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How to Avoid Merger Heartburn

How to Avoid Merger Heartburn

Before you go on an acquisition binge, you need to know who your target company's customers are and what they want.

As I recently noted in the Harvard Business Review, 70 percent to 80 percent of mergers are considered failures from an acquiring shareowner's perspective. Management has gone to the merger and acquisition gaming table over the past couple of decades and placed billion-dollar bets using their owners' capital, despite knowing that the odds of winning were far worse than roulette. Is anyone surprised that the owners of these companies took a beating again and again? Deal activity during the past five years of the 1990s annihilated at least $US1 trillion of acquiring shareowners' wealth, more than the entire dotcom bubble. Now, M&A activity is again rising.

Why on earth do so many CEOs succumb to the most costly corporate vice of all time - M&A gambling? Based on more than 30 years of working with companies in all types of industries around the world, I think the answer is simple. As conditions improve after an economic slowdown and intense cost cutting, lots of cash flows into companies, often far exceeding dividend and maintenance capital requirements. Investors rightly begin clamouring for management to commit this surplus cash to high-returning investments. Having picked the low-hanging fruit from cost management, top executives must now find more revenue. Examining their business plans, they find that the prospects for organic growth are far short of what is required to use available capital and meet investor expectations. Into this strategic void, bankers pounce with the "perfect" solution to the problem: a big acquisition. The deal will use a bunch of cash while meeting growth expectations. Or so it seems. Reflect on all of the hoopla associated with HP's acquisition of Compaq. Four years later, after failing to deliver on promised shareowner returns from that merger, the very visible and vocal CEO was asked to step down. In the meantime, archrival Dell gained shares in computers and began to make serious inroads into HP's primary source of profitability: printers.

Are CIOs innocent bystanders in this process, or are they guilty of complicity? I think the latter - but therein lies a phenomenal leadership opportunity. Every CIO must assume his or her CEO will eventually succumb to the M&A temptation. Once the deal is done, the CIO gets the mammoth job of integrating the IT systems of the acquiring and acquired companies. It has to be done fast and cheap to meet the ambitious cost reduction promises made to sell the deal to investors. Other priorities get subsumed. Significantly, most aspects of customer service and care get short shrift. We've all experienced this phenomenon as customers of endlessly merging telephone companies and banks.

A Customer-Centric Lens

To avoid getting run over by the bad-deal train, a company needs to produce sufficient organic growth - that is, find new investment opportunities that earn returns exceeding investors' minimum requirements. Those returns must be able to endure the inevitable onslaught of competitors for years. Is there any key to finding such investments? Turns out there is, and this is it: The only truly sustainable high-return investments are investments in customers.

Products come and go. But the ability to acquire, retain and grow highly profitable customers never loses its power. In company after company, I've found that the top 20 percent of the most profitable customers generate about 150 percent of the company's total profits. That sounds impossible until one recognizes that the bottom 20 percent often lose more than 100 percent of the company's profits. Figuring out who's profitable, who's not, and why are critical steps toward creating what I call a "truly customer-centric" company. After a company gains insights from these initial steps, management can begin the real work of segmenting customers and creating experiences for them that outstrip the competition and keep the profitable ones coming back for more. Customer-centricity also means organizing the business around customers to establish clear lines of accountability and ingraining in the culture a never-ending customer learning process. Most companies claim to be customer-centric, but as customers, we all know from the poor experiences we've had that, too often, these claims are bold-faced lies. True customer-centricity requires implementing each of the above steps. My experiences working with great companies that really get this - such as Best Buy and Royal Bank of Canada - convince me that implementing a customer-centric culture is by far the best way to generate sustainable high returns from your company's most important asset, its customers.

But most companies can't even get started. They don't know who's profitable and who's not. They may know the profitability of the yogurt division or the Adelaide store or the Northeast region. But the overwhelming majority have no real clue whether John, Sue or Charley are profitable - or, if their customers are companies, whether GM, IBM or GE are profitable. Before you protest that you certainly do have a clue, know that hundreds of leaders over the past decade have uttered similar responses to me, only to recoil in horror when, after working with their finance and marketing organizations, I show them that their perceptions of who's profitable and who's not are seriously wrong.

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