Warren Buffet on Synergies
A whirlwind history of corporate M&A
M&A has its origins in the large horizontal mergers of the late nineteenth and early twentieth century, when a large rise in manufacturing and nation-building networks such as telephony benefited greatly from the economies of scale that mergers achieved. This of course quickly led to anti-competitive behaviour and the introduction of law to curb monopolistic control.
The resultant regulatory conditions produced the sort of oligopolies we see even today in many mature markets, where competitors themselves needed to merge in order to play with the big kids. Then, post World War II, came the conglomerates — formed through mergers to bring into the fold companies that did not have a clear relationship to an acquirer’s original business. In effect, big companies were using acquisition to diversify their revenue streams and create holding companies, the best example of which is General Electric.
Whilst an oil crisis and stock market havoc undid this trend’s momentum, some markets sustained a tradition of the holding company — Japan, for example, had its keiretsu (系列), a fixture of the Japanese economic miracle that attempted to supersede Japanese family-controlled monopolies, giving us such names as Mitsubishi and today’s Toyota Group. You can pretty much guess that the next phase after national conglomerates was multinational mergers, which probably fell out of favour more because of Enron and the dot.com boom than because of the fundamentals of that strategy.
The field has also seen waves of incredible wealth, greed and intrigue with each new chapter of history; private equity, leveraged buy-outs, emerging economy growth plans, hostile takeovers, sub-prime mortgage shuffling, startup unicorn hysteria, and Initial Coin Offerings.
If none of that means anything to you, perhaps you instead recall Richard Gere’s character in Pretty Woman — a corporate raider that acquires and then breaks up companies into small bits to turn transactional profits — only to arrive at the epiphany that he loves his call girl, and instead of breaking up corporate assets he wants to “build something”. Well, that’s basically the other history of M&A.
M&A research has built a discourse on ‘value’
Business researchers have watched this dramatic history unfold, observing with one question above all others: “do M&A transactions deliver value?”
Yes, many aspects of a merger and post-merger integration have been exhaustively explored, and trends in what a company might acquire have been documented the world over, but the most pressing question for both theory and practice has always been whether 1+1 = >2, and as an extension of this, what is the value of an acquisition… how much should I pay for a company in anticipation of the value it will create for me?
The theoretical answer to M&A value creation came in the form of the concept of ‘synergies’. “I am strong in A, but weak in B. You are an excellent B company. If I acquire you, I become strong in both A and B. Our combination is synergistic.” Ideally synergies lead to value greater than the sum of the parts (1+1=3) when only through the combination of two companies can certain value be realised. This might be through scale economics, competitive differentiation , or procedural efficiency. For example, a retailer might acquire another retailer to achieve the largest retail footprint in the country (inimitable differentiation), have purchasing power to buy goods cheaper (scale economics), introduce a streamlined supply chain (procedural efficiency), and rationalise the HR functions down to one (de-duplication).
There is a certain neat logic to synergy theory, and it is easily communicated as the focus of due diligence or as a rationale for market observers. But in practice it can be very difficult to prove because there are many moving parts. While one function in a company may enjoy benefits, another may suffer compounding pressure such that the net benefit to a company is negative synergy. This is sometimes described as the ‘contagion-’ or ‘capacity effect’. The other big challenge is that realising synergistic benefits usually requires additional effort and resources, as well as different leadership capabilities and sophisticated cultural change management.
Just imagine the coming together Nokia and Siemens in 2006: two global leaders in their respective markets, with distinct cultures (national cultures, in fact) and management styles born out of decades of validating success — for the resultant Nokia Siemens Networks, synergistic strategy was the least important concern for post-merger success.
“Even best practice… produces failure rates of 66–75%”, McKinsey 2010.
“83% of merger deals did not boost shareholder returns”, KPMG 2015.
Don’t take these factoids with a grain of salt — take about 5 tablespoons. Methodological issues abound with these numbers, in part because it is so difficult to isolate the long term future value attributable to the transaction, especially when the assets are combined into a single entity. Upsides and downsides blur into whatever story you might want to tell. But many research firms have tracked this question with a consistent methodology over time, and despite no consistency between research, numbers always place M&A success rates far south of 50%.
Unfortunately (perhaps), there are also myriad reasons why a company might pursue an acquisition that have nothing at all to do with the value a transaction will create. Sometimes a company with cash must demonstrate it can be more creative with the money than its investors, with the only alternative being to declare defeat by returning that money to shareholders. Perhaps a posture in a firm’s public relations requires that they show signs of inorganic (meaning acquisition-led) growth against a promised timeline. Broader economic trends also influence M&A behaviour, as do competitive pressures in an industry produced by market demand or market disruptions. Business literature is replete with stories of less than successful acquisitions, but that might be more damning of the strategic intent than the M&A instrument itself.
International corporate history has produced a voluminous set of cautionary tales about M&A, perhaps forgetting the real history and forces that defined these case studies. And this was the stage set for the Not for Profit sector.
