In our last post we discussed where accountability for synergies should rest. Here we pick up the discussion with the next logical step, the do’s and don’ts of synergy measurement and reporting.
Do align synergy measurement with synergy accountability. This seems like a no-brainer; however, over the years I’ve seen several companies mis-align synergy accountability, measurement, and span of control over synergy achievement, so it is worth a call-out here. A common way this plays out is to have Finance be held accountable for not being tough enough in the budgeting and forecasting process while simultaneously holding Corporate Development accountable for the published deal metrics being missed, all while the acquiring business unit exercising span of control is either not held accountable, or is allowed to obscure results with clever reporting tactics. Align accountability with span of control and then put measures and metrics in accordingly.
Do tie non-transformational operating metrics into your company’s existing measurement framework. There is no need to re-invent the wheel when it comes to measuring results of operations; furthermore, it is counter-productive to have multiple measures for the same items. Simple operating metrics that don’t require large transformational projects should transition to run-the-business measurement approaches soon after change of control. Accretive revenue would fall into this category, as would ongoing cost synergies that can be achieved in the first 90 days and have few dependencies. Day 1 headcount reductions and simple integration items such as standardizing on a common payroll platform could be two examples of the latter.
If you utilize a lot of comparative or long-term measures, carve out one-time items such as costs to achieve that might create distortion. Ideally these one-time costs will be captured in your synergy business cases prepared during deal valuation anyway (See November, 2019 post Deal Valuation: Inclusion of Costs to Achieve Part 3) and can easily be tracked as program costs instead of operating items, preventing distortion in future comparative measures.
Do measure transformational items centrally until most dependencies have cleared. One of the more common, and damaging, mistakes that I’ve seen is to incentivize an acquiring business to achieve dramatic transformation in an acquired business while simultaneously trying to get through an earn-out period or other deal contingency that’s managed outside of the BU, i.e. by Corporate Development. This usually will also occur while Finance, IT, and HR have their own extensive transformation/integration programs underway, with lots of dependencies to go around for all sides.
On truly transformational programs it is better to centralize synergy accountability and measurement until most of the dependencies have cleared. The PMO can then reinforce near-term synergy priorities with incentives, balancing any contingencies such as earn-out arrangements via interaction with the executive steering committee, and create a step-plan that recognizes the timing, costs, and dependencies of synergy realization. When enough dependencies have cleared so that the span of control over outcomes can be dispersed, transition the program to a run-the-business model and follow the approach described above, using existing measurement frameworks for ongoing operational results.
Don’t apply a traditional framework to a “blue sky” acquisition. Recall from our target operating model series that acquisitions to boost innovation and/or creativity usually optimize at lower levels of integration; furthermore, there is usually neither a prescribed timeline nor a pre-determined value defining the desired outcome of the transaction. As such, traditional measurement frameworks are inappropriate and may even be detrimental. Leave golden-egg-laying geese alone in the near run, until the business has progressed to the point where measurable outcomes can be defined for measurement. At that point determine the appropriate metrics, ensuring they are aligned with span of control as always.
Don’t forget to include qualitative and/or macro-level measures. Identify, define, and subsequently track qualitative items that you expect to be key to value capture. These often include employee engagement and/or retention, measures of influence such as social media followers, gains in customer awareness and/or perception favorability, etc. The acquiring business is usually the appropriate accountable party for these metrics and, while they are often overlooked, they are also vital to ensuring that synergy capture is approached holistically.
Don’t forget to adjust for new realities. Static measures soon become stagnant measures whose disconnect from reality leads to a lack of engagement or worse. Markets change, competitors and customers make moves. Pandemics happen. If something irreversible transpires and impacts a previously determined metric, then adjust it accordingly.
Overall, remember that what gets measured gets managed, and what gets managed gets accomplished. The goal of measuring synergy realization is to create an environment of accountability and corresponding incentives that gets results. Measurement is not an end in itself, but rather a means to a desired end. For this reason, it is important to balance the rigor of the measurement approach with its corresponding administrative burden. Keeping synergy measures simple, aligned, and balanced as described above helps companies both achieve the synergies from completed transactions and ascertain strengths and weaknesses in their overall M&A approach for use on future deals.
How the world has changed since my last post in February! Now that 2020 craziness has finally leveled off (knock wood) we can continue with our series on synergies. As promised this edition will focus on establishing accountability for synergy realization.
3 general rules should be applied when determine who should be held accountable for synergy realization. The first general rule is as follows:
1. Accountability for synergies should align with span of control over the synergy realization efforts and the majority of all corresponding dependencies.
Revisiting some content from our April, 2018 posts will be helpful in understanding how this rule applies to various deal types:
Deal Rationale Considerations and TOM Selection
Recall from February’s post that we identified 2 basic categories of deals:
Complimentary deals have much greater variability in optimal TOMs, but there is a general rule that can be applied:
The greater the level of innovation or creativity implicit in the revenue synergies, the lower the level of optimal integration
The table below provides a general outline of where most complementary deals will optimize:
As recalled above, complimentary deals have a wider array of target operating models than do overlapping transactions and the optimal accountability structure also varies accordingly. A second general rule of synergy accountability can be applied as follows:
2. The greater the reliance on extra-accretive revenue synergies, the more accountability and control should (usually) rest with the acquiring business unit and centralized management should be minimized.
