Chapter IV Managing Risks in Mergers, Acquisitions and Strategic Alliances

There is a serious problem facing senior executives who choose acquisitions as a corporate growth strategy. My study reveals that fully 65 per cent of major strategic acquisitions have been failures. And some have been truly major failures resulting in dramatic losses of value for the shareholders of the acquiring company. With market values and acquisition premiums at record highs, it is time to articulate demanding standards for what constitutes informed or prudent decision-making. The risks are too great otherwise. - Mark L Sirower1.

Understanding the risks in mergers and acquisitions

A combination of factors - increased global competition, regulatory changes, fast changing technology, need for faster growth and industry excess capacity - has fuelled mergers and acquisitions (M&A) in recent times. The M&A phenomenon has been noticeable not only in developed markets like the US, Europe and Japan but also in emerging markets like India. In 1998, worldwide mergers and acquisitions were valued2 at $2.4 trillion. In 1999, this figure increased3 to $3.4 trillion. In 2000, the pace seemed to slow down, with only the Glaxo Wellcome SmithKline Beecham merger valued at over $50 billion. However, the total value of the deals worldwide crossed $3.5 trillion. Much of this activity took place in the first half of 2000. The recent merger proposal by HP and Compaq is a clear indication that merger mania is well and truly alive. Like capacity expansion, vertical integration and diversification, a large merger or an acquisition is a strategic move since it can make or break a company. However, mergers and acquisitions involve unique challenges such as the valuation of the company being acquired and integration of the pre merger entities. Valuation is a subjective matter, involving several assumptions. Integration of the pre-merger entities is a demanding task and has to be managed skillfully. So, it makes sense to devote a separate chapter to cover the risks associated with acquisitions4 and how to manage them. Mark Sirower, an internationally acclaimed expert in the field of mergers and acquisitions found that two thirds of the 168 deals he analysed between 1979 and 1990, destroyed value for shareholders. When he looked at the shares of 100 large companies that made major acquisitions between 1994 and 1997, Sirower found that the acquirers stock, on an average trailed the S&P 500 by 8.6%, one year after the deal was announced. 60 of these stocks under-performed in relation to the market, while 32 posted negative returns. Many of the companies acquired were often sold off later, sometimes at a loss.
1 2 3 4

The Synergy Trap. According to Security Data Co. The Economist, July 20, 2000. In this chapter, we use the terms, mergers and acquisitions interchangeably though there are some important differences. (See glossary).

Consider Kimberly Clarks acquisition of Scott Paper in 1995. This acquisition made Kimberly-Clark the worlds largest tissue maker. One year later however, sales were down and profits and operating income had shrunk. By 1999, the merged entity was trailing the S&P 500 Stock Index. AT&T gave several seemingly valid reasons for its acquisition of NCR. But after five years of incurring losses, amounting to more than $2 billion, AT&T accepted that the acquisition would not work. In 1995, it decided to spin the company off. Quite clearly, mergers and acquisitions involve heavy risks. In their excitement and enthusiasm to close the deal fast, managers throw caution to the winds. Later, there is a gap between expectations and actual performance and shareholders wealth is eroded. This chapter covers some of the important risks in M&As and provides a framework for dealing with them.
Strategic Issues in Mergers & Acquisitions

Identifying Synergies

Valuation

Integration

Why mergers are risky

Major acquisitions have to be handled carefully because they leave little scope for trial and error and are difficult to reverse. The risks involved are not merely financial ones. A failed merger can disrupt work processes, diminish customer confidence, damage the companys reputation, cause employees to leave and result in poor employee motivation levels. So the old saying, discretion is the better part of valour, is well and truly applicable here. A comprehensive assessment of the various risks involved is a must before striking an M&A deal. Circumstances under which the acquisition may fail, including the worst case scenarios, should be carefully considered. Even if the probability of a failure is very low, but the consequences of the failure are significant, one should think carefully before hastening to complete the deal. According to Eccles, Lanes and Wilson5, most companies fail to undertake a thorough risk analysis before making an acquisition. Which is why they end up burning their fingers. The strategic implications of a merger should be understood carefully. Otherwise, the shareholders wealth will be eroded. As Mark Sirower6 puts it neatly, When you make a bid for the equity of another company, you are issuing cash or claims to the shareholders of that company. If you issue claims or cash in an amount greater than the
5 6

Harvard Business Review, July August 1999. The Synergy Trap.

economic value of the assets you purchase, you have merely transferred value from the shareholders of your firm to the shareholders of the target right from the beginning. In an acquisition, the acquirer pays up front for the right to control the assets of the target firm, with the hope of generating a future stream of cash flows. If demanding standards are not set to facilitate informed and prudent decision-making, the investment made will not yield commensurate returns.
Target Table I Some top M&A deals in 2001 Acquirer Value of deal ($ million) 57,547 31,739 25,263 23,398 19,656 14,904 13,132 12,821 11,973 11,511

AT&T Broadband & Internet (US) Comcast (US) Hughes Electronics (US) Echostar Communications (US) Compaq Computer (US) Hewlett Packard (US) American General (US) American International Group (US) Dresdner Bank (Germany) Allianz (Germany) Bank of Scotland (UK) Halifax Group (UK) Wachovia (US) First Union (US) Benacci (Mexico) Citigroup (US) Telecom Italia (Italy) Olivetti (Italy) Billiton (UK) BHP (Australia) Compiled from various sources

There are two main reasons for the failure of an acquisition. One is the tendency to lay too much stress on the strategic, unquantifiable benefits of the deal. This results in over-valuation of the acquired company. The second reason is the use of wrong integration strategies. As a result, actually realised synergies turn out to be well short of the projected ones. Many companies are confident about generating cost savings before the merger. But they are unaware of the practical difficulties involved in realising them. For example, a job may be eliminated, but the person currently on that job may simply be shifted to another department. As a result, the head count remains intact and there is no cost reduction. Many firms enter a merger hoping that efficiency can be improved by combining the best practices and core competencies of the acquiring and acquired companies. Cultural factors may however, prevent such knowledge sharing. The 1998 merger of Daimler Benz and Chrysler is a good example. Also, it may take much longer to generate cost savings than anticipated. The longer it takes to cut costs, the lesser the value of the synergies generated. Revenue growth, the reason given to justify many mergers, is in general more difficult to achieve than cost cutting. In fact, growth may be adversely affected after a merger if customer or competitor reactions are hostile. When Lockheed Martin acquired Loral, it lost business from important customers such as McDonnell Douglas, who were Lockheeds competitors. So, companies must also look at the acquisition in terms of the impact it makes on competitors. The acquisition should minimise the possibility of retaliation by competitors. Some M&A experts look at revenue enhancement as a soft synergy and discount it heavily while calculating synergy value.