M&A meets the Not for Profit (NFP)
There is a fairly classical evolution of ‘for purpose’ organisations (see ‘Nonprofit Organization Lifecycle’). Starting organically in response to need, growing through grass roots activism and hustle, butting up against funding issues alleviated by a benefactor, they shift to a revenue mode. Then they hit scale issues, encounter unprecedented organisational challenges, and look to the experience of the for profit sector to navigate the challenges of being a larger organisation in need of strategic and operational discipline. The for purpose organisation then wrestles with retaining that original spark of meaning while maturing as an institution. At this point, NFPs tend to distinguish themselves from the profit sector in three main ways: 1) stronger purpose, 2) less resources, 3) an abiding sense that there’s something to learn from the for profit sector about leading at scale.
I’m sure that’s not the story of every NFP. I’m sure there are similar caricatures for the journey of small businesses. I also suspect that the M&A skill-gap for NFPs may be no greater than that of large enterprise!
So when it comes to discussing M&A — the most corporate of corporate practices — is it any wonder a NFP’s first port of call for advice is the profit sector? Is it any wonder that our point of reference is the exhaustive, well funded, well researched body of knowledge that has occupied the minds of corporate leaders for a century? Is it any surprise that a resource-constrained organisation with perceived skill gaps and a risk aversion due to the importance of their cause is terrified by the shockingly low success rates?
Drawing from the for profit tradition, the NFP is told to beware:
- Success rates are low, and value is difficult to discern
- The case for synergies must be incredibly compelling: economies of scale, differentiation, labour productivity
- Post-merger activities are complex, and create distraction
- Your stretched workforce will be stretched further
- The cultural impost is high, and can destroy organisations
- Leadership requirements are unique and the capability is expensive
NFP M&A has enjoyed far less research, and its tradition is more like a set of anecdotes. Therefore, there is little to counter this warning.
As it happens, in some jurisdictions (e.g. U.S) there is a surprisingly large volume of M&A, but the main precipitant is economic distress or the dissolution of leadership (refer to The Bridgespan Group’s study of 3300 deals across 4 states over 11 years). This means that M&A is seen most often as a “tool for tough times”, which is a far cry from exploring strategic opportunity and testing the limits of value creation. Being born of crisis also doesn’t augur well for the transaction.
A new case for the NFP M&A (an Australian story)
According to the Australian Bureau of Statistics, the not for profit sector has annual revenue of over $100 billion, assets of almost $200 billion, and employs ~8% of Australia’s workforce. That’s 5 times as many employees as the mining sector, and greater revenue than our agricultural and fishing industry. Point 1: NFP is enormous.
In a 2016 report by JBWere, Australia was said to have 56,894 NFP organisations — one for every 422 individuals, doubling every 20 years. And despite regular ACNC cancellations, there are still 10 new charities established every business day. Point 2: NFP is incredibly crowded.
The NAB Charitable Giving Index 2017 suggests that donors face headwinds from high household debt levels, slow wages growth and high utility prices, all of which may impact their desire to spend. NAB data also suggests “Baby Boomers give more generously to charities than those from Generation Y, contributing 3 times more per donor on average”. Point 3: NFP revenue is challenged.
Enormous, crowded and facing a revenue challenge — the for purpose sector’s high fragmentation must be inefficient, and this fragmentation is at a scale of national significance. So what if we didn’t look at M&A as a tool only for the distressed, and instead proposed that there is a magical instrument that will help your NFP to:
- Build critical mass
- Broaden services and reach
- Secure more expertise and passionate resources
- Provide a step change in scale to pursue your purpose
- Reduce competition for funding
- Strengthen sectoral ties
- Overcome the scale barriers of your more asset-intensive activities
- Improve brand clarity and cut-through in the market
Also, NFPs needn’t think of success in the same terms as a for profit organisation — they don’t have to look upon their environment as a zero sum war.
Unlike the profit sector, a purpose-led organisation may aspire to one day close its doors. For example, an organisation dedicated to homelessness may aspire to become so successful as to be unnecessary with the eradication of homelessness. Also, other participants in the ecosystem can be considered peers and partners, rather than competitors. While NFPs might be drawn into seeing peers approaching the same sources of funding as ‘competition’, donors and philanthropy would gladly support the reframing of this dynamic as an opportunity for tight cooperation, sharing, and strong integration.
Higher-minded NFP leaders may just have the sort of clarity of vision and courageous decision making capability to derive incredible value from M&A — the sort of leadership that corporations only dream about! NFPs have something to teach the profit sector about being purpose led, and it is exactly this strength that makes me believe the NFP M&A success rate could be its own unique story.
One Australian NFP Governance and Performance Study (2014) suggested that “mergers are not a solution to the not-for-profit sector’s problems”, but that headline was quickly tempered with the advice that “it is just one of a number of tools”. Interestingly, the study showed that 20% of respondents had considered M&A, citing the main reasons as the improvement of services, efficiency or service range — initially prompted by either government encouragement or the hope to appear more attractive to funders. Perhaps there is a timidity that casts NFP M&A as a tool for tough times, but could it be a more deliberate tool for advancing an organisation’s mission?
If we keep the idea as plain and simple as “binding together for a cause”, perhaps M&A — with uniquely NFP characteristics — could be the next big disruptive enabler for this sector.
And for all organisations, perhaps the secret to an improved success rate is to start by asking what opportunities M&A presents in the service of your purpose and vision.2