Managing the Urge to Merge

BOSTON (06/05/2000) - Whether your firm is negotiating a megabucks merger or is vulnerable to getting gobbled up by a competitor, we'll tell you how to quickly integrate IT systems so the new company can get on with business.

Imagine arriving at work one morning to find your management is announcing a merger that was negotiated without any input from IT. Your new marching orders are to integrate two huge and disparate IT infrastructures, do it without disrupting internal or external customers, and reduce combined IT costs by 40 percent.

This is an increasingly likely scenario as the urge to merge spreads like a virus through corporate boardrooms. According to a study by Compass America in Reston, Virginia, at least 30 percent of the Global 2000 are currently considering an acquisition, and another 40 percent are potential acquisition targets. The dollar volume of mergers and acquisitions has increased more than five-fold since 1995, and Compass expects global merger and acquisition activity to reach US$5 trillon this year.

More than three-fourths of these mergers will fail to deliver the promised synergies, savings and shareholder value. But corporations really hit the jackpot when mergers do work. A McKinsey & Co. study found that companies formed through mergers that succeed go on to beat the stock market by 50 percent.

The odds of pulling off an effective merger increase significantly when IT is involved early in the game. The success of a merger hinges on the ability of the IT department to plan and execute the necessary integration in a timely fashion. You have to establish core communications as soon as the law allows, decide which technologies to keep or replace, and hang onto key employees through the transition. Consider this your guide to expediting IT integration.

IT isn't the attraction

Despite increasing automation and e-business initiatives, companies aren't being bought for their IT resources.

"For the most part, mergers are driven by business or product issues, not IT infrastructure," says Karin Maday, a managing director in KPMG Consulting's high-tech practice in Mountain View, California. When companies get superior IT through an acquisition, it's usually a pleasant surprise.

There are some exceptions. A traditional bank that wants to get into Web-based services might decide that buying an online bank is the cheapest way to get the necessary capabilities and skills. IT infrastructure may also factor into a roll-up deal when the goal is to consolidate several small players in a fragmented industry.

In that case, the acquirer looks for a target that has a scalable architecture, says John Kreitler, a partner in Shipman & Goodwin LLP in Hartford, Connecticut. Although his firm is helping a client in the medical supply market do a roll-up, "buying for infrastructure is really rare," he says.

Conversely, acquisition targets are rarely dropped because suitors don't like what they see once they get a peek under the IT hood.

"There were some Y2K situations where acquisitions were deferred until after the turnover, but I can't think of a single instance in which a merger didn't happen because of infrastructure problems," says Eileen Birge, research vice president at Concours Group, an IT consultancy in Kingwood, Texas. Instead, infrastructure problems are more likely to be reflected in the financial arrangements of the deal.

Austin Adams, the executive vice president who is overseeing First Union Bank's aggressive growth-by-acquisition activities, says the Charlotte, North Carolina, bank has never dropped a potential target because of its IT infrastructure.

"Sometimes the organization has some large outsourcing contracts that are in the early stages and are going to be very expensive to break, but that just means our management might have to adjust its financial estimates," Adams says.

Stages of the deal

There is considerable debate about IT's role in the premerger evaluations and negotiations, which go through several phases. Gartner Group Inc. has defined six of them:

* Strategy - Senior management decides to fulfill its business objectives through acquisition, and may have no specific target in mind yet.

* Planning - Senior management selects candidates or engages investment bankers to do so, and comes up with a "guestimate" bid to qualify as a suitor.

* Evaluation - Once qualified as a bidder, the company gets access to a limited amount of real information that is used to make a real bid.

* Acquisition - If the bid is accepted, the two companies enter into negotiations about final terms and conditions.

* Integration - The merger is consummated and the integration process begins.

* Operation - In the final state, the combined entity reaches its normal operating mode.

While industry experts have observed some encouraging trends, it is still common for IT to be excluded from talks until quite late in the process.

"Clients say, 'They didn't tell us until the deal was done, and now we have some unrealistic goals to meet,'" says Gartner Group research director Michael Gerrard. "Instead, IT should be involved in the premerger process as soon as is practical."