Tata Tea: Tetley acquisition runs into problems In mid 2000, Indias largest tea company, Tata Tea announced it was buying the UK-based Tetley for 271 million in a leveraged buyout. Tetley, which earned a net profit of 35 million in 1998 on sales of 280 million was the third largest brand in the global $600 million packaged tea market - behind Unilevers Brook Bond and Lipton. Tata Tea viewed the acquisition as a quick way to gain access to markets in the US, Canada, Europe and Australia. It also looked at the opportunities created by Tetleys estimated weekly purchase of three million kg of tea from 10,000 estates in 35 different countries. Besides, Tata Tea hoped to gain packaging expertise from Tetley. Tata Tea did not pay cash upfront. Instead, it pumped 70 million of equity into a special purpose vehicle. Then it leveraged the equity to borrow 235 million from the market. Tata Tea hoped that cash flows from Tetley would be adequate to pay off the debt. At the time of finalising the deal, there were press reports that Tata Tea was probably overpaying7 - it had offered 100 million more than the second highest bidder. To service the debt, Tetley needed to generate cash flows of at least 48 million per year, whereas it generated only 29 million in 1999. Tata Tea had hoped for a quantum jump in cash flows after the acquisition. But unfortunately for Tata Tea, retail tea prices in the UK market fell. Moreover, the popularity of tea continued to decline in the UK while the market share for natural juices and coffee went up. By September 2001, the deal was running into short-term financial problems. The Tatas announced they would bring in an additional 60 million as equity. This would facilitate retirement of expensive debt and reduce interest charges by about 8 million per year. If cash flows touch 40 million, the risk of not being able to service the debt will be eliminated. This will however not be an easy task. Tata Tea Managing Director, R K Krishna Kumar recently admitted 8 that additional investments will be needed to revive demand.

Companies making an acquisition not only have to meet the performance targets the market already expects, but also the higher targets implied by the acquisition premium. When they pay the acquisition premium, managers are essentially committing themselves to delivering more than what the market expects on the basis of current projections. This is a point which is often forgotten. Even when the numbers do not justify an acquisition, executives may insist on going ahead for strategic benefits that cannot be quantified. In the heat of finalising the deal, what is conveniently overlooked is that most strategic benefits ultimately should be reflected in some form of cost reduction or revenue growth. Similarly, rushing ahead to finalise a deal before a competitor does so, is not always a wise move. In many cases, it makes sense to allow the competitor to pay a higher price and weaken its competitive position rather than rush into the deal. Acquisitions involve changes and often have a destabilising effect. During the integration of the pre-merger entities, stress, tension, uncertainty and an exodus of employees are likely. To avoid this, building a climate of trust among the employees of the merging entities is extremely important. Most companies underestimate the difficulties involved in integrating the pre-merger entities. A recent example is the ICICI ICICI bank merger.

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Business World, September 10, 2001. Business World, September 10, 2001.

International Paper: Aggressive acquisitions strategy creates problems The paper industry has been known to go through boom and bust cycles. Size and market share are critical in the paper industry, whose products look more like commodities than brands. John Dillon, the CEO of International Paper (IP) the worlds largest paper company looks at acquisitions as a way to control prices. After paying $7.1 billion to acquire office paper company Union Camp in early 1999, IP purchased its rival, Champion Paper Corp for $9.6 billion in June 2000. These expensive acquisitions left IP with a debt of $15.5 billion, (50% of capital and four times cash flows) towards the end of 2000. Dillon has been divesting non-core businesses such as petroleum and minerals to pay for the acquisitions. The markets however, remain cynical about IPs moves. IP is yet to prove it can integrate its acquisitions and realise the synergies it has projected before its acquisitions. It has been slow to close down factories, an important step in reducing industry capacity and consequently improving prices. In October 2000, Dillon announced that he would be shutting 1.2 million tonnes of capacity or 5% of total production. Much more however needs to be done. Reaction to the Champion deal has been lukewarm. The companys stock price has fallen during the period 1995-2000. IPs growth-by-acquisitions strategy may well turn out to be risky, especially at a time when the US economy has gone into a recession.

A disciplined approach to acquisitions is necessary to weed out unviable deals. As Eccles, Lanes and Wilson put it9, Over half the deals being done today will destroy value for the acquiring companys shareholders. Whats the reason for the disparity between these simple lessons and these poor results? We believe that far too many companies neglect the organizational discipline needed to ensure that analytical rigour triumphs over emotion and ego. Porter10 argues that acquisitions make sense only when three conditions hold good: The acquired companys management is more keen on withdrawing, than continuing to run the operations. So, the minimum price, it expects, is quite low. The market for companies is imperfect and does not eliminate aboveaverage returns through the bidding process. The buyer has unique abilities and competencies which it can use to manage the acquired companys business far more efficiently and effectively.
The collapse of Indiainfo.com The experience of Indiainfo.com highlights the risks involved in the kind of reckless acquisitions and alliances made by dotcom businesses in India. During the period December 1999 February 2000, Indiainfo kicked off its launch in the Indian market with an ad blitz that cost Rs. 11-15 crore and announced that it would catch up with leader Rediff.com. When founder Raj Koneru brought some senior professionals into the management team, venture capitalists expressed their happiness. Impressed by the companys vision and aggressive plans, Morgan Stanley decided to pay $11.5 million to acquire a 7% stake. But, managing the rapid growth proved difficult. A cultural clash between the erstwhile entrepreneurs whose websites had been taken over by Koneru and the new breed of professional managers made matters worse. While these entrepreneurs were known to live frugally, the professionals led a fancy lifestyle. Meanwhile, Koneru plunged headlong into acquisitions without detailed consultations with his
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Harvard Business Review, July-August 1999. Competitive Strategy.

senior team. In many cases, payments were made in cash. One deal involved a payment of Rs 200 crore ($45 million) to VSNL, Indias leading Internet Service Provider, so that every time a VSNL user would log on, he would land on the Indiainfo home page. Senior executives first came to know about the deal at a press conference! Koneru apparently estimated that the increase in traffic would take the companys valuation to about $1 billion. Koneru also made a big mistake in deciding to postpone his IPO. The reason for the delay was probably preoccupation with integrating the acquisitions which had been made at a furious pace, one after the other. The huge expenditures on advertising, salaries and acquisitions added up to Rs. 30 crores by September 2000. Many senior executives began to desert the sinking ship.

