, Patricia Anslinger and Justin
Jenk Outlook Journal, July 2002
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Hewlett-Packard hadn't been much of a favorite with Sanford
C. Bernstein & Company's A.M. Sacconaghi. For two years the computer
analyst declined to rate the company a “buy." Then in May he suddenly had a
change of heart. How come? Price, for one thing; having dropped nearly 25
percent since the proposed merger with Compaq Computer was announced, HP's
stock looked highly attractive. But Sacconaghi was also clearly impressed by
“the enormous and diligent effort" the two companies had put into planning in
the predeal phase how the combined entity would operate.
If this kind of rigorous analysis can win Wall Street
applause for one of the most contentious, high-profile mergers in recent
memory, why aren't more companies doing it?
Acquirers routinely perform due diligence. But for a
variety of reasons they tend to do their checking too quickly and focus it too
narrowly—mainly on understanding historical financial reports, uncovering
possible legal liabilities and hunting for other unpleasant surprises. In other
words, acquirers usually concentrate on the past, not on the future of the
combined companies. Traditional due diligence is obviously necessary, but it’s
hardly sufficient to ensure a transaction’s long-term success.
The most successful acquirers go far beyond traditional due
diligence. They do something best described as strategic due diligence: the
disciplined prioritizing and organizing of a number of fundamental but too
often neglected principles.
The Right Price These successful acquirers
look ahead and measure the companies they’re proposing to buy against the
strategic vision they want to achieve. They test a whole spectrum of important
assumptions, in realms ranging from the more immediate challenges of
post-merger integration to the reaction of competitors and the longer-term
impact on the industry. How hard will it be to upgrade newly acquired
operations to best in class, or to change the incentive system for key
managers? Will customers react as hoped? How will competitors respond?
 With strategic due diligence built
into the transaction process from the outset, the truly successful acquirers
are the ones that usually pay the right price for the companies they buy—a
price that not only reflects the possible net synergies but also takes into
account the likelihood that they will be captured. This discipline allows the
more successful acquirers to deliver above-average returns to their
shareholders.
The majority of acquirers, unfortunately, fall well short
of this standard. As study upon study has shown, more than half of all mergers
and acquisitions end up destroying value for the companies involved. These
failures have produced a growing backlash among shareholders, who are
increasingly likely to protest (or simply sell their stock) when a deal is
announced. Board members, more keenly aware of their responsibilities than
ever, are likewise growing more cautious about M&A. And yet the forces
driving companies to merge or acquire—globalization, technological change,
competition for capital—show no signs of abating.
The result is a widening gap between the way financial
markets treat companies that know how to make acquisitions and the way they
treat those that don’t.
We’ve seen this divide open up in various consolidating
industries over the past decade, with one or two companies emerging as the
master acquirers (and strongest stocks) and the others looking more and more
like also-rans. Among the tier-one auto suppliers, for example, Johnson
Controls has set the standard for acquisitions. In the aluminum industry, Alcoa
stands out as a winner. And in financial services, Citigroup has proven to be
especially adept.
 Two European-based consumer products companies provide
an illuminating contrast. Both have made multiple acquisitions. But from 1996
to 2000, Company A saw the market respond favorably to 80 percent of its
biggest deals, whereas Company B got a positive market response to only 33
percent of its acquisitions. The difference in total returns to shareholders in
the same period is even starker: 22 percent for Company A, compared with minus
4 percent for Company B.
An obvious question arises. If there is a logical,
disciplined process that companies go through to gauge whether a transaction is
being properly valued—looking at issues such as industry impact, customer
reaction, competitor response—why aren’t more of them doing it?
View From the Top The answer may lie
partly in the dynamic, often top-down nature of deal making. When time is short
and discretion is important—and when the vision comes straight from the top—the
details of what it will take to make the big picture a reality often go
unchallenged and unexamined.
An informal Accenture survey of investment bankers
indicates that while acquirers typically spend two to three weeks on the whole
due diligence process, a mere three to five days are devoted to strategic
issues. And the strategic issues they do investigate are confined to confirming
synergies and revising the valuation.
 Understanding the target’s
financials—which are historical and invariably accounting-based—was considered
the most important task by far; validating the reasons to do the deal came near
the bottom of the list. In a sense, the purpose of traditional due diligence is
simply to confirm that the deal makes near-term financial sense.
The purpose of strategic due diligence, by contrast, is to
assess whether the acquisition will succeed, and beyond that, to identify
specifically what will need to be done in the post-merger integration to make
the transaction a success. Strategic due diligence usually involves a larger
cast of players than the traditional variety, and it always makes use of a
wider array of information sources.
If strategic due diligence sounds like more work than
traditional due diligence, it is. But the best deal makers build teams that
know how to run the process efficiently. When deadlines are tight, moreover,
the strategic due diligence discipline helps these successful acquirers to
focus on some key ideas and assumptions.
Start with Strategy
The
strategic rationale for an acquisition and the assumptions underlying the
acquirer’s valuation are far easier to test if they’re clearly stated. Let’s go
back to our European consumer products companies. Company A understood this
principle well, but Company B did not. Both wanted to establish leadership
positions in key markets around the world. Company A bought leading local
brands in its core business, after first making sure that the targets’
marketing, distribution, manufacturing and information technology capabilities
fell within an acceptable range.