Gerrard identifies two main reasons why mergers fail. In the first, the acquiring company isn't successful in culturally assimilating the target.

Anticipated synergies are not achieved, and key people get frustrated and leave.

This is a bullet German Daimler-Benz AG and American Chrysler had to dodge when they stunned the world with their merger announcement in May 1998. The problem was compounded by the fact that the deal between the two automotive giants has initially handled as a true merger of equals - an M&A rarity - rather than an acquisition. At the time, Daimler-Benz was a $71 billion company, while Chrysler had revenue of $61 billion.

"The senior people in the two companies were open to new ways of doing things, and we were making some radical changes," says Sue Unger, the DaimlerChrysler AG senior vice president and chief information officer who is orchestrating the ongoing integration.

Unger, who came from Chrysler's headquarters in Auburn Hills, Michigan, spent a lot of the official engagement period in Germany, talking directly to the Daimler-Benz IT staff - in English.

While subsequent events have proven otherwise, there was some concern among the German IT staff that the merger was really an American takeover. "We had to help people understand the changes and why it was important to make them," Unger says. "You can never do enough communication in a situation like this."

While DaimlerChrysler's stock price continues to disappoint shareholders, Unger's team has done its job. In its first year as a combined entity, DaimlerChrysler reported $1.4 billion in synergy savings, and earnings growth has been outstripping revenue increases.

However, most integration efforts don't deliver the savings that were promised to the investment community, which is Gerrard's second main reason why merger and acquisitions fail. This may be caused by poor IT execution, but often it is a result of unrealistic upfront estimates. The earlier IT participates in premerger activities, the better these estimates will be.

If the estimates are off, your company is in trouble with Wall Street, Gerrard says. So much hinges on IT, and the businesses can't consolidate workforces until you consolidate systems. The cost of carrying two workforces gets dragged along with the IT delay costs.

According to a study of mergers by Concours Group, the amount that is ultimately spent on integration exceeds management's estimates by a factor of four to eight. The study also found that companies do a better job of coming up with realistic estimates when IT is involved earlier in the premerger process.

In highly IT-dependent industries, IT managers can bring some good perspectives to the discussion as early as stage two, which is when they are brought into First Union Bank's acquisition process.

"IT is very heavily involved from the time that we start looking at a company for possible acquisition," Adams says. "We have a very well-defined due diligence questionnaire and methodology."

The optimum point of IT entry also depends on the type of merger being considered. Cisco System Inc.'s acquisitions are highly successful, yet its IT professionals aren't included in premerger discussions.

"The cost of replacing the entire infrastructure of the target is immaterial compared to the market opportunity and the technology and the people we are getting," says Tim Merrifield, the senior IT manager responsible for Cisco's merger and acquisition integration activity. "It simply doesn't warrant us getting involved earlier. Our input does not in any way sway whether the company is purchased or not."

In highly regulated industries, mergers can take several years to complete.

American Electric Power and Central and South West Services announced their engagement in December 1997, but the deal is still awaiting final approval.

The two electric utilities - based in Columbus, Ohio, and Dallas, respectively, and serving different regions - didn't bring their IT staffs into the merger and acquisition process until about six months after the merger announcement.

The pending merger must run a full gauntlet of regulatory approvals in each state the two companies operate in before the deal is complete, and this challenge dwarfs IT integration issues.

In many deals, earlier IT involvement is critical but doesn't happen. There is often a sense that bringing in IT will complicate the exercise and confuse the issues.

"Most investment bankers don't want to hear why a deal shouldn't happen, so there is a natural tendency to ignore the operational integration issues," says Jim Champy, a vice president at Perot Systems in Boston. "Companies tend to ignore these issues and simply assume they can be dealt with."

Consequently, IT gets handed an expense-savings goal after the fact and is told to reach it.

Resetting expectations

When IT is not part of the merger and acquisition negotiations, the people calling the shots can make some na‹ve assumptions. They typically underestimate one-time integration costs, and are too optimistic about when the payoff will be realized.

