How to leverage M&A strategy as a successful tool for consistent non-organic exponential growth
The year 2021 was known for many records, such as the stock market, Crypto, Apple stock, and many more. But one record you may not have heard about is mergers and acquisitions transactions. At a whopping $6 Trillion, 2021 shattered all previous M&A records. But you don’t hear a lot about the M&A market. $6 Trillion was twice the annual average of the past decade. But what’s really unusual about the growing trend in mergers and acquisitions is that, year after year and survey after survey, the research into M&A deals shows that such transactions actually destroy value!
Yes, you read it correctly; they destroy value. I’ll get to that in a minute, and you’ll understand why and how this happens. But, more importantly, what I’ll be focusing on are the great lessons to be learned from this phenomenon for any business, whether or not you’re looking at mergers as a growth strategy.
Why Are M&As on a Growth Trend?
You may think that SPAC deals are the ones that contributed to the increase, but SPACs accounted for less than 10% of the total. There are many reasons for that, but some of the main drivers that I’ll be discussing here have to do with behavioral finance and the nonlinearity or the complexity of such transactions. Moreover, during the planning of M&As, the bar for the benefits that can be achieved from these transactions is set at levels that after you factor in the optimism and the margins of error, because of the complexity of programs like these, chances for value creation are dampened before execution starts.
What do you think is the single driver and motivator for M&As? If you answered Synergies, you’re spot-on. Whether driven by scope or scale objectives, mergers and acquisitions are common strategies adopted by companies looking to improve a company’s performance that is much greater than what can be achieved organically; in other words, the status quo performance.
On paper, when synergies can be justified by combining merged resources of two companies, it would make sense for companies to proceed with a merger.
What Are Synergies?
Synergies are arguably the most important indicators of an organization’s performance; the word has its roots in the Greek language, and it means “working together.”
In complex systems, synergies are the relationship between at least two parts or elements in a system where the interaction resulting from this relationship generates either more or less than the raw sum of its parts. There are positive and negative synergies:
- Negative synergies happen if an interaction between elements — in this case, employees in an organization — is less than the sum of its parts. Or where 1+1 ≤ 2
- Positive Synergies arise from what’s referred to as positive feedback loops between elements, and when such interaction leads to more than the sum of its parts. 1+1 > 2
Examples of positive synergies in nature are how Flowers and Bees interact to pollinate flowers and produce honey, or in business, how members of a diverse team or teams interact to create or introduce new winning products to the market.
In total, close to $40 trillion worth of M&A transactions have taken place over the past decade, with companies looking to monetize on possible synergies. So how did these mergers turn out?
Every year, several studies on tens of thousands of deals are conducted by reputable firms to measure the impact of M&A on a company’s performance. They monitor the deals that took place over a decade =trailing. The results of these vary slightly, but the conclusion is always the same. In the majority of M&A transactions, approximately two out of three mergers lead to negative synergies and destruction of value.
You may be wondering about the ones that succeed at creating value. Well, the expected benefits of successful mergers and acquisitions are usually to add an additional 5%-9% improvement in performance, but that’s after the deal is sealed and after the post-merger integration program, which typically takes you beyond the second or third year. In other words, your 3-year payback after you factor 5–10% in transaction fees, and the effort and cost of post-merger integration programs, your overall payback is likely to remain negative.
Beyond three years is anyone’s guess, and people who strongly believe in the accuracy of the numbers of four+ year forecasts in such a complex world and an ever-changing business climate are likely to fall for Prospect Theory biases. Hold that thought for a minute, as this is what I’ll get into next.
When Is M&A Worth it?
That said, there’s a small percentage of cases where M&As lead to benefits beyond the expected synergies to the acquirer. They’re the kind of acquisition that is optionalities-based and purely scope-driven acquisitions. Examples are when companies look to diversify their portfolio and revenue sources by adding options through acquisitions instead incubation, for example, in the case of Facebook’s acquisitions of Instagram and Oculus or the case of Amazon’s acquisitions of Ring, twitch, and Zoox. This is when the acquirer adds an entirely new or adjacent business unit, mostly with the strategic objective of a bet on optionalities, which I will discuss in much deeper detail in another article, But that’s not where the majority of the trillions in annual acquisition dollars are typically invested.
