Beyond the Balance Sheet

Summary: In this white paper we examine how an unbiased marketing perspective can help avoid some M&A pitfalls and how it can set the stage for a value building post-deal integration effort. The primary examples cited are from beverage alcohol and telecommunications and show how failure to agree on the reasons to do the deal can thwart the ability to increase shareholder value.

Every day, acquirers thoroughly investigate the health of target companies by looking at the numbers. And year in and year out, thousands of seemingly sound acquisitions fail to increase shareholder value. In fact, an alarming number of them actually destroy value. Diet Raspberry Snapple anyone?

People outside of the M&A business would be shocked to learn just how high the failure rate really is. An oft-quoted KPMG study puts it at over 83%, with failure defined as the inability to increase shareholder value of the combined entity 5 years after the acquisition.

These M&A train wrecks aren’t a new phenomena either.

“Out of five mergers, two are outright disasters, two neither live nor die, and one works.”

Peter Drucker

Forbes, January 1982

In the 31 years since Drucker’s comments appeared, the results haven’t improved. 31 classes have graduated with advanced degrees in the law, economics and business management, but they haven’t improved on the success rate. The expectation is that 2 + 2 = 5 when the equation more often is 2 + 2 = 3.

Even those deals that simply hold the line are hard pressed to explain why the effort and money spent was worth it. So other than the thrill of the deal, you have to ask yourself, “what was the point?”

Why do so many deals fail? Why do really bright people conduct such detailed financial reviews and yet stumble so frequently? How do major league financiers who can turn the numbers inside out produce batting averages that would have them on the next bus back to AA ball?

We think it is not what the numbers say, but what they don’t. The numbers might tell you how much of something the target makes, what it costs and how much profit it generates. But for most companies the making is only the prelude to its real business: the marketing … the whole process from shipping out the door to the consumption by the end user.

The point of any business is to sell what they can make. And how they sell it, how skilled they are and how much longer the market will exist is not buried in some financial report. These are marketing questions and marketers are best equipped to ask them and to sift through the answers.

No matter how a balance sheet is sliced, diced, torn apart and reassembled, it won’t tell you enough about the brands and their relationship to the customers. These customers might be other companies in the case of a B2B supplier of a good or service. Or they might be the end users or consumers who pluck the brand off the grocery store shelf and reaffirm their continuing attachment to it with their dollars whenever they go shopping.

A competent pre-deal survey of a category or industry can tell you which company has the greater share, who is trending up and who is trending down and even who the low cost producer is. So the would-be acquirer has a decent sense of who is making money and who isn’t. But the acquirer won’t know who the more skillful marketers are. Sara Lee sells a lot of bread and rolls¾big share, boxcar numbers. But there are other players out there who beat them on a store-by-store basis with marketing budgets that are mere slivers of what the big girl spends. Bigger isn’t always better. Better is better.

Some acquirers try to determine which potential target is the better marketer. But some don’t even make an attempt. And since they didn’t try to find out who is the best, they have no idea who is the worst.

Would-be dealmakers who decide to ask marketing questions sometimes turn to the wrong people for the answers: their current marketing staff, their agencies, consultants who might ultimately get to manage the acquired company, or the traditional due diligence team with all the legal and financial skill in the world but little practical marketing experience. All of these groups start from a point that makes an honest marketing assessment difficult: they all want the deal to happen. They are excited by it, see it as a personal growth opportunity and usually stand to reap some reward. And while they won’t consciously shade the findings, they can get caught up in the group-think inertia that fails to heed the danger signs. No matter what the potential problem may be or how big, they are confident they can handle it better than the targeted acquisition’s current regime.

The acquirer’s internal marketing function may see the opportunity to become more important in the category. “Now the distributors will have to listen to us!”

Their advertising agency may see the opportunity for increased billings. “If this doesn’t get me Super Bowl tickets, I don’t know what will.”

The potential management team may see the opportunity for permanent employment as the primary reason the deal has to get done. “All this place needs is me to make me, I mean it, famous.”

The traditional due diligence team may see the opportunity to do a deal as the reason to do a deal. “I guess we should have met with the Marketing Director but we can cover her after we start to worry about an integration plan.”

Extreme? Maybe. Rare? Unfortunately no.

But some M&A practitioners are starting to recognize the need for a marketing component in the pre-deal phase and in due diligence work. A marketing component also serves as the basis for a thorough and value building integration plan.

Marketing helps establish a “merged entity perspective” that looks beyond the first few quarters. Synergies, consolidation and cost cutting can keep the stakeholders happy for only so long. They may buy some time but rarely enough. The era of “where’s the growth?” approaches rapidly. And by the time everyone realizes an integration plan is needed, it is usually too late.

It is stunning how often a big deal is done with no real idea of what to do on Deal Day Plus One. Just doing the deal was so pre-occupying that post-deal planning was continually pushed off. And once a haphazard integration effort starts, it can be painful to the point of paralyzing the merged entity. Legend has it that it took Quaker Oats over two years to get its arms around Snapple, produce new ads and try to do something with the brand. (Concurrently the distribution channels were thrown into chaos and the brand suffered near fatal harm.) Makes one wonder just what everyone was doing during the due diligence phase?