Management looks at closing one branch location, and assumes 50 percent of the combined facilities' cost is being eliminated. Then they try to approach IT the same way and don't factor in the cost of integration. For example, senior executives may assume you can simply drop one enterprise resource planning (ERP) system and eliminate the second license fee, when integrating these often highly customized environments can take a few years.

"Our management called the IT transition team in one afternoon, handed us a list of goals, and told us to draft a plan for achieving them by the next morning," says one IT professional who recently led the integration efforts in a large merger. "We had less than 24 hours and we didn't have enough information, so we abruptly decided to close a very well-run data center. This turned out to be a big mistake."

IT managers who are faced with similar situations need to be very proactive about managing expectations - both internal and external. Sit down with senior executives and walk them through all the IT work that has to be done. If you're going to need to add staff or get help from an outsourcer, now is the time to say so.

If the target is large, you may not have the capacity to support it. If you can't, it might take a year and a half to close data centers that management had slotted for extinction in six months. There also might be some unpleasant surprises in the target's infrastructure, such as a big phone system that is obsolete and past due for replacement. These sorts of things don't show up in a balance sheet analysis.

Another potential minefield that may get overlooked is the contracts the acquired company has with external service providers. It may be expensive to change or break them, which can have a major impact on anticipated cost savings.

Just what kinds of savings can you expect? In IT-dependent industries such as financial services, merger and acquisition experts have seen mergers produce IT costs reductions of as much as 40 percent. First Union has sometimes done even better than this.

"In in-market acquisitions involving contiguous territories, we can sometimes get 30 percent to 40 percent expense efficiencies overall, and north of 50 percent on the technology side," says First Union's Adams. "In general, we are converting them to our systems and eliminating theirs. In out-of-market acquisitions that are geographic expansions, the initial savings are more in the 10 percent to 15 percent range."

Maximize your early returns by identifying and focusing on the things that will provide the biggest impact with minimum risk.

When provincial telcos in Alberta and British Columbia merged last year to form the Vancouver firm Telus, the IT transition team prioritized integration tasks by weighing its potential savings against how soon they could be achieved.

"In most cases, combining data centers would have a large potential for savings and can be implemented fairly quickly if you are not attempting to consolidate applications," says Jim Halco, director of IT integration for Telus. "You can move the applications from both companies into a single data center and get some economies of scale. With falling bandwidth prices, distances are becoming unimportant, and it doesn't really matter where the applications are running."

As you start the IT integration, report back up the chain constantly with your success stories. This may seem obvious, but experts say it doesn't happen enough.

Taking stock

Once the deal is struck and you get your marching orders, it's time to see how the acquired company's infrastructure stacks up against yours.

The type of merger will tell you what level of analysis you should do. It could range from a quick glance to an exhaustive inventory of both environments that will reveal who has the best practices in which areas.

Say a major oil company acquires a small refining company. They are just buying the refining assets; the IT infrastructure is unimportant. You have the same situation when a big bank buys a little one that is only 3 percent or 4 percent of its size. When companies make a regular practice of growing through such acquisitions, they develop a cookie-cutter rollout for replacing the target's systems with their own.

Other mergers must determine which company has the best practices in certain areas. "You aren't just counting the assets, you're looking for a good understanding of them: How they can be integrated, what their value is, what constraints come with them, and what risks they pose to your future plans," Gartner Group's Gerrard says.

Note that combining best-of-breed elements from two companies takes extensive upfront analysis and is much more complex than simply imposing the acquiring company's infrastructure on the target. According to Gartner Group, it is the most risk-prone path you can take.

In any given area, neither company may have the appropriate technology in place. For example, if both companies have highly customized ERP systems, the combined entity might be better served by a simpler, out-of-the-box solution.

"It also may make sense to keep some systems separate until the next natural technology upgrade point," says Jonathan Poe, a vice president and industry analyst at Meta Group in Burlingame, California.

And some systems may have to be kept apart indefinitely. At DaimlerChrysler, the automated assembly lines with their complex robotics are so different in the Mercedes and Chrysler manufacturing infrastructures that having the same system supporting both of them doesn't make much sense right now.

