Most Acquisitions Fail Because Buyers Miss This One Thing

They start with the best of intentions.

The CEO of BuyerCo — a large, cash-rich, but sluggish company — wants to buy younger, more nimble TargetCo. It will be a game-changer, he says. TargetCo will bring in new capabilities, fuel growth, and expand BuyerCo’s reach. BuyerCo’s board approves the deal, TargetCo accepts the offer, and NewCo is formed.

Months (if not weeks) later, the two cultures clash. TargetCo misses its financial targets for the first time in recent memory. Its market momentum slows; its market share slips. TargetCo talent starts to leave. Within two years, few of the synergies promised in the investment thesis have been realized. NewCo’s finance team is preparing for a significant goodwill write-off. Trade journals call the deal a loser. Suddenly, everyone was against it from the beginning.

When it comes to mergers and acquisitions (M&A), flops are incredibly common. In fact, 70–90 percent of acquisitions fall short of buyer expectations. Buyers are routinely overconfident about the benefits a deal will yield and unprepared for the complexities of integration.

M&A deals fail because buyers pay too little attention to the inner workings of the target company’s organizational operating system (OS).

The Ready has written extensively about the organizational OS, but in short, it is the constellation of things a company does (processes), uses (tools), and prioritizes (principles) to fulfill its mission.

Comprising nine key dimensions, an OS encapsulates everything from the way a company recruits and rewards people; its product and innovation practices; its investment allocation process; its information and communication tools; its ethos around delegating authority and making decisions; its governance practices; its values; its utilization of space; its strategic cadence; and more. Analysis of these dimensions provides a reliable snapshot of organizational health and resilience.

It’s the buyer’s lack of (full) insight into a target’s OS, particularly at the due diligence phase, that leaves buyers ill-equipped to successfully steer the integration after the deal.

If you’ve ever been on the sell side of an M&A deal, you know it’s the business equivalent of a diagnostic colonoscopy, only less enjoyable. It’s an exhaustive process designed to surface everything there is to know about the seller on four dimensions: financial, legal, strategic, and managerial.

During the financial and legal diligence, analysts pore over the documents in the seller’s data room. They excavate the financial statements and scrutinize operating plans, supplier contracts, and major customer accounts.

The strategic part of diligence tries to identify and validate all the areas of possible strategic alignment between acquirer and target, also known as “synergy.” Where might the target help the buyer enter new markets, better serve existing customers, achieve operating scale, or gain a new capability? The target’s senior management team usually gets a hard look as well.

With all the insights obtained from due diligence, the buyer creates an elaborate investment thesis, financial model, and valuation. Done well, diligence identifies all the merits of a deal while simultaneously quantifying various types of deal and integration risk: market risk, cash flow risk, key-man risk — you name it.

So far so good, right?

It isn’t until the integration phase, when the pressure to realize all those “synergies” revs up, that the gaps in due diligence become clear.

Like most buyers do, our BuyerCo management team begins phase one of integration. They merge BuyerCo’s and TargetCo’s marketing, finance, legal, and IT teams. Then they consolidate offices and make BuyerCo’s headquarters the HQ for NewCo. They begin to eliminate redundant back-office systems, and increase the frequency and rigor of TargetCo’s reporting.

BuyerCo’s CFO, now CFO of NewCo, rolls out BuyerCo’s investment approval process and expense policies across NewCo. The CTO of NewCo (also from BuyerCo) promises to unify BuyerCo and TargetCo around a single product development methodology. The NewCo CHRO enlists his HR managers to transition TargetCo’s employee base to BuyerCo’s reward system.

Their behavior is rational. No executive wants to manage an array of uneven practices within the same organization.

It’s also destructive. With each tweak, they are dismantling critical elements of TargetCo’s operating system without an understanding of what purpose those practices served, how costly they will be to change, or to what extent TargetCo’s performance will be harmed by them. Before they realize it’s happening, Target’sCo’s success formula unravels.

Now imagine a due diligence process that asked:

  • What are TargetCo’s ways of working?
  • How sensitive is the company’s performance to those ways of working?
  • In what areas would imposed change to current practice pose the biggest risk to the company’s organizational health?
  • Where are the biggest organizational clashes between buyer and target likely to be? Are they surmountable?
  • What are the target company’s biggest organizational vulnerabilities?
  • Which vulnerabilities, if fixed, could unlock significant enterprise potential?
  • In what areas of the OS should TargetCo’s approach replace BuyerCo’s? And vice versa?
  • When is it advantageous to let each organization run autonomously?
  • What will it truly take — in time, investment, and management distraction — to cohere the newly combined org?
  • Are the organizations sufficiently compatible and/or adaptable to deliver the value the investment thesis and financial model is promising?

Assessment of organizational fit and fitness is a dire blind spot for most acquirers, one that can lead to value-destroying outcomes like off-base valuations, botched post-purchase integrations, and the pursuit of illogical deals. So, before any acquisition, incorporate organizational due diligence as part of your M&A process.

Below are examples of common integration challenges that deep organizational due diligence would help to avoid:

I’ve seen large, staid corporations acquire inventive, dynamic companies in hopes of soaking up the target’s youthful agility…and then I’ve watched them suffocate the target with the weight of their bureaucracy. Without deliberate intervention, a buyer’s OS will almost always muscle out the target’s.

A smarter approach is to decide upfront which practices and aspects of your own OS you are willing to disrupt and subordinate to the target’s way of working.

To really test what life post-deal might be like, try designing the OS of NewCo during diligence. When you overlay your OS and theirs, where do you and TargetCo match up, complement, and clash across the nine dimensions?

Are there enterprise tools and practices you have in common? If so, then you can probably assume faster, less costly integration in those areas. Complementary areas, where your different ways of working can beneficially co-exist, are the most realistic opportunities for synergy and capacity-building. But in areas where you clash, which system will prevail? How much money and time will it cost to pull off the flip successfully? Make sure you have fully accounted for these synergies, risks and costs in your financial model and integration plan.

Obtaining the information you need to map another company’s operating system is challenging, so where do you look? The easy answer is to hire a firm with a reliable methodology for assessing organizational health and identifying integration threats and opportunities.

If you’re flying solo, however, you aren’t likely to find the information you need in the seller’s data room. Start by contacting former employees from a range of divisions and levels within the organization, as well as customers, suppliers, and industry analysts.

Pore over the organization’s recent employee engagement surveys, if available, as well as employer review sites (like Glassdoor). Study the company’s formal organization charts and major role descriptions, then validate what you see with the aforementioned experts to understand where paper matches or deviates from reality. By the end, you should have a good picture of the organization’s formal and informal structures, a mental map of their formal and informal decision-making processes, and more.

Of course, not everyone will be keen to undertake this level of organizational diligence. Investment bankers and many executives would prefer the relative straightforwardness of financial and strategic analyses over the thorny nature of measuring organizational system fitness and fit. But if you want integration to succeed, not just the deal, this is the work to be done.

And the potential payoff is enormous. Avoiding a costly acquisition mistake is one obvious one, but you also increase the potential to find untapped value or hidden costs that may impact valuation. And, you’re more likely to identify the sources of value-destroying post-purchase org conflict, which gives the team an opportunity to properly mitigate or eliminate them.

Organizational due diligence has one last edge over financial and strategic diligence: keeping the team’s eye on the marriage you’ll share after the acquisition, not just the exciting courtship.

For help assessing the organizational health of your next potential acquisition, contact The Ready.