By Denise Harrison, Senior Consultant, CSSP, Inc.
Note: This article was previously posted in Course and Direction in August 2008.
Once we have determined an acquisition is part of the solution to achieve our strategy, we must evaluate the potential candidates. This evaluation step is paramount to the financial success of the acquisition. One recurring error is that only one company is identified, or a specific company becomes available and is deemed to be the solution. DO NOT LET COMPANY AVAILABILITY DRIVE STRATEGY OR LIMIT THE CHOICES YOU EVALUATE. Once your team identifies potential acquisition candidates, rate each company based on criteria:
- How well does the company fit with strategy? How well does the company actually fulfill the desired objectives of the acquisition?
- What else comes with the acquisition? Very few acquisitions are pure plays.
- Do they have competencies (then rate to see if they are strategic), or do they have strategic assets (knowledge resident in one or a few individuals)? How is the competency shared and documented?
- Will the targeted company’s culture fit our culture?
- What will happen to the key people? Will they walk? Do we want them to walk?
- What is the targeted company’s market position in all of its markets? Are they the number 4 player or number 1 or 2?
- What are the industry dynamics? Are there any significant threats on the horizon? New competitors? New technology?
- How will this acquisition change the competitive landscape? Will the acquisition enhance the company’s competitive position? Where will it detract?
Let’s explore each one of these criterion.
Fit with strategy
Very rarely is a targeted company a “perfect” fit. All candidates must be evaluated based on how closely they fulfill the strategic objective for the acquisition. Does the company meet the customer relationships set out as part of your objective? Does it have the required products and/or services? Does it have the distribution channels that we need? It is important that the team sets up key criteria before acquisitions are evaluated. If this is not done upfront, you will have no way to evaluate how one company stacks up against another company.
“Other baggage” is where many acquisitions fail. The targeted company has what you want and fits nicely into the strategy you are looking to accomplish; but it comes with many other areas in which you have interest. It may have products and/or services not part of your strategy; it may also not be in your strategic market. Now what? It looks like a minor problem; however, your team could lose focus due to these extraneous products/services and/or markets. All of a sudden, your strategic plan includes areas that are not part of your core business; and resources are diverted to these areas instead of focusing on the original strategy. Conflicts arise concerning priorities within the company and these conflicts distract the company from its original mission.
Recently a medical devices company wanted to fill a gap in its product line. They purchased an available company and began integrating the acquired company into its planning process. This acquired company was in a number of market segments new to the original company.
These segments had different requirements for the product; thus, causing a great deal of conflict in product development and future feature/ functionality requirements of the product. The product had one set of requirements meeting the acquiring company’s needs and another set meeting the extraneous segments’ needs. A product emerged which was a compromise, and neither of the markets was happy with the result. The new products were not successful, and new product development time lengthened because the product being developed served two different masters. Trying to serve these conflicting priorities sent the acquired business into a tailspin. When you make an acquisition, consider accompanying baggage when evaluating an acquisition target. You must have a plan for dealing with the baggage (spinning off, keeping) before you make the acquisition; otherwise, conflicts will occur and cause the acquisition to be unsuccessful.
Evaluating the competencies of the acquisition target is important to understanding the true value of the acquisition. The intellectual capital may, in fact, be the reason for the acquisition. For example, your product is offered in either of two technologies: you have a strategic competency with one technology, but no in-house knowledge of the other. With a goal to expand, you find that there are specific cases where the other technology has advantages over the one you offer. In this case, you can decide to develop the expertise in house; or acquire a company where the knowledge exists. The latter is often the faster path allowing you to capitalize on the technology and the current customer base of the acquisition target. In order to fully assess the resident competencies, you must evaluate the following:
- Is this really a competency or an asset? Is the knowledge only held by a single person? If it is held by a single person, it is a strategic asset and this asset has legs and may walk.
- How is the competency knowledge passed on to other employees? Is it documented? Is there formal training in place? Is there hands-on training? You want to be sure there is an educational process in place to ensure skill, knowledge and process sharing.
- Is there a process for continual improvement? This may set the company apart now, but how easy is it to copy? Are there plans for the next generation? Is it possible for the competition to leap frog?
- Is the production or service function outsourced? If so, does this create a future competitor? Is the knowledge really resident in house? Gaining a competency is often an important part of the acquisition strategy; however, you must ensure this knowledge is positioned in a way giving you a sustainable competitive advantage.