Some of the IT consultancies have put together databases of the best practices of Fortune 500 companies that you can use as benchmarks for evaluating your own environment. "We can tell you that for a company in a specific industry, there are IT operational processes that will work at a certain speed for a certain dollar value," says Gregory Smith, head of the merger and acquisition practice at Compass America.

In some cases, speed may be more important than choosing technology pieces.

"Unless the target's system has a unique and differentiating aspect that affects your customer relationships or how you face the market, you normally should trash the system and replace it with yours," Concours Group Birge says.

Speed is also a major factor in integration costs. First Union integrates acquisitions in about three months, which reduces expenses and helps maintain the target's customer base. "At the end of the day, spending money on making the deal work is taking resources away from growing your company," Poe says.

You may not get any advance warning of a merger, so you need to be ready for it. IT managers who don't plan for a merger and acquisition before it hits them are like deer caught in the headlights.

Breidenbach is a freelance technology journalist and consultant. She can be reached at sbreidenbach@usa.net.

DEREGULATION SPARKS UTILITY MERGER

Consolidations are rife in the energy business as deregulation forces monopolies to adjust to a competitive environment. One prominent example is the pending merger of American Electric Power of Columbus, Ohio, and Central & South West Corp. of Dallas, which together will serve 11 states.

The utilities announced the deal in December 1997 and are expected to receive final approval sometime this summer. Executive management faced a morass of regulatory obstacles nationally and in each locality. It did not involve IT in the merger negotiations. Once the deal was struck, IT was told to come up with $10 billion in savings over 10 years.

Because the merger was going to take at least two years to close, the IT transition team had time to perform an extensive evaluation of each company's infrastructure. The group examined everything from master time clocks to network switches and placed each technology in one of five categories:

* Watch: Emerging technologies that are not ready for prime time but should be kept under investigation.

* Promote: Technologies that business units are encouraged to use.

* Contain: Technologies to be approved for specific purposes only.

* Maintain: Technologies in place that will continue to be used but not extended.

* Replace: Technologies that IT is actively eliminating.

"The various committees encompassed almost everyone in the two IT departments," says Ken Foster, the IT transition team leader from CSW in Tulsa, Okla. "We learned from talking to the people who are down on the bare metal and understand specific technologies in detail."

The team wasn't just picking the system that was best in its current environment, nor was cost efficiency at the top of the list. The goal was to identify solutions that were highly scalable and highly adaptable, because the unbundling requirements of deregulation are pushing utilities into the unfamiliar waters of business-to-business e-commerce.

"Our cost-reduction goals are making us look at e-procurement technologies," Foster says. "My rough back-of-the-envelope assessment shows our B2B [business-to-business] activity increasing 3,000 percent in the next year, and my only concern is that I've underestimated it significantly."

FIRST UNION BANKS ON MERGERS FOR GROWTH

First Union, the nation's sixth-largest bank, has a track record that is the envy of its industry. An aggressive growth-by-acquisition strategy has boosted the bank's assets from $7.3 billion in 1984 to $253 billion at the end of 1999.

All this experience has taught the Charlotte, North Carolina, bank the value of early IT involvement in the merger and acquisition process. IT participates in the due diligence phase and helps the executive management determine what kinds of expense efficiencies could be achieved by the merger.

The banking giant typically buys smaller competitors that operate in the same region, then combines operations and closes redundant facilities. The faster the integration, the less it will cost and the fewer disruptions there will be to customers.

"First Union converts acquisitions faster than any other large bank in the country," says Austin Adams, the executive vice president in charge of First Union's merger and acquisition integration activities. "Our average conversion time in the 1990s was three months."

When First Union acquired the second-largest bank in Florida and eliminated 27 branches, there was a net gain of only one location in the state. Despite all these closings, the transition was seamless enough that First Union retained more than 80 percent of the target's customers.

The savings on IT was even greater and the bank often achieves IT cost efficiencies of more than 50 percent, according to Adams. However, First Union's executive management understands that IT enables the whole merger and acquisition process and isn't just another expense to be cut.

