Getting Smarter About Mergers and Acquisitions


Welcome to HBR IdeaCast from Harvard Business Review. I’m Sarah Green. I’m in the studio today with Andrew Waldeck, a partner at the innovation and consulting firm Innosight and the co-author, with Clayton M. Christensen, Richard Alton, and Curtis Rising, of the March 2011 article, the New M&A Playbook. Andy, thanks much for coming in.

ANDREW WALDECK: Thanks for having me.

SARAH GREEN: At the start of the article, you review some of the dismal failure rates for mergers. Something like 70 to 90% of them fail and acquirers always seem to overpay. But the deal volume in 2011 so far has been much higher than last year. Can you tell us what’s going on? Why is this happening? Why are people still doing this even though they’re seemed doomed to fail?

ANDREW WALDECK: Sure. Well, an important piece to remember is, first of all, the environment has a lot to say in this. So, coming out of the financial crisis, we now are in an environment where the financial markets have stabilized. So companies can actually get financing to do transactions. And then secondly, companies are realizing that just cost-cutting alone isn’t going to be sufficient to achieve their strategic goals. And so you see them turning to M&A more in this environment.

The broader issue is that M&A always has this lure, a lure to managers. Which is, it’s a way to transform my business, make a radical bold step. And so, acquisitions always seem as this attractive, elusive target for managers to pursue.

SARAH GREEN: Well, let’s talk a little bit more about the attractive strategies behind these. Because at the heart of the article is a difference between a couple different kinds of acquisitions. Can you explain the two major kinds of acquisitions that you talk about in the article and maybe walk us through some examples?

ANDREW WALDECK: Sure. So what we lay out in the article is this fundamental argument that says that the scary statistics around M&A are really the result of a categorization problem. And so, there are tons and tons of research that’s been done on the field of M&A. But much of that research is around describing the attributes of transactions, rather than thinking through what’s the fundamental purpose of a particular deal. And so in our research, what we found were there were actually two distinct purposes that drive a manager’s desire to pursue a transaction.

In one of those cases, a manager’s looking to improve the performance of their current business model. So they’re looking to either increase their prices or improve their cost position. And so in that case, the types of transactions that you would pursue there, we characterize as being ones that are leveraging your model. That’s different than the other purpose, which is where you’re really trying to fundamentally transform your business. Here, you’re looking at ways to expand into new markets, go after new customers. And in that instance, we describe those transactions as reinventing my model.

And the reason why we felt it was important to call out these two different circumstances is because they actually drive fundamentally different behavior. And so the type of a deal that you would target for a leverage my model transaction is fundamentally different than what you would do in a reinvent my model transaction. And then similarly, how you think about evaluation is different, as well as then how you think about integration also.

SARAH GREEN: So can you give us an example of maybe what the reinvent my model kind of acquisition looks like versus the leverage my model type?

ANDREW WALDECK: Sure. So a proven successful reinvent my model transaction would be what BestBuy did when they acquired Geek Squad. So there, they acquired a fundamentally different business model that they then placed inside of the store that gave them access to a new revenue stream, but also then further supported the overall value proposition that they were offering to customers and consumers in their stores. That’s different than what you see in leverage my model acquisitions where fundamentally what you have is a company acquiring a set of resources that further strengthen its existing model. You see this a lot of times in pharma, where you see big pharma acquiring new technologies, new drugs, new therapies that they can then put into their sales force that then maximizes the value of that existing model that they have.

SARAH GREEN: Now, it sounds like to me when you’re talking about the reinvent my model– that to me intuitively sounds like it’s actually better than the leverage model. Is it actually better? Or are they just different, and difference strokes for different folks?

ANDREW WALDECK: Yeah, no, that’s a great question. And frankly, the leverage my model transactions sound a little bit pedestrian. But they’re actually critically important. And that is the source of where great value can be created. And so, the first step that a manager has to do is strengthen that core business. And so, the majority of transactions that you see out there are actually leverage my model types of transactions.

Not every management team should be pursuing a reinvent my model type of deal. In many cases, where they should be focusing is on strengthening that core business first before they try to actually transform the existing model that they have.

SARAH GREEN: Are there certain industries though where the reinvent my business model type acquisition is actually more effective– or certain industries where that type of acquisition will be more suited to success?

ANDREW WALDECK: Certainly in cases where you see industries going through pretty significant change. So oftentimes that can be regulatory change. It can be a technology change. Look at where both financial services and health care are today. Both of them are facing– in the case of health care, we have health care reform which has dramatically changed the business model and the economics for some players. In financial services, we’ve had some regulatory change in the specter of additional regulatory change. Both of those environments would create opportunities for companies to think about how do they fundamentally recreate business models that position them then for success in the future.

SARAH GREEN: So, I want to get a little bit into the weeds on implementation here because we’re talking about things you should think about before you decide whether to buy a company. One of the examples in the article I really liked was when you talk Chrysler, because I think people like to pile on Chrysler. But from the way you talked about in the article, it really sounded like this was an implementation problem when they were bought by Daimler. So can you just talk us through that a little bit and some of the implementation challenges?