Identifying the synergies

The aim of an acquisition is to make the merged entity more valuable than the sum of the values of the pre-merger entities. As mentioned earlier, synergies can add value only if the merged entity registers a performance that is better than what is already reflected in the market prices of the pre-merger entities. In almost two out of three acquisitions, the acquirers stock price falls after the deal is announced. This is a clear indication that the markets tend to be cynical about the realisation of the synergies projected. One reason could be that the markets have already discounted the expectation of an improvement in the operating performance of the acquired company. In extreme cases, the markets may even feel that by diverting resources from stronger divisions, for the purpose of realising synergies, value may be subtracted, rather than added. At a more strategic level, acquisitions, by engaging the top management in the integration process may allow competitors to leap ahead. Boeing faced a major crisis in its production line in the late 1990s, when its attention was entirely focussed on its integration with McDonnel Douglas. (See Box item on pg. 9) Much of the risk in an M&A deal arises from the acquiring companys inability to identify and quantify synergies accurately. Often, the synergies which are highlighted, do not materialise, while those which may have been completely overlooked become very important. Usually, it is years after the acquisition that it becomes clear whether the price paid for the acquisition was the right one or not. Alex Mandi, who negotiated the acquisition of Mc Caw Cellular on behalf of AT&T recalled,11 Everybody said wed paid too much. But with hindsight, its clear that cellular telephony was a critical asset for the telecommunications business and it would have been a tough proposition to build that business from scratch. Buying Mc Caw was very much the right thing to do. As mentioned earlier, it is easier to achieve cost reduction than to boost sales. According to Dennis Kozlowski, CEO of Tyco International12: You can nearly always achieve them because you can see up front where they are But theres much more risk with revenue enhancements; they are much more difficult to implement. Kozlowski adds that people are often too optimistic about revenues. When Citibank merged with Travelers, the merged entity quickly reaped profits from cost cutting, but its expectations on cross selling different financial services to customers did not quite materialise. However, achieving revenue enhancement through an acquisition, though difficult, is not impossible. When the specialty chemical company, Rohm and Haas acquired Morton, it aggressively used the acquired companys expertise in polyurethane adhesives and powder coatings and its access to new markets, to generate more sales. The Time Warner-Turner Broadcasting System merger was also quite successful in this regard. The
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Harvard Business Review, May-June 2000. Harvard Business Review, May-June 2000.

AOL-time Warner merger has also shown a lot of promise for cross selling, though it is too early to pass a final judgment.

Arriving at the premium

One of the most thoughtful analyses of the premium involved in acquisitions is provided by Porter13. Porter points out that an efficient market precludes the possibility of the new company generating more returns than what the pre-merger entities generated before the merger. If the management of the acquired company is sound and the company itself has a bright future, its market price would already have been bid up. On the other hand, if its future is bleak or the management is weak, the stock price could be low, but the infusion of capital and effort required to turn it around could also be massive. As Porter puts it: To the extent that the market for companies is working efficiently, then, the price of an acquisition will eliminate most of the returns for the buyer The market for companies and the sellers alternative of continuing to operate the business, work against reaping above-average profits from acquisitions. Perhaps, this is why acquisitions so often seem not to meet managers expectations. While acquiring a company, firms must be careful about irrational bidders with non-profit motives or those who are pursuing the deal purely because of the idiosyncrasies of the top management. In the race to the finishing line, companies may end up paying too high a price because of the influence of such bidders. The board should exercise some control in such situations. According to Sirower, the acquiring company must consider the following while working out the premium: Market expectations about the acquired company, when considered alone. Impact on competitors and their possible responses Tangible performance gains from the merger and the management talent necessary to achieve the gains Milestones in the implementation plan Additional investments which will be necessary Comparison of the acquisition with alternative investments.
The Time Warner Turner Broadcasting System Merger The Time Warner (TW) Turner Broadcasting System (TBS) merger of 1995 has been one of the more successful mergers of our times. The two CEOs, Gerald Levin of TW and Ted Turner of TBS became unlikely partners in a merger deal that few expected to click. At the time of the merger, TBS was in serious financial difficulty. After buying MGM in 1986 for its content, TBS had accumulated a lot of debt. TBS was also dependent for distribution on two cable systems companies, Tele-communications In (TCI) and TW, which had been investing heavily in cable infrastructure. Meanwhile, TWs competitive position was threatened by the merger of Walt Disney and Capital Cities / ABC. When the merger was announced, analysts were cynical and few thought that Levin and Turner would be able to work together. The two companies had significant differences in management style. TBS managers went by instinct, while TW was more methodical. TBS managers initially felt uncomfortable when their decisions were subjected to a rigorous analysis. But gradually, the two parties realised the benefits that could be reaped from the merger. Cable networks could buy material from the movie business and leverage the publishing assets like Time and Sports Illustrated. A brand like Batman could be exploited by the movie studio, publishing and cable television. Many brands not only gained more visibility but also generated more revenues.
13

Competitive Strategy.

With a presence in both content and distribution, the merged entity could change the relationship between the two to its advantage. In the past, movies, reached the cable stations very late, typically six to eight years after they were released. In other words, cable was regarded as the end of the line. With its clout in distribution, TW could now bring movies to the cable network much faster. This increased subscription and cable advertising revenues. Investors perception of the merger improved rapidly. TW developed the image of a formidable media company with a presence in publishing, movie and television production, music, cable systems, cable networks and a small television broadcast network. The strategy of using different media platforms to distribute the same piece of content seems to have worked. Now, TW has entered a new phase after the merger with America Online. (See Box Item on pg. 8).

Behavioral issues also affect the way in which the premium is arrived at. A study by Wharton professor, Julie Wulf14 has revealed that CEOs often strike deals that benefit them personally, but are not in the interests of the shareholders. CEOs of poorly performing companies and of companies in industries which are rapidly consolidating, are more concerned about retaining their position on the board rather than negotiating the best deal for their shareholders. The board has to ensure that senior managements personal interests do not supersede the interests of shareholders, while fixing the premium.