And this is one of the failure-to-plan disasters we can easily quantify. When you very publicly buy a brand for $1.7 billion and turn around and dump it for $300 million, you can pretty much guarantee the Wall Street Journal is going to publish your report card.

When no integration plan is prepared in advance, the game becomes non-stop catch up, where mistakes and fatal blunders abound. We know of one telecommunications merger where the target company had within its product portfolio a small, but profitable business in bundled services for a specific customer group. The acquirer didn’t see any potential, so it set about shutting down the service line.

Unfortunately, you just can’t turn off someone’s phone service. You have to get them to move to something else. The new company spent truckloads of money to get current customers to switch, even to the point of hiring marketing agencies to run promotions and advertising encouraging the customers to dump the product and change service.

But this Monty Python-like integration effort didn’t stop there. About 12 months after the product line was shut down, someone up the food chain decided that a bundled offering was the way of the future and set about re-inventing, re-launching and re-supporting a product line virtually identical to the one they had shut down just a year earlier. Sounds like an episode of “The Twilight Zone.” Only more bizarre.

Sometimes integration fails to increase shareholder value because everyone loses sight of just why they wanted to do the deal in the first place. One area for interesting integration foul ups is in the beverage alcohol business.

For the last 20 years, the beer, wine and spirits business has gone through a tremendous upheaval and relentless consolidation. Brands, whole companies and import/distribution rights have been the subjects of scores of acquisitions, divestitures, spin offs and re-combinations.

Starting in the early 1980’s, the major players decided they needed to get bigger to counter the growing strength of a consolidating distribution network. One such attempt to buy clout demonstrates why everyone should complete the following sentence, and keep a copy of it in their pocket until 1 year after the deal closes:

“We are buying (insert name of target here) because ___________________.”

Sounds simple enough, but having everyone compare answers in the pre-deal phase, agree on one version in the due diligence phase, and use it as a guideline for the post-deal integration can clarify the process.

But we are getting ahead of ourselves.

As in our other white papers we will change the names to protect the innocent. (But you know who you are.)

Company A was a one of the larger players in the spirits business but was very much a one trick pony, meaning nearly all of its past success and current standing in the industry was the result of one brand, the category leader and by far the largest profit contributor in the company. Company A knew it needed more brands.

Unfortunately its track record of new product success was more miss than hit because a formal new products process didn’t exist. In fact, their brokers who handled the brand in other countries did more to develop new products than they did.

Meanwhile, Company B was riding a tidal wave of new product success. It had never in its history had one large brand to line its pockets with profits. Its beverage alcohol business was only one of several diversified holdings.

Culturally it was hungrier and more innovative than Company A. It had a large, active new product function and recently it had struck gold.

One of its R&D people had a preference for a certain fruit flavor. He loved it in pies and wanted to put it in an alcoholic drink. After months of work, he perfected the formula and Company B got it out in the stores where it flew off the shelves and set sales records that still stand.

The swiftness of the new product’s growth and the piles of money being made caught the attention of Company A and everyone else in the industry. A bidding war ensued, with Company A betting the farm and ultimately being crowned the winner.

But now the story takes a strange twist. One would think that Company A really wanted the process that had created the overnight success, not another one trick pony. Wrong!

The integration process pretty much consisted of acquiring the brand, selling off the unrelated businesses and bringing to Company A only a few junior level people from Company B. Most of them were dismissed in the following 12 months.

Company A had paid for the opportunity to create a new product function that might have led the industry. All it had to do was keep the new products team not gut it.

But instead, it had simply overpaid for a brand it turned into another one trick pony.

Now back to fill in the blanks:

In the postmortem we find that some members of Company A management had completed the sentence like this:

“We are buying Company B to get better at new products, grow our volume and build long-term profits.”

The group of Company A management that controlled the decision-making process and called all the integration shots had completed it like this:

“We are buying Company B to get our hands on the most exciting brand in the industry so we can use it to bend our distributors to our will.”

These two very different viewpoints are a recipe for yet another acquisition that failed to increase shareholder value of the combined entity. It could have made for a better story with a happier ending if everyone had agreed on how to complete the sentence before the bidding commenced.

A marketing perspective during due diligence could have prevented this value withering integration effort by forcing discussion about Company B’s real strength. It would have helped air the issue earlier in the process and agreement might have been reached that Company B’s strength was found not in its brands but in its New Products effort and people.

Marketing due diligence isn’t only about marketing. It is about culture, people and core competencies. And you don’t often find that insight in corporate by-laws, lists of litigation, contracts, quarterly reports or intellectual property summaries. It’s time to start thinking differently before the M&A train picks up too much speed.

If you would like to receive future white papers or learn more about the marketing due diligence services of Growth Trinity Group, contact Lowell Wallace at (224) 766-0968 or email him at lwallace@growthtrinity.com.

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