ANDREW WALDECK: Sure. So the challenge in any acquisition and particularly in a leverage my model type of acquisition is thinking through what are the specific resources that I want to plug in to my existing model, and are those resources, in fact, truly plug compatible. So when we talk about plug compatibility, what we mean are, can I take an existing resource from the acquired company, put it into my existing model, and have it have either a neutral to positive impact on the metrics that are then used to evaluate the success of that particular model.

And so oftentimes what happens is companies, when they are making these integration decisions, will actually get that equation wrong. They’ll try to integrate the wrong pieces or undervalue certain resources that a company might have. And so in the case of Daimler, where you look at what Daimler did with Chrysler, Chrysler had certain competencies around the product development process which actually would have been a source of value for Daimler. But in the integration process, Daimler put the wrong pieces together or emphasized the wrong pieces when they thought about integration.

SARAH GREEN: So let’s look at a more current example and see if we can look into a crystal ball here. Have a little bit of fun. Everyone’s talking about the Huffington Post acquisition by AOL. If you’re a fly on the wall or an executive in the room, what do you think they should be thinking about now to make sure that is implemented successfully?

ANDREW WALDECK: Yeah, well the first question, probably no surprise, is to first ask the categorization question. To say, what type of a transaction do we think this is? And it certainly appears like the AOL, Huff Post combination is a leverage my model transaction. Where AOL has been in a quite aggressive restructuring process to create what that new model looks like in the future. They bring in their capabilities of the Huffington Post, particularly with their expertise around content and frankly the audience that the Huff Post has, as a way to then improve the performance of AOL’s overall model.

In particular, their ability to drive higher prices on advertising because of the attractive audience base that Huffington Post brings. And so, if that is in fact the correct categorization, then the next question to think about then is, is AOL thinking about integration in the right ways? And certainly when you look at Arianna’s position, where not only is she going to stay in charge of the Huff Post, but now she’s going to sit over all of the content pieces at AOL, would certainly signal that at least in the minds of the senior management team at AOL, they are viewing the Huff Post and that combination as a way to then further improve their content mix going forward.

And so then the fly on the wall advice would be, let’s make sure we’ve got the categorization correct. If we do, then let’s be clear about what are the specific set of resources we’re trying to integrate into the model. And then of course the third piece is, because the people are such an important piece of the resources of Huffington Post, are you doing actually the right thing to keep that management team and those other critical resources, who were so key, to then drive the value that you’ve paid for today, that you expect to come in over the next three to five years.

SARAH GREEN: Let’s talk a little bit here about the valuation process, because I know with all of these mergers and acquisitions that I’m reading about lately, it seems like the numbers that are flying around sometimes are almost like cartoon comic book numbers. Where do people get these numbers and how can you be sure that they’re really based on something?

ANDREW WALDECK: So the valuation question goes central to the field of M&A. It’s one of the topics that’s often written about and talked about. You look back across all the literature, one of the key failure mechanisms that is repeatedly cited and rightfully so, is that people overpay for transactions. So, what we talk about in the article is that, first of all, you have to think about valuation in the context of the type of opportunity you’re pursuing. And the valuation approach is going to be different in a leverage my model than a reinvent my model type of transaction. And all of this has to be framed from the perspective of what’s the value of an acquired entity to the existing business model in a case of a leverage my model acquisition.

And the challenge here is that oftentimes market forces drive companies to overpay in this circumstance. So if I am big pharma and I’m pursuing the next great therapeutic, the next great drug, I’m going to face intense competition from my other direct competitors for that particular asset, which oftentimes causes me to want to than overpay because I feel like I have to have that asset. I then start to put more pressure on finding cost synergies. All sorts of things that make it really hard to figure out what actually is the right price that I should pay for that particular acquisition.

You actually have the opposite problem when you’re trying to do a reinvent my model transaction. In this case, all of your internal approaches and processes are going to cause you to want to underpay what you should for that acquisition. So whether it’s the comparable companies that we look, the internal hurdle rates, all of these forces cause us to systematically undervalue reinvent my model types of opportunities. And what we try to show in the paper is that, in fact, if a company actually does have real transformational potential, you can actually pay a much higher price and still have that acquisition deliver economic value. Which, as a former finance person, is very hard for me to say that you should actually pay at even higher price for a transaction. But that actually is the case when you are focused on a reinvent my model acquisition.

And of course, to feel comfortable doing so– it places even more scrutiny on the upfront part of that to get comfortable that this particular company does in fact have that type of potential that would justify paying a higher price than you may have paid by traditional valuation metrics.

SARAH GREEN: Well, with a 90% failure rate, there certainly is lots of room to improve. Andy, thank you so much for coming in and talking with us today.

ANDREW WALDECK: Great. Thank you.

SARAH GREEN: That was Andrew Waldeck. And the article, The New M&A Playbook, appears in the March 2011 of Harvard Business Review. Have questions? The authors will be responding to comments on through the middle of March.

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