Stock Vs Cash deals

The way the deal is financed determines how risk is shared between the buyer and the seller. In general, there are two types of financial risk faced during an acquisition the fall in the share price of the acquiring company from the time of announcement of the deal to its closing, and the possibility of synergies not being realised after the deal is closed. In a cash deal, the acquiring company assumes both the risks completely. In a stock swap, where a fixed value of the acquiring companys shares is offered to the acquired company, the first risk remains with the acquiring company, but the second risk is shared by the two companies. In a stock swap where a fixed number of shares is offered to the acquired company, both the risks are shared between the two companies. The method of financing the deal is influenced by several factors. If the acquirer feels its shares are undervalued, it prefers a cash deal as any fresh issue of shares would further erode the wealth of existing shareholders. If the acquirer is very confident about actually realising the projected synergies, a cash deal makes sense. Where such confidence is lacking, a stock deal allows the risk to be at least partially hedged. In general, a fixed value offer is an indication of greater confidence on the part of the acquirer than a fixed number of shares and tends to be better received by the market. A fixed share offer, ironically enough, by minimising the pre-closing market risk for the acquirer, acts as a kind of self fulfilling prophecy and drives the share price downwards.

Integration
Many mergers fail at the integration stage. So, it is important to understand the risks involved in integration and the ways to manage these risks. All acquisitions must begin with a strategic vision, which should serve as a guide for the integration process. There should also be an operating strategy which addresses the issue of how the value chain performance can be improved, whether competitors will react aggressively, and if they
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knowledge.wharton.upenn.edu. January 4, 2000.

do, how they can be dealt with. Vision and operating strategy must be backed by proper systems and processes to align the behavior of managers with corporate objectives. Some operations should be tightly integrated while others should be left alone. What to integrate and what to leave alone is a matter of judgement but there are some guidelines, that could prove useful. We will cover this point later in the chapter.
The AOL Time Warner Merger On January 10, 2000, America Online (AOL) and Time Warner (TW) announced that they were merging. For all practical purposes, the deal was a reverse takeover by AOL. While the icon of the internet world had just 20% of TWs revenues and 15% of its workforce, its large market cap made it the senior partner. AOL shareholders received one share in the merged entity while TW shareholders got 1.5 shares for each of their existing shares. AOL shareholders owned 55% and TW shareholders 45% of the new company. Effectively, AOL paid a premium of 71% over the market value of TW. The combined entity was valued at $350 billion. Though the two companies were confident of boosting revenues, many analysts expressed concerns that the merger would slow down AOL and rob it of its entrepreneurial drive. AOL however, remained confident that TWs cable network and content would generate new growth opportunities. Before the announcement of the deal, TW shares traded at a multiple of 14 times EBITDA (Earnings Before Interest Tax depreciation and Amortisation ) while AOL shares traded at a multiple of 55. The immediate reaction to the deal was negative. By January 12, the combined market capitalisation was actually lower at $260 billion, compared to $270 billion before the announcement. The market value of AOL shares fell by 19% while that of TW shares went up by $22 billion. AOL which had a strong brand and enjoyed a large customer base was clearly one of the pioneers in the new economy. However, anticipating the rapid commoditisation of the Internet access business, AOL realised it needed the pipes of cable television to carry Internet content. Moreover, AOL did not really have much content of its own. It decided to move fast and make full use of its high market capitalisation. In October 1999, Steve Case, CEO of AOL called TW CEO, Gerald Levin to discuss the merger, Levin sensed an opportunity as his companys stock was not doing particularly well in the market. In December 1998, TW had been worth more than AOL. But by December 1999, AOLs worth was 2.5 times that of TW. Quite clearly, TW was on the decline. Case also sweetened the deal for TW by inviting Levin to be the merged entitys CEO. After the merger was announced, the Federal Trade Commission (FTC) began to interrogate the senior executives of the two companies to determine whether the merger would come under the purview of anti trust legislation. Case and Levin refused to accept a demand by FTC to regulate the placement of AOL-TW content. However, they agreed to report any complaints from competitors if they were denied AOL-TW content. Low hanging fruit synergies were quickly identified. CNN.com programs could be featured on AOL, while AOL discs would be bundled with TW product shipments. Warner movies could be promoted on AOL-owned Moviefone. The merged entity could offer books, movies, magazines and music to customers on TV, paper, PC, cell phone or any of the other wireless devices. Even as the FTC was in the process of approving the merger, integration efforts began. Interdivisional committees were set up to facilitate the integration. Efforts to generate cross selling opportunities in the areas of subscriptions, advertising and promotions began. An attempt to sell TIMEs magazines through AOL was very successful. A year later, the merger was showing signs of trouble. The projected revenue growth of 12-15% and $1 billion in cost savings looked way off target. According to Merrill Lynch estimates, growth would only be 11%, while losses would cross $5 billion due to merger write-offs. A slowing US economy and a sharp cutback on ad spending by companies was hitting growth. By early 2001, AOLs stock had dropped by 48% to $37.50. (See graph showing the stock price movement). One positive feature of the merger is that the transition at the highest level of management has been smooth. Levin has been clearly in charge of both day-to-day operations and key strategic and personnel moves. Case has disengaged from day-to-day operations to concentrate on macro level issues. In

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an email to Fortune15, Case said that the management set-up kept him informed about what was happening and allowed him to provide his perspective where required, without in any way meddling with the day-today operations. It is now clear that the fortunes of AOL-TW are closely tied to the erstwhile AOL group. Many of the top executive positions have gone to AOL. Most of its senior executives are still around, 18 months after the merger was announced. While AOLs performance in the first quarter of 2001 was good, TW has continued to struggle due to falling advertising revenues. Moreover, making Hollywood movies remains an unpredictable, low margin business. The markets perceive the integration to be still incomplete. In response to the 2001 second quarter results, the share price declined by 9% even though EDITDA jumped by 20% over the previous year. Cultural differences continue to be a formidable barrier to the integration process. As the Economist16 recently reported: There is a wide cultural gap between the restless 20 somethings from AOL and New York institutions such as the 78 year old Time Inc There is much grumbling among journalists (at Time Warner) about a new tightness with money and the fears, this has prompted for editorial quality. AOL feels things are moving in the right direction. As an example of the synergies being generated, it cites a recent Madonna world tour arranged by Warner Brother Records, in which AOL subscribers can buy advance tickets and see unreleased photos and videos. AOL remains confident that its community can be persuaded to buy a range of entertainment products.

