Three Disciplines To Beat The Merger Performance Odds

by Katrina Pugh

Mergers fail for several reasons and one of the most common is the failure of managers to plan how to retain the knowledge that existed in both organizations before the merger. Or, simply put, knowledge is too often lost in the merger. A simple solution, meaningful conversation properly organized and structured, will help managers combine not only the companies, but the all important knowledge that employees in both organizations have. This author describes how to do it

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n response to the recession’s toll on businesses, as well as the current low costs of capital and rising levels of cash, economists have been forecasting a surge in M&A activity. That such a surge was already gathering steam became apparent in the first 16 weeks of 2011, when Reuters carried a hefty 8,510 articles on M&A. In April, we stood on the brink of one of the most influential mergers in the financial markets: The potential combination of NYSE and the NASDAQ-Intercontinental Exchange (ICE) venture. According to an April 19, 2011 letter, the NASDAQ-ICE team was “deeply committed” to a merger with the NYSE. It had offered a 21 percent premium over Deutsche Boerse’s competing offer, acquired $3.8B in secured financing, $66M in voting NYSE securities, and made a $350MM reverse breakup promise.1 It all but provided the roses and chocolates. Well, almost.

NASDAQ also indicated that it would split the combined company in two, and hinted that it would aggressively cut operating costs by eliminating redundancies on the floor, in the back office, and in management. In the end, the less-aggressive Deutsche Boerse won the war of the suitors: By May 16 the NASDAQ-ICE venture had withdrawn its bid, but only after the U.S. Department of Justice threatened a lawsuit, a threat that sent the NYSE Euronext market cap down to its lowest level in 30 months.

If NASDAQ was unhappy that it didn’t get to the altar, it need not have been. Marriages between businesses fail far more often than they succeed. As research by the Wharton School and executive recruiter Heidrick and Struggles concluded, the failure rate for mergers in the 1990s and 2000s has been as high as 74 percent over one to five years after the deal has been done.2

In fact, merged organizations lose twice: once when valuable employees leave and once when know-how is lost. This can occur even when employees with know-how survive the cuts, as that know-how is often invisible to the many merger integration teams. Knowledge loss or fragmentation slows down work, hurts quality and compromises service levels, making the merged entity far less than the sum of its parts.

Articles and cottage-industry consultants abound with advice on merger due diligence, leadership, communications, measurement, and rationalizing work. However, little practical advice is offered for identifying and integrating the know-how that is now dispersed throughout the merged organization.

This article introduces the Knowledge Jam, a process and a set of disciplines – indeed, a culture – for surfacing and translating know-how into productive work in the merged organization. Knowledge Jams target pockets of knowledge, use facilitated conversation to surface insights, and rapidly apply that knowledge to the task of making and developing new products, processes and structures. Intentional knowledge integration replaces and compensates knowledge flight, and a “jam” culture improves employees’ sense of fairness, belonging and transparency.

It’s the knowledge, stupid
Businesses merge to improve efficiency, get into new markets, expand market power, accelerate innovation and increase new product launches. But all too often the merged organization fails to achieve these goals. Merger performance, as defined by stock performance, has grossly underperformed management expectations. Researchers agree that mergers fail between 40-70 percent of the time. They blame a lack of objectivity in the due diligence, poor executive leadership, communications failures, bad technology bets, data integration failures, and customer defections. These may all be true, and there is great evidence to support all of these reasons.

But new evidence indicates that these reasons are symptoms of a larger problem: knowledge fragmentation. Knowledge fragmentation is the dispersion of know-how around the firm in employees’ heads, habits, and hard-drives, with no coherent alignment with the new work and processes of the combined entity. A recent study at American University sheds some new light. Researchers Robert Feinberg and Ralph Sonenshine studied 63 publicly traded mergers from 1996 to 2006, with deal sizes ranging from $50 million (3D Systems-DTM) to $120 billion (AOL-Time Warner). Feinberg and Soneshine’s general results agree with the previous research by the Wharton School and Heidrick and Struggles. Across the newly merged companies, Feinberg and Sonenshine found cumulative abnormal returns (risk-adjusted cumulative share price gains), or CARs, of minus 4 percent, 17 percent and 29 percent over one, three and five-year periods, respectively.3

Their specific results are more compelling. The researchers observed that out-sized “intangible assets” (market-valued assets in excess of book value) have a long-term positive impact on firm performance, lifting CAR on average by 5 points. However, they found that the very mergers in which you’d expect to see these intangible assets appreciate – horizontal mergers joining big R&D groups—appear to lose their advantage and subsequently, the intangible asset premium.4 This is ironic, says Sonenshine, as he points to an earlier article showing that acquirers with high R&D-intensity pay larger premiums, so their investors will be even more disappointed with the eventual merger stock performance.5

Why we fail to capitalize on the knowledge in a merger
Short hand for intangible assets like large groups of R&D employees is “knowledge.” Why is it that the returns on merged knowledge are so elusive? Part of this is talent flight. Wharton management professor Martin Sikora, editor of Mergers & Acquisitions: The Dealmaker’s Journal, notes that talent flight is a pervasive problem. It’s part of what he calls the “merger syndrome,” resulting from victory-like messages and job-cutting actions by the new management.

But knowledge loss that is even more insidious than talent flight is talent invisibility. All too often function rationalizations, image management, and position jockeying distract leaders from focusing on knowledge retention. Such leaders under-invest in identifying, transferring and capitalizing on the know-how dispersed throughout the two firms. I describe this under-investment as “knowledge blind spots,” “knowledge mismatches,” and “knowledge jail.”