Company B bought local brands, too, but it often settled
for secondary ones, and it was less exacting about their capabilities. Further
clouding the picture, Company B made several acquisitions in reaction to
transactions made by competitors; these acquisitions were outside its core
markets and were not based on meaningful and achievable synergies. Therefore,
they created little value.
 Involve Your Top Operational Professionals
Early On
Making sure that your target’s distribution or IT
system will mesh with yours—or that it can at least be improved along the lines
you require—is not a job for a beginner. Nor is it something you can afford to
start addressing late in the merger and acquisition process. Yet in many
acquisitions these tasks are tackled—often by relatively junior people—when the
purchase is already well advanced. Not, however, at Company A, which made sure
that its top professionals in distribution, IT, marketing, operations and other
functions were involved in the pre-deal due diligence process.
The need to listen to employees is most acute for a handful
of business-critical functions. It is essential to assess how key managers at
your company—and at the target company—will react to the proposed transaction.
Successful acquirers look ahead at how the merged companies will need to
operate. A major cause of M&A failure is disruption of the companies’
existing activities.
Gather Information from Diverse
Sources
Considering the stakes in most deals, traditional due
diligence relies on remarkably few information sources. Only 10 percent of
respondents to our informal survey of M&A practitioners said the due
diligence process included four or more sources outside the company. Fewer than
one-third of respondents said due diligence included interviewing customers of
the target company. Yet it’s hard to overemphasize the importance of speaking
with those customers—who are, after all, one of the major reasons for doing the
deal.
The number of external sources contacted during strategic
due diligence, by contrast, might be a dozen or more. Besides customers, the
list could include competitors and their customers, suppliers, former employees
and joint venture partners, among others.
Whether approached formally or informally (as is sometimes
necessary), these people can help answer many of the acquirer’s questions. For
example: What companies are you likely to give more business to, and why? What
are the main obstacles to the target company winning more business? Has the
target’s management team had any relatively recent key hires or defections?
 Look Beyond the Obvious
Synergies
In a traditional assessment of a deal’s benefits,
acquirers usually place great emphasis on near-term opportunities for cost
savings rather than on revenue enhancement. Given the stock market’s demands
for a quick post-deal rise in earnings, perhaps this isn’t so surprising. But
the focus on the near term further skews the typical acquirer’s due diligence
process—which, if it tackles strategic questions at all, will tend to
concentrate on relatively low-hanging fruit, such as immediate cost reductions
or basic ways to drive revenue. These could include supply chain and
operational improvements, a reduction in logistics costs as well as in working
capital, and so forth.
On the revenue side, the focus should include adding new
distribution channels and geographies, extending the product portfolio and
increasing outlays for productive R&D, among other things. These are
important value-creation levers, to be sure, and it’s important to test them.
But alone, they’re unlikely to make the merged companies a long-term success.
The best acquirers, by contrast, have a strategy that looks
beyond the near term, and a due diligence process for testing and supporting
that vision. These companies not only test a much broader array of
value-creation levers but also examine negative effects the merger might
create.
On the positive side, they explore possibilities for
defending market share with enhanced or bundled offerings, or for streamlining
the business processes and organiza-tional structure of the new, combined
entity. On the negative side, the companies worry about the possible loss of
revenue from customer defections, the loss of talented employees, an overly
complicated organizational structure, competitor reactions and other possible
problems.
 Strategic due diligence can be best
thought of as the way that successful acquirers manage to keep a grand design,
and the many structures and factors needed to support it, simultaneously in
view. Straightforward in concept, it requires great discipline in practice. The
companies that are making it work are looking inward to operations people;
outward to customers, competitors, shareholders and regulators; and down the
road to the future of the merged companies—all at the same time.
But the payoffs of strategic due diligence are
commensurately large. For starters, the process screens out some transactions
and re-prices others—both valuable contributions. The most important effect of
strategic due diligence, however, is a simple but profound shift in
emphasis—from getting deals done to getting them done right. And that increases
the chances of the transaction creating value, rather than destroying it.
 Michael May is the managing partner of
the Accenture Strategy & Business Architecture service line. Mr. May works
with senior executives and boards of directors on overall strategic issues,
including corporate strategy, new business models, governance and business
architecture. Mr. May also is chairman of the company’s thought leadership
executive committee. He is based in New York.
michael.may@accenture.com Patricia Anslinger, a New York-based
partner, is the global/North American lead for Accenture's Mergers &
Acquisitions services. With more than 17 years' experience in M&A
consulting, investment banking and operations, she has worked on more than 150
transactions involving all aspects of M&A, portfolio restructuring,
operational improvement, corporate finance and corporate strategy.
patricia.anslinger@accenture.com Justin Jenk, a London-based partner,
heads Accenture’s Mergers & Acquisitions/corporate strategy services in
Europe. Mr. Jenk has more than 20 years of consulting and managerial experience
in Greater Europe, the Americas and Asia across numerous industries. He works
with senior management and shareholders on all aspects of M&A, corporate
finance, strategy, portfolio restructuring, operational improvement and
corporate governance.
justin.jenk@accenture.com Back to
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