AOL Time Warner

100 90 80 70 Merger

US $

60 50 40 30 20 1/1/00 3/1/00 5/1/00 7/1/00 9/1/00 1/1/01 3/1/01 5/1/01 7/1/01 9/1/01 11/1/99 11/1/00 11/1/01 1/1/02

Date Closing Stock Price

The 1986 merger of Borroughs and Sperry illustrates some of the difficulties involved in the integration of pre-merger entities. The two computer makers who came together to form Unisys, felt that the merger would generate economies of scale, improve efficiencies and boost price competitiveness. The integration of the distribution systems was however a disaster. The companies had different order-entry and billing procedures. After the attempted integration, equipment orders were executed late and customers were frequently frustrated by delayed delivery. By November 1990, the stock price of Unisys was only $3 per share. About 90% of shareholder value had been destroyed.
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July 23, 2001. July 21, 2001.

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The 1986 acquisition of Republic Airlines by Northwest Airlines also ran into integration problems. The two computer systems could not be synchronised. Integration of crew and gate scheduling and human resources functions also ran into serious problems. Republics employees, on an average, drew lower salaries than those of Northwest. Low morale led to a deterioration in customer service. In August 1987, a Northwest plane crashed after taking off from Detroit. Matters continued to worsen till 1989, when Northwest was bought out by a group of private investors. Personal chemistry, especially at the top, matters a lot during the integration of the pre-merger entities. In general, it is advisable not to have two bosses. Decisive leadership is best provided by a single individual, not by a two-man team or a committee. Indeed, if two co-CEOs are named after the merger, there will ensue a period of uncertainty during which people wait to see who finally gains the upper hand. In the Citicorp-Travellers Group merger, Sandy Weill of Travellers has taken control, ousting Citicorps John Reed and in the Daimler Chrysler merger, Jurgen Schrempp has gained ascendancy over Chryslers Bob Eaton. In both cases, until a clear leader emerged, things were in a state of flux and employees remained confused. Tatenbaum17 has argued that, a top Human Resources (HR) executive must be involved in the negotiations before a merger deal is finalised. HR managers usually enter much later, to deal with issues like compensation. Instead, if they join the discussions at an early stage and conduct a cultural audit, potential trouble spots can be identified, very early on. Tatenbaum provides seven guidelines for managing the integration process. The integration team should build organisational capability by retaining talented manpower. Tatenbaums research reveals that 47% of the senior managers in an acquired firm leave within the first year of the acquisition and 72% within the first three years. Downsizing activities must be managed smoothly and sensitively. Otherwise, they may fuel a large scale exodus of people. A related issue is finding the right roles for the people. Cisco for example tells employees clearly what their new jobs will be after the merger and to whom they will report. Systems and procedures that are implemented must be in line with the strategic intent of the acquisition. For example, bureaucratic procedures can be highly counterproductive if the acquired company is known to have a flexible, entrepreneurial culture. The integration team must identify the cultural traits that are consistent with the business goals of the merged entity and take steps to spread them across the two entities. The team must manage cultural differences by collaborating with managers throughout the organisation. Superordinate goals can be set to motivate the two entities to work together. Post merger drift tendencies should be minimised by managing the transition quickly. If decisions and changes are not implemented fast, the acquirer may become focussed on internal issues and lose sight of customers and competitors. Decisions about layoffs, restructuring, reporting relationships, etc must be made within days of the deal being signed and communicated quickly to the employees. However, care must be taken to ensure that people are treated with respect and sensitivity.
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Organizational Dynamics, Autumn 1999.

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Hearing of employees tends be selective during the early days of a merger, when anxiety levels are high. So, some messages may have to be repeated. Besides internal communication with employees, management must also keep external stakeholders such as customers, vendors and the community informed. When a company has decided to pursue a strategy of growth by acquisitions, clearly defined integration plans can be helpful. The company should identify the team which will conduct the due diligence and the team which will plan and implement the merger. Checklists must be prepared to indicate the tasks and suggested deadlines. Cisco, which makes acquisitions at regular intervals, uses a standard business process for managing acquisitions.

The Boeing Mc Donnell Douglas Merger In 1993, the US government announced that its military procurement budget was being cut by 50% and informed defence contractors that they must consolidate. One company which looked at the turn of events with concern was Mc Donnell Douglas (MD), a leading manufacturer of military aircraft. Meanwhile, the much stronger Boeing realised that its excessive dependence on the cyclical market for civil aircraft was risky. To address this concern, it acquired a major stake in Rockwell International, a defence supplier. When MD realised its competitive position was deteriorating rapidly, it even considered acquiring the defence businesses of Hughes Electronics and Texas Instruments. At this point, Boeing CEO, Phil Condit and MD CEO, Hary Storecipher felt that the time had come to revive merger talks which had failed in 1995. Boeing knew that if MD went ahead with other acquisitions, it would be priced beyond its own reach. So, it rushed to close the deal. The merger was announced in December 1996 and received approvals from competition authorities in the US and Europe by August, 1997. After the merger, Boeing ran into problems on account of a factor it had totally failed to anticipate. In the wake of competition from Airbus, it had aggressively booked orders by slashing prices. When demand rose sharply, Boeings production system was thrown out of gear. Due to a parts shortage, much work had to be done outside the normal production system. By September 1998, Boeing was in big trouble. It had to take a charge of $4 billion. Quite clearly, the task of implementing the merger had distracted the attention of the top management from operational issues. In February 1999, Boeings share price reached a low. Condit warned his top management that the company was a potential takeover target. These were rumours that GE had its eyes on Boeing, but GE denied them. Boeing made some changes in senior management and put in place a new organisation structure with different businesses focussed on different customer needs. It decided to tap new businesses such as broad-band communications, satellite navigation for air traffic controllers and services such as running airforce bases. Boeing also realised the importance of sharing knowledge and leveraging its research capabilities across the organisation. Phantom Works, the R&D centre of MD became the focal point for new initiatives to improve manufacturing processes across the group. The idea was to integrate the expertise of Boeing, MD and Rockwell, through both short-run and long-run programs. Looking back, it is quite evident that the Boeing-MD merger was not really well planned. The integration process was faulty and consumed a lot of precious management time. Core functional areas did not receive the attention they needed. Most of the synergies realised came by sheer chance than by any great planning. An important lesson from the Boeing MD merger seems to be that synergies often come in areas where they are least expected. Source: This box item draws heavily from the article, Building a new Boeing, The Economist, August 10, 2000.