Spend time understanding the culture of the new organization. Is the management approach top down and autocratic, or bottom up and participative? Is there a strong work ethic, or are people out at 3:00 p.m. on Friday leaving customer calls unanswered? What are the stories being told within the company? Important? You bet! Add information by looking at the HR manual — what are the policies — will they mesh?
A government contractor was looking to make an acquisition to enhance their market share in a particular government agency. They know from customer comments the company was run by a very autocratic leader having his fingers in everything. The acquisition team was sure the acquisition would flourish once the leader was out. Was this a realistic assumption? What type of leader would the next tier of management be? These were the folks who stayed with this leader for more than 20-plus years in spite of the leader’s autocratic style. Do you think good autonomous leaders would stay in this environment? No, of course not!
An agricultural services company was looking to expand customer services being offered. It decided to expand by purchasing a company selling and applying fertilizer and other soil nutrients. While working on one of the ranches, an acquiring-company principal was offered some fertilizer at a low price by employees of the acquired company. They did this by siphoning off some fertilizer going to a customer and returning the liquid to its original volume by adding water. When the employees were fired, they walked off with the account lists. Honesty should be one of the key values for which you look. So often we assume honesty is present; but if this team had asked around, I expect they would have uncovered dishonest practices by these employees. Spend time interviewing customers and people who actually work with the individuals to see if there is a pattern inconsistent with your company’s values.
The targeted acquisition opens up key channels of distribution for you in Asia. You know these channels developed through personal relationships. After the acquisition, the people responsible for making and maintaining these relationships leave and the door to Asia is closed to your products and services. It is important to know who the key players are and the intent of each of those key players. There are many ways to keep key employees around including tying the payouts to performance over future years. However, you must also ensure that there is honest knowledge transferred about backing up every key position. Before making the acquisition, you will want to know how back-up responsibilities are handled and whether or not there is a succession plan. If there is a succession plan, are the people who are designated successors being trained to handle the job? Also, ask what happens when key people go on vacation. A clear warning sign is some key people not having gone on vacation or taken more than a few days off at a time. This lack of vacation means two things: They are truly unwilling to train back-up employees and really have no back-up plan. This is not unusual in small companies, but be aware that human assets can walk. Be sure to have a plan to deal with human assets, or discount said company on this aspect of the valuation.
Okay, everyone has heard the requirement of being #1 or #2 in a market in order to maintain significant profits. Well, the same is true as you evaluate your target company. Look and see how they stack up in their markets. If at first glance they do not do well; ask if it is because of a different segmentation or if they actually dominate specific niches. If they are not profitable in certain segments, ask questions.
Return to the agriculture services company mentioned earlier. Yes, they purchased a fertilizer company. Unfortunately, it was only ranked number 4 or higher (e.g. 5 or 6) in its market segments. Talk about pushing a string uphill! Did the acquiring team have a strategy for moving up the market position? No, and for several years the company struggled. Finally, the team assessed their strategic competencies and how these competencies could be leveraged to gain shares in their market. They also redefined the markets to target winning growers. Good news — the strategy worked — but it took five years to come to fruition. Next time, they will look harder at the target company’s market position.
If this targeted acquisition allows you to enter a new market, you need to understand the market dynamics. Who are the competitors? Is there a new technology coming? In order to assess this, you must talk to people who watch this industry, i.e., investment analysts, regulators, and customers. Customers can often identify upcoming changes others in the industry do not see; e.g. new entrants may be presenting their concepts to the company’s core customer base. Other external forces may impact the industry dynamics. For example, there are changes in energy-efficiency regulatory requirements, you must ensure the acquisition target has plans in place and/or under development to meet these new requirements. Look to see if prototypes are available.
Anticipate the reaction of customers and potential customers’ to the acquisition. When Pepsi bought Burger King, did they anticipate Pepsi would no longer be a candidate for McDonald’s and other fast food chains competing with Burger King? Did this acquisition make sense?
As you consider purchasing another company, it is important to consider these eight criteria as you develop specific targets for your acquisition search. With your criteria in place before you begin your search, you will be more objective as you evaluate the candidate acquisitions. Good luck!
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Denise Harrison is a senior consultant for the Center for Simplified Strategic Planning, Inc. She can be reached at firstname.lastname@example.org.
© Copyright 2014 by Center for Simplified Strategic Planning, Inc., Ann Arbor, MI — Reprint permission granted with full attribution.