Now, if synergies are the main driver of M&As, it’s no wonder that “low synergies” would be stated as the leading cause of merger failure but also “culture fit” because this is naturally a killer of synergies. These findings have been established because most M&A studies go beyond assessing payoff and value; they also determine why mergers fail, such as the recent ones conducted by BCG and Bain.
And here’s the problem. Many companies proceed with M&As even when they internally have huge gaps in synergies and ignore the “culture fit” between the merged entities.
But what’s even more interesting is a study conducted by Bain & Company, which went deeper into the root cause of why this happens in the first place, meaning, why are there no synergies? It also found that “Overestimated synergies from combining the companies” was stated by 55% of surveyed companies as a leading cause of M&A failure. So why does this happen so frequently?
Overconfidence and Optimism Are Culprits
Well, it’s in our nature as humans to be risk-averse but, at the same time, overconfident, which makes for a dangerous combination. Let me explain. These findings from behavioral economics are based on experimental research conducted by Daniel Kahneman and it’s referred to as Prospect Theory, for which he got awarded the Nobel Prize in 2002. In his best-selling book “Thinking Fast and Slow,” Kahneman explained it in detail, where he compressed his lifelong research on behavioral economics. Prospect theory is a paradox, and I consider Kahneman’s findings nothing short of extraordinary in many respects. Moreover, they have far-reaching implications not only in managerial decision-making but also in decisions taken by leaders in financial markets, public policy, wars, global trade, and many more, which I will get into in much more detail in another article.
In the context of M&A, these findings that people are overconfident and optimistic make for a dangerous combination. That’s why when Kahneman was once asked: which cognitive bias he would eliminate if he had a Magic wand. He answered: overconfidence. For example, overconfidence and optimism can lead to what is evident in the majority of failed transactions shown earlier by overestimation of results and synergies on paper, during planning, and when going through transactions.
If you’re familiar with Kahneman’s work, you also know the main reveal of Prospect Theory is that, as humans, we are risk-averse, and we prefer not losing over winning, but at the same time, we are optimistic, which is Paradox.
How Should We Tackle this Paradox?
When processing new information, you need to narrow your focus by sifting quickly and zooming in on what really matters to make the right decisions without such biases. An approach that can be adopted is called System Thinking. In systems thinking, you need to sift through the information and distinguish between linear and nonlinear settings before relying on heuristics for making decisions. I discuss this process, the framework, and the mental mode in detail in How to Think in Complex Systems.
As discussed earlier, when thinking about M&A as a strategy for non-organic growth, we set the bar at a level based on synergies that can be achieved from scale. This strategy has a high margin of error and lower returns than synergies that can be unlocked from a scope-based strategy. The strategic objective of M&A should be to unlock scope potential that can be scaled to achieve extraordinary growth outcomes resulting from exponentially compounded growth as opposed to a single factor. To achieve this, M&As should be planned based on scope first and scale second, and the main driver and goal should be optionality-based thinking.
If you enjoyed reading this article and are curious about entering the world of systems thinking, check out my other articles:
Harding, D., Vorobyov, A., Kumar, S., & Galligan, S. (2022, February 8). State of the M&A Market. Bain. https://www.bain.com/insights/state-of-the-market-m-and-a-report-2022/
Kahneman, D. (2011). Thinking, Fast and Slow. Farrar, Straus and Giroux.
Kengelbach, J., Utzerath, D., Kaserer, C., & Schatt, S. (2010, March 27). How Successful M&A Deals Split the Synergies. BCG Global. https://www.bcg.com/publications/2013/mergers-acquisitions-postmerger-integration-divide-conquer-deals-split-synergies
Miles, L., Borchert, A., & Ramanathan, A. E. (2014, August 13). Why Some Merging Companies Become Synergy Overachievers. Bain & Company. https://www.bain.com/insights/why-some-merging-companies-become-synergy-overachievers
Post-Merger Integration. (n.d.). BCG Global. https://www.bcg.com/capabilities/mergers-acquisitions-transactions-pmi/post-merger-integration
Thompson, E. K., & Kim, C. (2020). Post-M&A Performance and Failure: Implications of Time until Deal Completion. Sustainability, 12(7), 2999. https://doi.org/10.3390/su12072999
Value of mergers and acquisition (M&A) transactions worldwide from 2010 to 2021. (2019). Statista; Statista. https://www.statista.com/statistics/267369/volume-of-mergers-and-acquisitions-worldwide/