13

Boeing
73 68 63 58 53 US $ 48 43 38 33 28 23 1/3/97 5/3/97 1/3/98 5/3/98 9/3/98 1/3/99 5/3/99 5/3/00 9/3/00 1/3/01 5/3/01 9/3/01 1/3/02 9/3/97 9/3/99 1/3/00 Merger

Date

Closing Stock Price

Understanding the role of communication

Communication plays an important role during the integration of the pre-merger entities. Genuine communication increases the perceived benevolence of the management and consequently promotes trust. It minimises the negative reactions of employees in the acquired company. As a popular saying goes, the certainty of misery is better than the misery of uncertainty. Lack of communication increases uncertainty and weakens the confidence of employees in the management. A good communication strategy is necessary to ensure that rumours are not allowed to fill the information gap. Employees must be informed about the acquiring company, the proposed changes and the impact of these changes on the employees. All efforts should be made to reassure the employees of the acquired firm and make them understand the intentions and philosophy of the acquiring company. In the case of cross-border acquisitions, the role of communication is even more critical. Immediately after the acquisition, employees need to know what will happen to their job, their colleagues and their company. It is only through honest communication that their anxieties can be set at rest. Here, the quality of communication is the overriding factor. Later, when employees have to adjust to the changes, frequency of communication becomes important. Frequent communication however does not mean that all details must be communicated, especially when the management itself is not clear about what will happen. A high level of transparency will send the right signals to the employees even if all the information cannot be shared with them. Acquirers also need to demonstrate to the employees of the acquired company that there will be consistency and openness in the new environment. When Intel acquired Chips & Technologies in 1997, it decided to integrate it with one of its divisions, though it had at first announced that it would keep it as a separate unit. Many key people left and

14

the benefits of the acquisition were sharply undermined. Similarly, when IBM acquired telecommunication equipment maker Rolm in 1984, it made the mistake of dictating terms to the acquired companys employees. Some key technical employees left. The takeover was not effective and IBM sold Rolm to Siemens.
France Telecom: Growth by acquisitions leads to huge debt burden With its traditional telecom business shrinking due to deregulation and intensifying competition, France Telecom (FT), has been strengthening its presence in faster growing segments such as mobile phones and internet services. Under CEO Michel Bon, FT has purchased Orange, the mobile phone services provider for $40 billion, Free Serve, Britains biggest internet service provider, for $2.5 billion and Equant, the data services provider, for $4 billion. The government controlled FT is now Europes second largest cell phone company after Vodafone. It has joined T Online and Telefonica as one of the leading ISPs in Europe. FT generates (early 2001 figures) almost 20% of its revenues outside France, compared to only 2% five years back. Acquisitions have bolstered FTs market share, but resulted in a debt burden of some $53 billion. The company faces a cash crunch at a time when it has to invest heavily in next generation wireless networks, which have long gestation periods. Investors are worried about FTs financial health and have driven down the share price by almost 60% during the period early 2000 to early 2001. Bon himself has admitted, Its frightening. Only time will tell whether FT will be able to manage the risks arising out of its aggressive acquisition strategy. Source: Carol Matlack and Stanley Reid, France Telecoms $53 billion burden, Business Week, January 8, 2001, pp. 22-23.

France Telecom
220 200 180 160 140 120 100 80 60 40 20 10/20/99 10/20/00 10/20/97 10/20/98 10/20/01 1/20/98 4/20/98 7/20/98 1/20/99 4/20/99 7/20/99 1/20/00 4/20/00 7/20/00 1/20/01 4/20/01 7/20/01

US $

Date Closing Stock Price

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The Bayerische Vereinsbank Hypobank Merger In July 1997, the two Bavarian banks, Bayerische Vereinsbank and Hypobank merged to form Hypo Vereinsbank (HVB). The move seemed to make sense in the context of Germanys inefficient and fragmented banking market. The two banks were long time rivals, located close to each other. With a similar branch network and a similar mix of businesses, they identified several opportunities to cut costs. HVB also hoped the merger would enable it to become a major player in the German mortgage banking market. However, the merger was more a reaction to the prevailing circumstances than a proactive, wellthought-out strategy. Vereinsbank was on the verge of a hostile takeover by Deutsche Bank. It had approached Commerzbank for support in warding off this takeover attempt but later resigned itself to a deal with Hypobank. On its part, Hypobank even though it was making decent profits was worried about being taken over by Dresdner Bank. Bavarian politicians actively supported the merger as they wanted to create a national champion. This was a part of their grandiose plan to convert Munich into a financial centre that could rival Frankfurt. The government offered a one-off tax waiver on the exchange of shares involved in the transaction. Without this concession, the merger might not have gone ahead. It was quite clear that several issues had been left unresolved at the time of the merger. Moreover, there was tension in the air due to rumours that Vereinsbanks ultimate goal was a takeover of Hypobank. Albrecht Schmidt, the head of Vereinsbank, took charge of the merged entity. Vereinsbank took nine of the 14 seats on the Board of Management and also gained control over many key departments. Ebenhard Martini, the Chief of Hypobank decided to move on to the more ornamental Supervisory Board. (Under German laws, limited companies typically have two boards, a Board of Management, vested with executive powers and a Supervisory Board which oversees the functioning of the Board of Management). These moves were however, consistent with Martinis delegating philosophy and Schmidts hands on management style. Martinis hands-off-approach could also have been due to Hypobanks non performing assets (NPA) in the property business. These assets had resulted from Hypobanks aggressive lending in East Germany during the construction boom following German unification. Only a year after the merger, did the seriousness of the bad loans problem become evident. In October 1998, Schmidt announced that loan provisions of $2.1 billion would have to be made. He also hinted that these losses had been covered up by Hypobank. This led to a serious clash with Martini. The merged entitys reputation was damaged. People felt that a backroom struggle was going on between the chief executives of the pre-merger entities. Only in October 1999, after an auditor submitted his report, was Schmidts assessment vindicated. Martini and the four remaining members on the Board of Management, from Hypobank resigned. Later, Schmidt signalled peace by putting ex-Hypobankers in charge of the property division and giving them many of the top jobs in accounting and controlling. Meanwhile, the integration proceeded smoothly. 500 overlapping branches were closed. Much of the systems integration was also completed in less than three years, well ahead of schedule. In May 2000, encouraged by the performance of HVB, Schmidt announced he was acquiring Bank Austria, the biggest bank in Austria. Source: This box item is drawn heavily from the article, A Bavarian botch-up, The Economist, August 5, 2000, pp. 68-69.

