Stage 2: Compete as an institution. The ability to integrate many acquisitions into a single operating company—and the knowledge of when to do this—are the primary determinants of whether a rollup will reach its promised financial and market performance. The key is to alter the modus operandi of the acquired companies, ensuring that they operate not as a loose confederation but rather as a large and cohesive institution. The changes required to cut costs and ignite growth are often huge, spanning all aspects of the business—from management and control to sales and operations. And the most successful rollups execute this critical stage with measured speed, precision, and certainty. (See "Focus: Quest Diagnostics," at the end of this article.) A rollup that fails to achieve these changes swiftly and accurately is left with higher costs and an unwieldy debt burden—and without the powerful growth engine it needs to flourish.
Stage 3: Achieve market leadership. The few companies that make it through Stage 2 are admirably positioned. They begin to redefine the rules of competition and reach attractive levels of profitability. Now, however, they may be competing with other rollups. Service Corporation, Stewart Enterprises, and the Loewen Group Inc. all were pursuing similar rollup strategies in the "death care" industry, just as Quest Diagnostics, Laboratory Corporation of America, and SmithKline Beecham PLC were in medical laboratory diagnostics. A common outcome in Stage 3 is a consolidation of two companies hoping to avoid a battle in the marketplace. Quest Diagnostics' acquisition of SmithKline's lab business to create the largest medical-testing company in the world is an example of this, as was the merger of Waste Management and USA Waste in 1998.
In the vast majority of rollups we've examined, the problems center on Stage 2. Too often, issues are not adequately anticipated, and the resources and personnel needed to address them are not put into place—a process that needs to begin shortly after Stage 1 begins. Typically, five key problems cause rollups to unwind:
1. Deal-makers dominate. The management team tends to be heavily weighted toward deal-makers, who lack the understanding, capability, and motivation to focus on what must be done immediately to consolidate the institution. Frequently, so many stock options are granted to existing management that few incentives are available to lure in professional managers.
2. Owners remain independent. Promises made to companies during the acquisition process, such as continued autonomy or independence from the head office, interfere with the mission to create a cohesive organization. Often the acquired company's owner is asked to stay and "earn out" the acquisition premium over time, which leaves the business as a separate unit so that performance can be accurately measured. This undercuts integration.
3. A sense of urgency is lost. The former owner-operators may now feel the business is someone else's problem. If they are still running field operations, this attitude can quickly kill even the best efforts to create value.
4. Stakeholders have competing agendas. The bankers or investment fund, the top management, and the former owner-operators often pursue substantially different initiatives. Frequently, the root of this problem is the lack of a common operating vision or business model. The remedy is strong leadership: a clear, well-articulated vision and operating plan shared across the entire organization.
5. Information systems are hard to integrate. Multiple systems in place at dozens of smaller companies can create minefields—in areas from billing to financial reporting to customer care—that leave a rollup hostage to a disjointed systems infrastructure. The situation is substantially more complex than a traditional merger, where two large entities might need to integrate a pair of discrete systems.