Synergy Hunt: Meeting the Challenges of Tracking and Reporting Synergy Capture
Historical M&A data indicates that well over 60 percent of M&A transactions fail to create their expected value. 1 Assuming the value objectives of the transaction are well defined, executives and managers charged with successfully executing the integration should ask themselves, “How do we measure and communicate to stakeholders that we have captured the value we set out to achieve?”
Typically, M&A transactions create value in two ways. First, the transaction helps the company to sell more goods or services than the competition in new or existing markets. Second, the transaction allows the combined company to operate more efficiently. In both cases, the assumption is that the performance of the combined company will exceed the expected performance of each independent entity. Generally, the difference between the performance of the combined entity and the sum performance of the individual entities is referred to as “synergies.”
This performance-based definition of synergies provides a practical measure of success that can be easily communicated to stakeholders, if the inherent challenges involved with identifying and tracking synergies can be overcome. This article provides practical ways to address five of the primary challenges:
- Isolating performance improvements
- Factoring costs to achieve
- Accounting for timing and limiting scope
- Aligning incentives with target attainment
- Developing a reliable tracking system
Challenge 1: Isolating performance improvements
Companies tend to account for costs and measure performance in different ways. For example, one company may roll certain expenses into sales; another may roll them into supply chain. How do you identify and isolate performance improvements when the acquired company accounted for costs differently than the newly combined organization?
Additionally, as the integration effort proceeds, day-to-day operations continue. The competitive landscape changes, new competitors emerge, old adversaries exit, and markets react to changes in the environment.
The assumptions on which synergy estimates were made are constantly changing. And in many cases, the assumptions are simply no longer true. These changes make it difficult to realize synergies and even more difficult to isolate and quantify performance improvements so that they can be attributed to the integration activities.
Key to meeting the challenge: Create a performance baseline
To isolate performance improvements, the two companies’ performance must be aligned on a baseline that provides near apples-to-apples comparison.
Developing the baseline is often tricky and can be difficult. However, the result is an invaluable, almost apples-to-apples performance viewpoint against which future performance can be effectively measured. A solid baseline helps filter out the “noise” added by changes in operations and the external environment and creates a yardstick against which future performance improvements will be measured.
The baseline also provides a quick way to validate synergy targets against typical industry benchmarks. This comparison provides a useful reality check and serves as a catalyst for identifying additional synergy opportunities.
The time and energy spent on developing a baseline, which leadership of both companies can agree to and approve, is critical and more than worth the effort.
Challenge 2: Factoring costs to achieve
Transaction value and premium are (or at least should be) driven by the potential for performance gains that exceed current market and shareholder expectations. These performance gains are offset by short term integration costs; however, the cost of integration is not fully known when a transaction closes.
The transaction stress aggravated by tight timelines may force management to make quick estimates of costs to achieve, which may lack specific details on the cost drivers and assumptions or lack direct links to integration plans. Additionally, managers may overestimate costs to achieve, hoping to absorb unknown risks. Or they may underestimate the complexity and costs of the integration. To compound the problem, these estimates are usually not subject to the rigorous review and approval that is typical for capital projects.
Even obtaining a fair estimate of integration costs is complicated in some cases by legal restrictions that prevent sharing of certain types of competitively sensitive information before the transaction closes. Both parties may develop broad ranges of costs to achieve citing adherence to this anti-trust legislation, which limits sharing information required for more detailed cost estimates. Service providers should be aware of non-disclosure agreements or confidentiality obligations that may be in place.
Key to meeting the challenge: Create a clean team to develop estimates
Costs to achieve are always estimates. Who can tell precisely what the cost of a good or service will be in the future? Understanding the cost to achieve the desired level of integration depends on understanding the details of both companies, and this is not usually possible until after close.
By overcoming regulatory hurdles, a “clean team” can provide more thorough analysis of synergy targets and costs to achieve prior to transaction close. Here’s how it works: The clean team is staffed with neutral, dedicated resources and employees from both companies. If the M&A deal does not close, these employees cannot return to their parent company, so qualified employees who are approaching retirement are often chosen for the team.
Competitively sensitive information from both companies can flow to the clean team where members analyze data and develop recommendations for attainable synergies and costs to achieve. The findings of the clean team are only published if the transaction is consummated. If the transaction is not closed, the data and recommendations are destroyed and the team is disbanded. This approach can greatly increase the accuracy of targets and hasten the time-to-value.
Challenge 3: Accounting for timing and limiting scope
Timing impacts the net present value of attaining synergies. In many cases, management assumes that benefits will begin to accrue immediately upon close. The truth is, detailed planning and implementation timelines may show that no performance improvement will be seen for years. This is particularly true with the integration of IT systems. In fact, the cost to maintain separate IT systems, implement bridge systems, and create short-term work-arounds may increase the cost to achieve and reduce the eventual benefit.
Some synergies, such as headcount reduction, initially appear to be fairly straightforward from a timing perspective. But sometimes, management assumes that headcount can be immediately reduced, overlooking the typical need for a phased reduction in force to facilitate knowledge transfer or to execute integration plans.