Understanding the importance of cultural differences

More often than not, significant cultural differences exist between the pre-merger entities. Managing these cultural differences is the strategic challenge during integration. Consider the following examples. The merger of UK-based Beecham and the US based SmithKline involved not only two national cultures but also two business cultures - one very scientific and academic and the other more commercially oriented. The American pharmaceutical company, Upjohns centralised and aggressive culture clashed with Swedish major Pharmacias decentralised laid back management style.

16

After the merger between Daimler Benz and Chrysler, the Germans and Americans have struggled to understand each other and their ways of working. Daimlers bureaucratic engineering culture in which different departments work separately has clashed with Chryslers free-wheeling, cross-functional product development approach. (See case at the end of the chapter). Cultural clashes can be significant in industries such as the media, where egos tend to be big. This was so in the case of the 1989 merger between Time and Warner. Cultural differences became an important issue when Aetna, a tradition-bound, stodgy and slow-moving organization merged with US Healthcare, generally considered to be a brash, aggressive and entrepreneurial Health Maintenance Organisation (HMO). Citicorps staid buttoned-down world of traditional commercial banking has had to take on Traveller groups free wheeling, deal making, investment banking culture. One pressing issue in this merger has been the overbearing attitude of investment bankers who are typically paid much higher salaries than their counterparts in commercial banking. (See case at the end of the chapter). The Exxon-Mobil merger has also seen the coming together of two contrasting cultures. Exxon is generally considered to be independent and not particularly good at managing the media. Mobil on the other hand, is more accessible, accepts new ideas and is good at public relations. Exxons slow decision-making processes focus on cutting costs, while Mobil has been known to take big risks. It moved into central Asia in the aftermath of the break-up of the Soviet Union, ahead of many other oil companies. Cultural problems have been an important issue in the AOL-Time Warner (See Box item the end of the chapter) and Norwest/Wells Fargo deals as well.
Cisco: Growth through Acquisitions

In technology-driven businesses, mergers and acquisitions (M&A) give quick access to new skills, competencies and people. Since September 1993, Cisco has acquired 73 companies. In spite of the recent slowdown of the US economy, the company has not given up acquisitions. . In 2001, (till October), Cisco completed four acquisitions. In October 2001, John Chambers, Ciscos CEO announced that the company would buy eight to 12 small companies in the near future, primarily in the fibre optics business. Before making a new acquisition, Cisco assesses the merits and downsides. It examines the target companys vision, its success with customers, its long-term strategy, its compatibility with its own culture and its geographic proximity to Cisco. A team headed by Mike Volpi (Volpi), senior vice president, (Business Development and Alliances), examines the depth of talent of the target company, the quality of the management and venture funding. The engineering team examines the technology, while the finance executives scrutinize the companys books. Volpis team consults Ciscos business units and customers to know more about their technological needs. Sometimes, customers influence Ciscos acquisition strategy. For example, in March 1998, at the instance of US West, an important customer, Cisco acquired Netspeed, which made high-speed Internet access products for home users. Cisco has a separate integration team, which tailors the integration process to suit the specific needs of each new acquisition. The team assembles a customized packet of information that includes a description of Ciscos organizational structure and employee benefits and the strategic importance of the newly acquired company. Immediately after an acquisition is announced, Ciscos human resource and business development teams travel to the acquired companys headquarters and meet people in small groups to set expectations and clarify doubts.

17

Ciscos integration team collaborates with the acquired companys management in mapping employees based on their experience. In general, product engineering and marketing groups remain as independent business units, while sales and manufacturing groups are merged into Ciscos existing departments. The integration team puts the employees of the acquired company through a tailor-made orientation program, that introduces them to Ciscos hiring practices, its products and development projects. On August 26,1999, Cisco announced that it was paying $6.9 billion (in a stock deal) to acquire Cerent, a two year old start-up, with cumulative sales of only $10 million. Cerents technology integrated voice and data traffic and zipped into optical fibres efficiently. Cisco viewed Cerents technology as critical for linking the Internet and telephone systems and for taking on rivals like Nortel Networks. Chambers won over Cerent CEO Carl Russo by assuring him that all personnel decisions concerning the employees of the acquired company would be made jointly. Some of Ciscos acquisitions have made a significant contribution to its growth. Crescendo Communications, acquired for $95 million in 1993, generated revenues of $7 billion in 2000. However, not all the deals have been successful, a good example being Granite Systems, for which Cisco paid $220 million in stock. Ciscos investment in Ardent Communications, (whose product range includes integrated voice, video and data equipment that can connect a companys branches with its headquarters) has also not been very successful. Though Cisco obtained two seats on the board and worked closely with Ardents engineers, Volpi later acknowledged that Cisco had interfered too much in the acquired companys operations and that results had not been satisfactory. Another acquisition which has run into trouble is Monterrey (1991). When it was acquired, Monterrey was two years old and a year away from a marketable product. Recently, Cisco dropped the Monterrey wavelength router from its product line. Looking back, analysts feel the company was acquired too early in its life. Cisco has written off $108 million from the $517 million acquisition. Many of Ciscos acquisitions have been funded with its highly valuable stock. However, it has also used cash or a combination of both stock and cash to fund acquisitions. The way in which the purchase is funded depends on the objectives of Cisco and the target company, the tax implications and finally liquidity. Ciscos share declined from a peak of $80.06 in March 2000 to $11.48 in early 2001. So, the company will presumably use more of its $18.5 billion cash pile, rather than its stock to make acquisitions in the immediate future. A recent change in the method of accounting in the US will have a significant impact on Ciscos future acquisition plans. All deals have to be classified as purchases. This means goodwill, the difference between the purchase price and the value of assets, must be written off, if impaired. Cisco has traditionally used the pooling method of accounting in which no goodwill is created. In pooling, at least 90% of the purchase must be conducted in stock. One of the reasons for the relative success of Cisco in managing acquisitions has been the clear value proposition it has brought to the table. The company has targeted small start-ups on the verge of takeoff. Using its well oiled distribution channels, it has been able to increase sales of the acquired companys products significantly, in most cases. Ciscos broad product line has strengthened its relationship with customers who like one company to take care of their networking requirements. According to Howard Charney, CEO of Grand Junction Networks at the time it was acquired by Cisco 18, Even though at moments, it was painful, what saved it was that they wanted us to become bigger by two orders of magnitude. Our engineers could see we really had the potential to go from 5% market share to 25%.

