Executive Summary
The standard explanation for failed M&A deals points to integration as the problem. It turns out that this is more of a problem for companies that are acquiring complementary businesses that they know quite well. That’s because integrating the new business isn’t entirely the story. Your customers need to have a reason to like the new combination, which may require change as well as integration.
According to most studies, between 70 and 90 percent of acquisitions fail. Most explanations for this depressing number emphasize problems with integrating the two parties involved. That’s perfectly true, but my experience suggests that integration problems are particularly severe in cases you wouldn’t necessarily expect — when the acquisition is a related diversification, that is a “complementary” business, which the acquirer understands quite well. The case of Quadrant illustrates my observation.
Quadrant, not its real name, is a public company in the printing business with nearly 4,000 staff. It has a national footprint and its clients are companies and government departments which require large print runs of brochures, magazines, catalogues and marketing material. The company’s share price had been on a gradual downward slide since it floated in 2008. In 2017 it stood at a quarter of its original price. Shareholders were hurting and directors were under pressure to act.
Diversification to the Rescue
In 2017 the board decided to counteract the downward spiral by diversifying via acquisition. This would bulk up the business in terms of services and add more revenue to the enterprise. The board also needed to find a business with better profit margins.
But this was not to be just any diversification. The new acquisition had to be “related.” The board alighted on a firm in graphic design. The hope was that both businesses would complement each other, and that clients would buy printing and graphic design services. The board expected each business to cross-sell to its existing clients. This relationship was the driving motivation for the acquisition.
By 2018 things were not going quite as smoothly as the board had hoped. As Mike, the CEO, put it, “we’re facing challenges in integrating the two businesses.” At this point, they asked me to conduct a strategy review to unravel what was going wrong. I can tell you now that the acquisition didn’t end well, in fact the acquired entity was eventually sold, thus joining the long line of acquisition failures that that feed the business news pages.
Even back in 2018 when I conducted my review, this fate was clearly signaled. I undertook three sets of interviews to get to the heart of the problem. One set involved the five members of the board, another nine senior managers, and another a sample of “key clients.” The interviews were designed to uncover any obstacles going forward and, in the clients’ cases, to get their assessment of the likely success of the corporate marriage. So what was going wrong?
Integration Fixation
Let me start with the results of my interviews with the five directors. In answer to the question, “What are Quadrant’s key challenges?,” integration came up as an imperative with all five. Their reputations depended on the success of the acquisition. I received a range of responses around integration challenges, such as “building a single culture; ensuring that we have a commonality of thought; being excellent at collaboration; cross selling; sharing clients; leveraging the service lines.” As one director put it succinctly. “Integration has to be our focus. We’ve put a lot of energy into this.”
“Integration” was also cited as a key challenge for five of the senior managers who worked in head office. When I asked the four regional managers who were not in head office but located far and wide, integration was still a concern, but they also expressed more local apprehensions. These included “finding staff with professional skills; dealing with added bureaucracy; differentiating from competitors; dealing with shrinking margins; and retaining staff.”
It was clear from this and other questions that bedding the new acquisition down was top of mind. It was also clear that the more senior respondents were, the more it weighed on their minds. Everyone had great hopes that the acquisition would work. It must be said, though, that this hope was coupled with considerable anxiety at top management and board levels.
What Did the Clients Think?
The final arbiters of the acquisition’s likely success are, of course, clients. The directors and managers were on tenterhooks when it came to the results of these interviews. They couldn’t wait to hear what their clients thought.
We decided on interviewing 10 “key clients.” These were spread across the range of client types and the person to be interviewed in each organization was nominated by Quadrant’s management. Each was the key decision-maker when it came to choosing Quadrant or the competition as suppliers.
While “anxiety” best describes the emotion of Quadrant’s board and senior management when it came to cross-selling between printing and graphic design services, “disinterest” would best sum up clients’ emotions. Some clients only needed one of the two services offered. Others couldn’t see the logic and benefits in coupling both. This wariness was indicated by comments such as this from a client with a national footprint “each state office is different — they make their own decisions.” But the summary comment was this, “I’d need to be convinced. Someone would need to talk to us.”
Clearly, Quadrant’s clients were not particularly celebrating its big business model breakthrough. While in the boardroom and in the heads of the directors, the complementarity looked great, the clients simply couldn’t see it. The hopes of the board had been dashed by the cold commercial reality of clients’ bottom lines.
Beware the Related Diversification
Corporate acquisitions come in three forms: same-industry, unrelated, and related. Quadrant had made same-industry acquisitions in the past, when it had purchased other printing companies. Integrating these was paramount and required branding and systems changes, but by and large these same-industry acquisitions went well.
At the other extreme lies the unrelated diversification. In this form the acquired firm is from an industry unlike that of the purchaser. There’s relatively little need for integration in the so-called conglomerate model. The Australian company Wesfarmers is one example, with businesses in a variety of different industries, including hardware, supermarkets, and clothing stores. Each company stands alone.
Then there’s related diversification, a precarious blend of the other two forms that poses special risks. Management is required to undertake a double challenge. To be sure, integrating two operations is an issue, but this form of acquisition also requires a business model change affecting both acquirer and target that would make existing customers on both sides (acquirer and target) see enough value in the expanded product range to change their existing purchasing behaviors for the products in that range. This was not the case in Quadrant, where customers simply couldn’t see the point of combining the two.
In late 2019 the acquisition was unwound and sold off. The share price had tanked to less than a tenth of its float price. Of the three non-executive directors, two resigned. One of these was the chairman. The fatal blow came because management misread their customers’ needs and consequently, the business model failed.
So next time you’re tempted to undertake a related diversification check your inside-out view against the outside-in view of your customers. Jump up from your desk and go talk to them. Test your hypothesis, since that’s all it is, against the cold hard reality of the clients’ worlds. You could save yourself a lot of money — and trouble.