Plus, since M&A transactions generally create a sense of urgency and organizational alignment that is difficult to replicate, management may want to capitalize on this momentum to implement other transformational changes. This is usually a great idea, but it should be carefully considered so as not to distract from the primary integration tasks or strain resources to the point of breaking. Poorly defined scope leads to extended integration timelines, incomplete integration, and synergy leakage.
Key to meeting the challenge: Assign a “synergy bulldog” to prevent slippage
When management leaves synergy owners to their own devices, not only does timing often slip and destroy value, but in some cases, the synergy owners focus on executing the easiest, often low-impact, initiatives first. This practice reduces the true synergy attained and slows down the overall integration timeline.
When a senior executive fills the role of “synergy bulldog,” programs tend to achieve better results. This individual works with synergy owners to review, rationalize, and provide oversight on synergy initiatives. He or she supports the acceleration of synergy capture by making resource allocation tradeoffs to meet timelines and exceed targets.
One necessary tradeoff may be to phase headcount reductions to allow for appropriate knowledge transfer and support. In addition, there is often a need to temporarily augment staff. Even as staff is reduced, there is critical work that must continue to be performed. Simply adding this work to existing employees may place the quality of work at risk and can lead to unhappy employees who leave just when you need them most. Phased headcount changes can significantly impact the net present value of overall synergies, but will greatly reduce the risk of disruptions to ongoing operations.
The bulldog can also provide direction on whether or not to implement other transformational changes along with the integration activities. If the change will improve overall performance or accelerate synergy capture, without driving up costs or straining resources, then it should be considered.
Challenge 4: Aligning incentives with target attainment
Once the transaction closes, senior executives who promised specific synergy targets often move on and leave the integration and synergy attainment to the new management. In this scenario, the executives who set the targets tend to be given incentives to maximize synergy estimates. If the incentives are not tied to eventual synergy attainment, they can be unrealistic.
Building a synergy program that aligns resources, rewards, and sanctions is probably the single most effective tool in a manager’s toolkit to help improve chances of success. However since the organization is in a state of flux, the people who set targets are typically not the owners of synergy execution initiatives, and are certainly not implementing. In many cases, the individuals who help set the targets may no longer be with the company.
Key to meeting the challenge: Use a team to set practical targets
Management must align incentives so that synergy targets are realistically developed, costs to achieve are carefully considered, practical implementation timelines are outlined and aligned with other initiatives, and the handoff from the planning team to the execution team is clear and crisp.
To accomplish this, senior management should create a synergy cross-functional team that includes at least one team member who is expected to be involved with implementation. Any incentives for identifying synergies should be linked to actual attainment. This attainment approach tends to drive a more practical approach to planning that includes a level of detail that can be communicated to an “implementer” even if the original team member leaves.
Challenge 5: Developing a reliable tracking system
In the regular course of business, events occur that redirect costs and capital and mask synergy attainment, making tracking difficult. To effectively use existing financial performance systems to measure synergy attainment requires modification and discipline. Financial systems are only as good and timely as the data that is collected or entered. They are usually set up to report against ongoing operations—not short-term initiatives. To complicate matters, existing systems cannot easily provide variance analysis that managers need to understand why synergy targets are being missed or exceeded, giving them the information needed to adjust course or reallocate resources. These limitations, along with the difficulty of isolating performance improvements, pose challenges to tracking synergies.
Key to meeting the challenge: Implement parallel tracking systems
Providing management with close-to-real-time reports on synergy attainment at regular intervals supports overall synergy attainment. These reports should provide information needed to allow managers to make small course corrections and resource allocation decisions to the benefit of the overall synergy program.
In many cases, synergy reports are developed with specialized tools that plug into existing financial systems if the appropriate cost centers and ledger accounts are set up. The drawback is that these systems always depend on the existing month-end financial close process and do not readily provide details on the drivers of any variance from plan.
Having an offline tracking mechanism to augment enterprise financial systems can often provide intra-month, near real-time synergy attainment views that inform management decisions. To support this dual tracking approach, new cost centers are used to track integration-only costs outside of normal operations. Success hinges on costs being charged to the correct cost center, and the reconciliation process must be rigorous and thorough.
Lastly, the synergy tracking systems should inform the management on the effectiveness of execution – did we achieve what we expected? This information should ultimately guide how executives and managers are rewarded.
What gets measured, gets done
Successful synergy programs focus on the details of execution. The old adage “what gets measured, get done” certainly appears to hold true. The marketplace is filled with examples of companies with good intentions and brilliant strategies that underestimated the synergy challenges and destroyed vast amounts of shareholder value. In the worst of these cases, poor implementation crippled what would have otherwise been sound individual businesses.
Unfortunately, there is no magic elixir, no single way to cure all the possible integration ills. We have suggested approaches that mitigate five of the key integration risks and support the development of a stable synergy program. These approaches should not be implemented blindly. They should be weighed against the overall integration strategy and structure and adjusted to support the overall integration program.
1 Sirower, Mark. “The Synergy Trap: How Companies Lose the Acquisition Game.” New York: Free Press, 1997, 2000.
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