First Union's IT managers use a cookie-cutter approach to integration that starts with a well-defined due diligence questionnaire. The bank identifies the differences between the two environments and compares service offerings to see if the acquired bank has unique products that bring First Union a new customer segment. "Then we have to consider what it takes to retain those customers," Adams says.

The general plan is to move the target onto First Union's infrastructure, but exceptions are occasionally in order. CoreStates was much stronger internationally when First Union acquired it in 1998, so First Union's international business was migrated to the target's systems.

Regardless of whose technology wins, people are regarded as the most important component. "The technical issues are moot if the people issues aren't addressed," Adams says.

CISCO IS SERIOUS ABOUT SNAPPING UP COMPETITORSFew companies have refined the growth-by-acquisition art better than Cisco, which has consumated 54 mergers in the past five years and is working on five more. The networking giant targets small startups for their intellectual capital, not their customers or manufacturing capacity.

"We acquire companies and integrate them completely," says Tim Merrifield, senior IT manager in charge of Cisco's merger and acquisition integration activity. "We don't have subsidiaries running their own systems, even temporarily. We learned that going slowly causes more problems than payoffs."

IT isn't consulted prior to the acquisition announcement because Cisco already has a method for quickly replacing the acquired firm's infrastructure with its own standard technologies. "We are on site the day of the announcement or within a few days. We let them know what our processes are and what is going to happen," Merrifield says.

The weekend after the acquisition is completed, the target is connected to Cisco's e-mail system and intranet. But while Cisco imposes its IT infrastructure on the new business units, Merrifield says, "Outside of the standard, corporate-based components, we are willing to learn from the targets."

Superior merger and acquisition integration is giving Cisco a competitive advantage, and Merrifield is always looking for incremental improvements to the process. After each target is absorbed, his team holds postmortems to discuss what worked and what didn't.

"You have to be open to feedback so you can make adjustments before the next integration project," Merrifield says. "Just because the process worked well in the past, doesn't mean it will work well in the future."

MERGER TIPS

-- Move quickly and communicate clearly.

If you wait a month or two to start building a single team, it will be too late. The new management team should be in place on day one, and reporting structures should be established in the first few weeks.

-- Establish and thoroughly empower a transition team.

Make sure everyone knows who is in charge and give these people the power and the obligation to make the tough decisions. Consider bringing in a third party that has no vested interest in either infrastructure.

-- Manage staff attitudes and expectations.

You only get one chance to make a first impression, so plan how you will present your organization to the acquired IT staff from the outset.

-- Don't be too democratic.

If one IT organization is to be the surviving one, say that upfront. Involving the acquired company's rank-and-file staff too much can generate a lot of contention.

-- Budget lots of time for people issues.

As important as technology integration is, people have to come first. Count on staffing issues taking up 40 percent of your time.

-- Don't overanalyze and overintegrate.

Don't bother with granular best-of-breed technology comparisons. Unless the acquired company has a highly differentiated infrastructure, stick with the acquirer's model and use the target's strengths as examples for improvement.

-- Think customers and business results.

Take special care to make IT decisions based on how internal and external users and business processes will be impacted.

-- Don't mix mergers and forklift upgrades.

It's tempting to use a merger as an opportunity to do a sweeping upgrade, but increasing the amount of change multiplies the risk of failure.

-- Prepare for a possible merger and acquisition in your company's future.

Standardize system interfaces and think about how you would deal with a rapid increase in network traffic and transactions. Such readiness can shorten integration time and reduce the risk of failure.

-- Lobby for early involvement in the next deal.

Document the impact IT has on the organization and make a case for earlier involvement in the future. Bringing IT into the merger and acquisition process early on greatly boosts success rates.

-- Consider merger and acquisition specialists.

If your company embarks on a growth-by-acquisition strategy, you need dedicated merger and acquisition specialists on staff.

-- Document and improve on merger and acquisition planning and execution.

Approach merger and acquisitions as an evolutionary process to which you make incremental improvements. Hold postmortems and outline problems that can be avoided the next time.

-- Use a process-driven approach to merger and acquisitions.

Don't simple make lists of what has to be done; develop processes, with checklists within each of them.

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