December 2019 Issue
Mergers and acquisitions (M&A) can generate growth, drive value, expand market access and establish a global presence. But while deals can benefit the companies involved, many mergers have resulted in lost value for shareholders.
One frequently cited cause of failed deals is cultural incompatibility. Mergers can leave employees feeling isolated, unsupported and unsure about what the future holds. This uncertainty can undercut the upsides of any deal and even derail it.
For a deal to be successful, acquirers must prioritise cultural considerations from the outset. Companies should seek to establish a new corporate culture with a set of shared values, beliefs and assumptions. “When organisations identify and describe the ideal culture, they need to put in place organisational structures to support it,” says Dimity Hodge, Asia Pacific head of leadership advisory at Spencer Stuart. “Careful considerations should also be put in place to guide how best to shift senior leadership behaviour and create incentives to reinforce culture-enhancing behaviours.”
Cultural clashes
Cultural integration can be challenging when the merging parties either fail to recognise each other’s cultures or take inadequate steps to enable their cultures to complement one another. According to a 2017 Bain survey of executives who have managed through mergers, culture clash – when two companies’ philosophies, styles, values and habits are in conflict – was the primary reason why many deals failed to achieve their promised value.
One way companies can give culture adequate attention is to link the cultural programme to tangible and quantifiable business results. Cultural due diligence and integration planning can smooth out the merger process. Cultural due diligence should be conducted early in the process and should consist of a cultural assessment highlighting areas of similarity and divergence which may impact integration efforts and the ability to achieve strategic objectives.
Companies are often surprised by the results of cultural due diligence. “It is a process that outlines the cultural DNA of an organisation,” explains Dr Finn Majlergaard, a post-merger integration expert at Gugin. “When companies compare the two cultural DNAs, they can identify the areas where the C-suite needs to focus its attention: areas where there is a big gap between two elements in the cultural DNAs. It can be, for instance, the way you approach problem solving. Do you rely on your colleagues? Do you escalate the problem to your boss or do you just leave it until someone else solves it for you? When you see a big gap when comparing cultural DNAs, the top executives must set the tone and outline the consequences of not following the rules. That said, leaving as many decisions as possible to the people who are affected by them is usually the best option. It is also very valuable to have an external firm facilitating the integration process so that everyone involved has a neutral facilitator who is not a part of the political or strategic agenda.”
Corporate leaders will be under enormous pressure to get the deal right, but their focus may ignore some of the more challenging aspects. “Senior management should prioritise elements such as how people are selected for key roles, what sort of culture and structure the strategy requires, the differences between the two organisations, and how people are feeling about the integration,” says Ms Hodge. “With a more structured, strategic approach to the people side of merger, including cultural integration, the outcome can be much different.”
“Companies are often surprised by the results of cultural due diligence.”
Even before a deal is struck, companies should assess the culture of each business. “This helps the leaders of each to better understand their own culture and that of the other organisation – using neutral language to articulate who they are and how they operate,” says Ms Hodge. “Having a shared culture vocabulary to work from, the integration team, which represents both organisations, is then able to come together to explore similarities and differences in their distinct cultures, and set a shared aspirational target culture based on the value creation thesis of the deal.”
Cultural clash may arise due to communication breakdowns and misunderstandings. “Each of us has a set of norms, values and basic assumptions,” says Dr Majlergaard. “All our actions and behaviours happen in accordance with these values and norms. When we are together with new people we judge their behaviour and actions based on our own norms, values and basic assumptions. That leads, of course, to a lot of misunderstandings that can easily lead to a conflict. When we disapprove of another person’s behaviour or appearance, we usually do not confront that other person directly. Instead we look for other people who have the same image of that person and we start promoting that image. It happens frequently in post-deal situations because we are more insecure than usual. In order to mitigate that insecurity, we form cliques as they provide us with some sort of comfort in a chaotic environment. To reduce the risk of having cultural incompetence derailing the integration process, we always advise that everyone takes a crash course on cultural intelligence.”
To overcome potential flashpoints, it is imperative that senior management is able to provide guidance and leadership. “A company’s culture is often driven by the C-suite,” says Jonathan Corsico, a partner at Simpson Thacher & Bartlett LLP. “The culture of the C-suite will tend to flow down through the employee base and become the culture of the entire firm. Thus, if the two C-suites that are involved in the deal have similar cultures, that is a good sign that the cultural fit between the two firms will be good. Similarly, if the C-suites are different, then it is likely that the companies as a whole are also different. Therefore, C-level executives have to be brutally honest when evaluating both their own culture and the culture of the counterparty. A C-suite that misunderstands itself will also likely misunderstand the counterparty.”