The key here is the phrase "extra-accretive", indicating that the revenue is to come from new innovations, not just the addition of mature markets, offers, etc. that result in a one-plus-one-equals-two sum. Often such synergies require careful attention to talent retention and a focus on creativity, innovation, and speed to market. The acquiring business should focus on the required portfolio and/or talent activities that will result in value capture. An IMO will still be very useful in the diligence to first 100 days phases of the transaction to ensure coordination, smooth onboarding, clear communications, capture of lessons learned, etc.; however, centralized program management should usually be discontinued after the first post-close phase and the business unit can assume responsibility- and synergy accountability- thereafter.
This rule also highlights why serial acquirers should always have an established “minimum TOM” that defines the minimum integration to meet legal, regulatory, and “must-have” corporate policy requirements. Up-front agreement on a minimum TOM will allow BU leadership maximum flexibility. For instance they may choose to leave many back-office processes in an as-is state or even outsource some activities to free up additional bandwidth. Regardless, being unshackled from the constraints of a highly-structured and standardized back office allows leaders to focus on the desired revenue growth unencumbered by the workload and distraction of a large integration program.
The third general rule can be applied to nearly all overlapping deals as well as many complementary deals where the synergies are primarily accretive:
3. The broader the synergy model, the narrower the ideal accountability should be, or the more comprehensive the synergy model, the greater the degree of centralization for deal outcome accountability
Dependencies are a key driver when applying this rule. A heavy or full integration that reaches across much of the business will require extensive planning, communications, coordination, and stakeholder management. The absence of a robust, well-sponsored, and centralized IMO foments discord and undermines value capture. The acquiring BU has no desire to learn the intricacies of the ERP tax data model for instance, and the inevitable “but we do this today” or “can’t we do this manually” will equally frustrate administrative staff. And there are even more complexities if back office activities are outsourced, as it is almost certain that the negotiators of those contracts aren’t in the acquiring business unit. As such what often happens is blaming, undermining, rework, and a loss of focus on deal outcomes. Setting up a centralized program office not only ensures a balanced approach to addressing dependencies across the business but can also create a "lightning rod" effect, centralizing any tensions and helping to maintain a spirit of cooperation between teams with differing priorities.
Effective governance is critical when centralizing complex, broad-reaching programs. The executive sponsor should ideally be a member of the C-suite, or at least have a substantial span of control and ultimate accountability for all outcomes, ensuring that Rule 1 above isn't violated. While this may seem like common sense, neglecting sponsorship while leaving accountability with the IMO is a surprisingly common error on transactions that fail to achieve value capture. Furthermore, the executive sponsor should have the authority to align performance and incentive structures to value capture objectives to facilitate focus and cooperation and to prevent conflicting goals from hampering progress.
On such complex integrations the level of dependencies will remain high for some time and early synergy targets are often planned for realization during this time. Centralized program management via an IMO (integration management office) is the best way to ensure that all milestones required to meet these objectives are achieved. To be more blunt, and IMO helps produce more value capture with less finger-pointing. As dependencies are cleared centralized management can be scaled back if desired, and synergy accountability transitioned to the business along with any remaining tasks.
This post kicks off a series on synergy accountability, management and tracking. Worthwhile synergy programs always start with realistic synergy assumptions, well-vetted against market realities and substantiated with data where possible. Unrealistic expectations produce a toxic slurry of maladaptive behaviors and ultimately result in the loss of both top talent and shareholder value. We’ve discussed several keys to proper deal valuation and synergy expectation-setting in prior posts and as a refresher links are provided below:
Another key to realistic expectations lies in the preparation of the target operating model or TOM (see Apr-Nov 2018 for our extensive series on this topic). Careful TOM preparation will highlight what your business will need to do in order to realize the value of your acquisition.
Note that if you have a highly structured environment- one that features a high level of outsourcing, automation, complex metadata designs, etc.- it is likely that you will have higher integration costs than less structured companies. This is due to the need for the target to conform to your structure via a full, or nearly full, integration, in order for your existing structure to properly accommodate the target’s business needs. It follows that in order to pay the same multiple for the deal, you must also have superior operating margin capabilities that compensate for this cost differential. If superior revenue-generating capabilities are present, i.e. a superior distribution network, access to additional markets, etc. then the cost differential might be overcome in the near term; however, if a low-cost back office is expected to generate this additional operating margin on its own, a longer time horizon is often needed. So, when defining synergy expectations, be sure to consider not just the calculations, but also the horizon and time value of money.
Once your synergy business cases have been created, with the corresponding costs and benefits quantified and the time horizon projected, consider whether they should undergo an additional validation process. As with business case creation itself, there is a cost/benefit tradeoff to consider before commencing a validation exercise. Deals where the acquirer already has significant insight into the applicable business case inputs and deals that are minor investments may not warrant this additional level or rigor; however, substantial investments and deals where the acquirer has a less expertise generally benefit. Validation may include processes such as:
Each of these approaches has different advantages and drawbacks. Personally, I find the cross-functional business case reviews and the benchmarking to be the most useful in providing net new insights. Benchmarking and the use of strategy consultants to re-evaluate topline assumptions both have the advantage of being “arms-length” to the transaction; however, it is important to make sure that there is enough relevant data available. If your business relies heavily on a new technology such as blockchain, it isn’t clear that there is either enough data for benchmarking to be useful as yet, not that such data- from the very emerging stages of a new industry- is free of noise caused simply by industry growing pains.
Once you are comfortable that your synergies have been properly identified, properly valued, and that the timing horizon is realistic, you can begin to address accountability. This is where we will pick up in the next installment.
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