As for the second question, a company must make a hard internal examination of whether the targeted value of the deal can be realized by the management team of the combined enterprise, and, if so, whether the projected time frame is realistic. For an in-market merger, it is vital that all the associated risks, in terms of customer and competitive responses, technology issues, and culture challenges, be weighed. When they have been weighed, the salient question becomes, Can these potential risks be managed? If preserving increased market share is a key driver of value, for instance, leaders had better be sure that the executives of the new company know their customers’ needs, can meet them, and can fend off competitors who will surely try to pick off customers and clients during this period of uncertainty.
Although testing whether a company has the capabilities to realize projected synergies is particularly important when it involves an in-market merger, out-of-market purchasers are well served by a similar internal analysis that helps them understand the key drivers of value in the target company (people, technology, specific customers) and what the key management requirements will be in the new organization.
The Deal’s Rationale
To focus strategic due diligence, it’s necessary to pinpoint the value-creation opportunities of each transaction. To assist in this process, we have identified two dimensions that influence the strategic rationale and underlying value-creation focus of a deal. These two drivers are shown in Exhibit 2. On one axis, the degree of integration between acquirer and target drives the size and number of potential synergies. On the other, the relative sizes of the acquirer and target influence whether “best of breed” solutions from either company will be adopted, or whether the target will simply be absorbed into the acquirer’s business model.
Mergers that are intended to strengthen current market position or that seek new growth opportunities by either entering a new market or developing new capabilities all have their own unique “degree of overlap” and “relative size,” but we have found they fall into one of four categories when we perform this analysis. We have named the categories in-market consolidation, in-market absorption, out-of-market transformation, and out-of-market “bolt-on.” Our four categories are broad, but we believe they are useful groupings that can serve as starting points for shaping any strategic due diligence effort.
Let’s take these four M&A categories one by one, recognizing that strategic due diligence always aims to validate the assumptions underpinning the strategic rationale.
The rationale for an out-of-market transformation (large target, low integration) is typically to transform a business by pursuing significant growth and broader capabilities in a new, attractive market. These are often “bet the farm” deals in which a company either extends the reach of its existing products or services into a new geographic market (such as with telephone and cable mergers), or diversifies into a new set of products and services (such as with a private equity group or conglomerate).
In this case, the strategic due diligence process should focus on testing the new market’s attractiveness, assessing the target’s competitive position, identifying critical capabilities and resources that need to be retained, judging potential market responses, and evaluating whether there are best-of-breed management practices or operating models that should be adopted across the organization. Also, those performing strategic due diligence must understand the complexities of governance where there is minimal formal integration; the systems and policies used to run the still distinct businesses should be uniform, and “legacy” people from both former companies should be dealt with consistently. Two distinctive cultures mean that cultural issues will manifest themselves in myriad ways and need to be well understood.