Mergers & Acquisitions: Considering the intangible
Failing to audit non-financial assets such as governance, brand image & client relationships increases the danger of making a wrong acquisition
The past couple of years have been a busy time for Asian dealmakers. According to news reports, merger and acquisition deals in 2011 grew by more than 40 percent over the past year, amongst which the lion’s share of inbound deals was lapped up by the Asia Pacific region (excluding Japan). The bullish outlook means we can expect further consolidation among Asian industries, with companies hoping to increase market share, enhance competitiveness and improve bottom lines through inorganic growth.
However, buyers should beware. M&A deals are inherently risky and anyone planning a merger or acquisition needs to ensure that their substantial investment pays off. One of the most serious stumbling blocks is that typical methods of deal evaluation are flawed; neither investors nor their advisors evaluate the intrinsic value of intangible capital – the non-monetary assets that cannot be seen, touched or physically measured, and so, are hard to quantify or value, but which include most of the key drivers of deal profitability.
Research conducted by Hay Group’s global R&D center for strategy execution in 2011, in collaboration with Harris Interactive, identified the key elements of intangible capital that have the greatest impact on post-merger integration and on the ultimate success of M&A transactions. The study reveals that business executives do not spend enough time assessing the value and ‘fit’ of a target’s intangible capital in the early stages of a transaction. As a result, they fail to identify the risks attached to it, and are unable to mitigate these risks effectively during post-merger integration. Most M&A failures can be attributed to this lack of attention to the human capital.
Evidently, focusing on deal-related intangible capital will pay big dividends in the longer-term through increased shareholder value. Executives and their business advisors need to quantify the intangibles for better management of such capital.
Essentially, intangible capital covers three areas: organizational capital, such as management processes and organizational culture; relational capital, such as brand position, customer management, partnerships and networks; and human capital, including knowledge, skills, leadership and employee engagement.
It is vital to assess these intangible elements in addition to tangible assets as early in the deal lifecycle as possible. As per the research, two-thirds of executives believe that an increased and earlier focus on intangible capital during the M&A process would have improved the success of their mergers. Furthermore, just over half of executives say that failing to audit non-financial assets such as governance, brand image and client relationships increases the danger of making the wrong acquisition.
Executives often assume that intangible capital is static and retains its value throughout the deal’s lifecycle. In reality, its value fluctuates in reaction to internal and external change. A target firm’s intangible capital is usually at its strongest in terms of value and stability at the start of a transaction. However, as the market hears rumors of a potential buyout, aspects such as client loyalty, brand image and employee commitment begin to destabilize, decreasing with each step of the pre-deal process. By the time the deal completes, intangible capital is at its most volatile and the proportion of shareholder value at risk is at its greatest.
The biggest challenge then would be - assessing an asset that has no physical form.
The answer lies in identifying those elements that have the most significant impact on the value of intangible capital. While it is vital to close the gap between the intangible capital of the target and acquirer companies, management needs to devote its attention to the ‘core drivers’ of intangible capital, rather than to intangible capital itself. Our research suggests that there are two such core drivers that can make or break any M&A deal – the extent of alignment of the leadership of the two companies involved, and on the alignment of their respective cultures.
The first, leadership alignment, is essentially a meeting of the minds on both sides. Early in the post-merger integration, executives should take the time to align their individual and collective expectations around the key focus areas, such as: brand positioning; client relationships; ownership and management; and, the new governance model.
Equally important is leadership decision-making behavior. Two-thirds of respondents to Hay Group’s M&A pulse surveys said that slow decision-making was a key barrier to effective integration. When decision-making roadblocks occur, leaders need to display the ability to overcome these situations – and quickly. In order to show colleagues and counterparts how the business will be run, right from the start, leaders need to be clear about: who is responsible for which decisions; how decisions will be made when executives cannot agree; and, what approach will be used to analyze decision-making obstacles.
The second aspect, the alignment of cultures, is a matter of the attitudes towards agility and risk-taking. Merging firms that have comparable organizational cultures are more likely to understand and support each others’ actions and decisions. However, Hay Group’s research suggests that executives targeting companies for merger or acquisition typically focus their due diligence efforts on the wrong issues. When asked if they conduct cultural analysis during the pre-deal phase, only 38 percent of executives surveyed said they did. And while executives are not blind to the value of carrying out a culture due diligence study, nearly 60 percent said they struggled to obtain information about the culture of the target company. Consequently, the majority (54 percent) admitted that failing to audit business culture increased the danger of making the wrong acquisition.
Culture is a strong driver of merger performance for primarily two reasons – the attitudes to risk-taking and organizational agility. While M&A is intrinsically a risky business, firms with the same relative tolerance to risk-taking are better able to deliver merger objectives. Culturally, it is imperative that both firms display a common positive appetite for risk-taking so that critical actions can be taken. Our research has also found that an agile culture is more likely to win the M&A game. During a merger, executives tend to consult widely to ensure everyone’s interests are considered before decisions are made, in an effort to display cultural sensitivity. But not making any decision is a decision in itself, and one which could jeopardize M&A success. In an agile culture, leaders understand the impact of timeliness and decisions are made as quickly as possible, on the basis of sound information, judgement and experience.
A successful M&A strategy depends on application of the right insights: first to identify the best transaction and second, to create value as quickly as possible. Having a clear understanding of what you are buying and how it ‘fits’ with your existing company through intangible capital analysis will help you achieve both of these goals.
Executives who pay active attention to intangible capital are more likely to create the right conditions for deal success and to deliver significant shareholder value from their acquisitions. This will be particularly valuable to their organization in an unpredictable economic environment, where growth is increasingly dependent on effective strategic decision-making.
ABOUT THE AUTHOR
Gaurav Lahiri is Managing Director at Hay Group India