Managing the M&A beast

We were gathered around the conference room a few weeks ago discussing what the theme of the next Mach 2 Newsletter ought to be when the topic landed right at our feet.

It was the announcement that Microsoft was making an unsolicited bid of $44.6 billion for Yahoo. It’s an acquisition designed to give Microsoft more heft to its search engine and online advertising businesses with which to combat its arch-nemesis, Google. If the acquisition goes through, it will be the largest ever in the tech sector.

It seems the “eat or be eaten” law of the jungle prevails in IT. The African proverb mentioned in our January e-newsletter says: Whether you are a gazelle or a lion, when the sun comes up each morning, you better start running.
Well, it appears at sunrise on Feb. 1st, Microsoft woke up in a sprint.

It’s the first blockbuster Merger & Acquisition (M&A) in a year that most insiders predict will be more active than 2007. While the mega-mergers get all the ink, they represent only the tip of the M&A iceberg. Hundreds of others, notably in the segment of the market in which we specialize (i.e. IT services firms with revenues below $100MM) fly well below the media’s radar screen.
So, we thought this would be a good time to discuss what small-to-midsize IT services executives ought to know and consider as they contemplate mergers and acquisitions for their company. In fact, we’re working on a number of M&A assignments as this issue is published, so it’s a topical discussion for us as well.

Naturally we’d be delighted to speak with you further about your growth strategies in general and your interest in M&A in particular. We’d also like to hear from those of you who’ve jumped into the M&A waters and have lived to fight another day. There’s no shortage of war stories when it comes to M&A.

Mike Harvath.

Mergers and acquisitions have long played a major role in corporate strategy across all industries, for good and for ill. However, it seems that M&A plays a more active and integral role in IT than most other industries.

So, what is it about IT that creates such hyperactivity in M&A? Here are but a few of the factors we think are unique to the industry and that seem to make M&A an enticing growth strategy:

Size and growth: The sheer size and scope of the industry, which Gartner predicts will reach $3.3 trillion in revenues in 2008 (+5.5% vs. 2007), make it a large tent offering big opportunity and big rewards for aggressive companies.

Youth: Relative to other mature industries, IT is still a youngster. Consider that Microsoft is 33 years old, SAP is 36, Oracle is 31, Cisco is 24, Sun is 26 and Business Objects is 18. Then, of course, there is Yahoo! at 14 and Google at 10, and a whole slew of IT babies; MySpace.com is five years old, Facebook is four, and YouTube, still an infant, is only three years old. There’s energy and vitality in the industry that’s constantly infused with an infectious, entrepreneurial drive. It continues to be a make-it-happen environment.

Innovation: It’s the industry’s raison d’être, the fuel that drives growth and opportunity, and it’s the one characteristic that separates this industry from all others. No moss grows on this rolling stone, as every day sees the introduction of revolutionary new ideas, technologies, products and services, with no end in sight.

Fragmentation: Beyond the fewer and fewer big-name brands at the top of the pecking order, the IT industry—notably services—is a truly fragmented category with hundreds of thousands of competitors. This breeds a healthy rivalry as companies look for new ways to grow and differentiate themselves.

Global reach: The market is the world. There are no boundaries. New companies, ideas and customers are to be found in every nook and cranny of the developed and developing economies, and they can be serviced from almost anywhere.

Entrepreneurial Lifecycle: Most startups and young IT service companies come from technology entrepreneurs—smart, restless, ambitious tech gurus who enjoy the thrill of creating new enterprises. Many of these companies grow to the point at which new skill sets are required to take the company to the next level. For many entrepreneurs, this is an opportunity to pass the company on to those with such skills, and then, for them, it’s back to the drawing board to start anew. IT, alone among industries, thrives on this evolutionary business model cycle.

Our most successful, revenue-driven clients will tell you that without an ongoing M&A initiative, you’re forfeiting over 50% of your growth potential. It’s why we advise clients not to think of it simply as an acquisition, but as an investment for a more promising future. In no particular order, here are some of the strategic reasons why you may want to consider M&A as an ingredient in your growth strategy portfolio:

• Access to management or technical talent.

• Access to new intellectual property, ideas, patents, equipment, product lines and/or technologies.

• Access to new markets and new customers.

• Improved earnings and sales stability.

• Growth in market share in the sectors in which you compete.

• Enhanced reputation in the marketplace or with stakeholders.

• Reduction of operating expenses, realizing economies of scale and of scope.

• Competitive insulation.

• Attracting, retaining and rewarding key employees.

These are all valid reasons why one would choose to go the M&A route. However, this is just the beginning of an eventful ride. Buckle up and hold on.

M&A has often been referred to as one of the most unnatural acts in business. There has to be some truth to this characterization given the abundance of data that indicates that between 50% and 80% of all mergers and acquisitions fail to live up to the intended goal.

The reason cited most often for why M&A goes awry is the failure of planning for and implementing correctly the post merger assimilation of cultures, people, values, attitudes and styles . . . what is called the soft side of the equation.

It’s an odd and intriguing twist of management fate that one of the most critical elements of a company’s long-term growth strategy is governed upside down. Most of management’s attention is focused on the upfront number crunching, due diligence phase of the project, which evidence suggests is one of the least likely areas where M&A runs afoul. The back-end—the post acquisition assimilation phase of the M&A—where research suggests 65% of the failure occurs and where management’s experience and firm hand is needed, is what gets the short shrift.

Let’s be fair and not put all the blame for these troublesome failure rates on post acquisition blunders. There are other textbook culprits eager to contribute to this dilemma, many of which are well-documented and need little embellishment here, to wit:

• Flawed corporate strategy by one or both companies.

• Executive hubris.

• Desperation and/or fear.

• False expectations of and subsequent proof of unrealized savings.

• Mischievous intent and documentation.

• Changing market conditions.

• Et al.

The consequence of failure for small-to-midsize IT services firms—without the financial reserves of their larger brethren, who can withstand an M&A miss or two and emerge humbled and bleeding but not broken—can be devastating. The question for these executives should not be whether to embark on an M&A strategy, but how to do it right.