Integration planning
In addition to cultural due diligence, companies should have a clear merger integration plan. Developing an integration agenda early on, often in parallel with early-stage due diligence, allows the acquirer to understand the culture of the other organisation and plan accordingly. “Integration planning after closing often leads to negative results,” points out George Casey, global managing partner at Shearman & Sterling. “The executives driving the deal should plan in advance, based on what they see and what type of culture they envision for the combined business organisation, based on what they see during due diligence. A significant part of cultural due diligence during the M&A process has to be focused on looking for signs of how people on the other side of the table act, how they arrive at decisions, how they negotiate and if there is any aggressive or disrespectful behaviour.”
The C-suite must play a key role in establishing post-merger integration plans, however, some companies underestimate this process. “There are several reasons for this,” notes Dr Majlergaard. “One is that the companies lack the competences to estimate the complexity of the project. Realising one’s own lack of competence is often tough. Another reason is that there is no real interest in the post-deal integration. That is because the financial incentives for the parties involved usually are limited to getting the deal signed. Often, no one cares about the integration process.”
The approach to post-deal integration differs significantly from company to company, and past experience is a major factor. “Many of the companies that are active in M&A do understand the importance of integration,” suggests Mr Casey. “But we see from time to time, where the deal team is driving the deal process as well, a dedicated and a well thought-through integration planning process is often lacking.”
According to Mr Corsico, an experienced acquirer has probably learned the value of integration planning and knows how much time and energy it consumes. “On the other hand, if the acquirer is not experienced, it is easy to get lulled into a false sense of security, where the acquirer underestimates the time demands and general difficulty of a successful integration,” he says. “Ultimately, acquirers that are experienced at M&A usually identify the importance of a good cultural fit. However, this does not mean that they can successfully identify which targets will and will not fit. Identifying the importance of the fit is just step one of the process. Steps two through 500 relate to evaluating the fit and bridging any gaps in a way that both acquirer and target employees feel cared for, respected and valued.”
In the UK, the regulatory regime tends to focus the minds of bidders on their post-completion integration plans at an early stage. “On a public M&A transaction governed by the UK Takeover Code, a bidder is required to explain in its offer documentation and announcement the long-term commercial justification for its offer and must state its intentions regarding a number of matters that have implications for post-completion integration planning,” says James Fletcher, a partner at Ashurst. “This includes the company’s intentions relating to the future business of the target, including its intentions for any research and development functions of the target, its intentions relating to the continued employment of the employees and management of the target and its strategic plans for the target, and their likely repercussions on employment and on the locations of the target’s places of business, including on the location of the target’s headquarters.”
Continuing to evaluate the cultural fit of the two organisations is another important step. Corporate cultural change is perennial. “As a company, you constantly have to adjust your culture so that it is attractive to employees, customers, society and all the other internal and external stakeholders,” says Dr Majlergaard. “Companies can struggle with finding out how they should change in order to become attractive for the next, much smaller generations. Companies are increasingly considering other areas. For example, climate change consciousness can be integrated into a future corporate culture. The emergence of artificial intelligence and automatisation are other areas that are pushing cultural changes in a number of companies. So the cultural change wheel should be spinning at all times, and faster than ever before.”
While cultural integration is undoubtedly difficult to measure, it should become clear in time whether the process has been successful. “Within a year or so, it should be visible whether people within the organisation continue to refer to their colleagues by reference to the pre-deal companies or by reference to a joint team within the combined organisation,” says Mr Casey. “It should also be visible whether the combined organisation has developed a consistent and coherent decision-making process or whether decisions continue to be made differently depending on where the employees came from. The most successful companies start focusing employees on common goals and the path to achieving them, make a concerted effort to have people from the different organisations work together on a daily basis as joint teams in driving value for the combined enterprise, all of which helps develop a feeling among employees that ‘we’ means people coming from both organisations and the word ‘they’ quickly fades away.”
Ensuring that cultural integration processes drive value creation is an important but challenging task. “It is about creating a set of shared values and making those central to how the combined organisation operates,” says Mr Fletcher. “Companies should consider including in senior managers’ appraisals an assessment of how they have upheld and promoted those values. This helps to ensure that the business has role models for those values and helps to set ‘the tone from the top’.”
In order to generate expected returns, culture should be at the heart of any merger. Prudent companies will identify and alter specific behaviours where necessary to ensure that culture can help them achieve their integration and value creation objectives.
© Financier Worldwide
BY
Richard Summerfield