18

Leading the Revolution.

18

Cisco
90 80 70 60 50 40 30 20 10 0 03.01.97 03.05.97 03.09.98 03.01.99 03.05.99 03.09.00 03.01.01 03.05.01 03.09.01 03.09.97 03.01.98 03.05.98 03.09.99 03.01.00 03.05.00 03.01.02

US $

Date Closing Stock Price

Kilman19, et al, have vividly described, the culture clashes which often take place during integration: Picture two icebergs in the ocean, where the tip of each represents the top management groups primarily financial people deciding the fate of the two companies and how the merger will work. As these top management groups set the merger in process, the two icebergs begin moving towards one another until the tips meet and mesh as one. Such a consolidation, however, can never take place. As the icebergs approach one another, it is not the tops that meet, rather it is the much larger mass below the surface of the water, the respective cultures that collide. Instead of synergy, there is a culture clash. It was mentioned earlier that a decision regarding the degree to which the premerger entities should be integrated is a matter of judgement. To a great extent, the degree of integration depends on cultural factors. Clayton Christensen20 makes an interesting observation on integration. He points out that an organisation has three broad types of capabilities resources, processes and values. Resources can be easily transferred, while processes and values are deeply entrenched and are difficult to change. If the acquired companys processes and values have been the main reason for its success, the company should be left well and truly alone. The parent company can pump resources into the acquired company. If a company is being acquired for its resources, tight integration may make sense. Many of Ciscos acquisitions have been aimed at acquiring resources in the form of products and people. The companys acquisitions are typically start-ups, which do not have deeply entrenched values. Cisco typically transfers the acquired companys resources into the parent companys processes and systems. In general, management of cultural differences is a critical issue while integrating the basic
19 20

Gaining control of the corporate culture, Jossey-Bass, 1985. Read his book, The Innovators Dilemma. We referred to this book in chapter III.

19

work processes, and systems. When the cultural differences are too sharp, it may make more sense to keep the acquiring and acquired entities separate.

Managing high tech acquisitions

Acquisition is an important growth strategy in high tech businesses. It takes quite a bit of time to develop new technology in-house. Acquisitions not only allow a firm to make use of a new technology faster, but also bring talented manpower into the organisation. Like in other acquisitions, due diligence is very important when high tech companies are involved. The acquiring company needs to make sure that the capabilities of the firm being acquired are both unique and valuable. AT&T acquired NCR in 1991, hoping that telecommunications and desktop computing technologies would converge. After the acquisition, AT&T discovered that substantial differences existed between its competencies in switching and NCRs Personal Computer (PC) technology. Consequently, synergies were very difficult to achieve. NCRs PC capabilities were also weaker than what AT&T expected. Advanced Micro Devices (AMD) conducted a thorough check on Nex Gen before acquiring it in 1996. Nex Gens unique chip design capabilities enabled AMD to develop new products and take on the mighty Intel. All acquisitions have to be managed with a high degree of sensitivity to people. But this is even more so in the case of high tech acquisitions. How the purchased company fits in and the role of the employees of the acquired company need to be clearly communicated. Often, it makes sense to keep the new people together in a separate division and make the owner of the purchased company a key member of the integration team. In particular, companies acquired for their skill in developing breakthrough technologies, must generally be allowed to continue as separate entities. Very often, it is a good idea not to disturb the key technical teams of the acquired company. By keeping people with complementary capabilities in one place, their productivity can be significantly enhanced. Whenever a high tech acquisition is planned, it is important to examine whether employees of the company being acquired have enough incentive to stay. Employees whose stock options are already vested, if they sense that their importance will diminish or their creativity will be stifled after the merger, may decide to quit. So, hostile takeovers are almost always bad in high tech businesses. They create suspicion in the minds of the employees of the acquired company. Once trust is breached, retaining talented people is virtually impossible. When Cisco acquired Crescendo, the head of the acquired company, Mario Mazzola became a rich man. But he decided to stay on rather than retire or form a new company. Cisco gave him plenty of responsibilities and made him the head of the companys line of enterprise products. According to Howard Charney, CEO of Grand Junction Networks, another Cisco acquisition21, Chambers (Ciscos CEO) treated me like a peer. He asked me what I thought and never talked down to me. Despite differences in size, Cisco treats every acquisition like a merger of equals. Cisco delivered on its promise.

21

Leading the Revolution, pp. 236-237.

20

Dilemmas/paradoxes in mergers and acquisitions Slow Vs quick change: Some advocate rapid change within the first 100 days of the merger. Others suggest a slower process that carries people along. More than speed however, compassion and goal congruence are the more important factors . Information sharing: Though all efforts should be made to share as much information as possible, it must be kept in mind that people caught in the process of integration will still tend to perceive that they are not being kept fully informed. Managing Vs coping: It is important to have a plan, but also to keep in mind that all factors may not be fully within the control of managers. Peoples fears and tensions will always disrupt organisational processes to some extent. Strategic significance: Studies indicate that the more significant, the target is to the acquirer, the greater the likelihood that the acquiring company will step in and take control of the situation, especially when progress is below expectations. (Daimler Benz certainly seems to be doing that to Chrysler). This creates antagonism among various employee groups and prevents a more iterative, evolutionary process that seems to characterise many successful mergers. Long-term and short-term focus: Sometimes, integration efforts tend to have an overly long-term focus. However, it is often the handling of short-term people-related issues that tend to have the biggest impact on the integration process. It takes time: Mergers and acquisitions result in severe disruptions and impose a tremendous strain on those involved. It may take up to five years for the change process to be fully completed. Expectations on both sides must be adjusted accordingly. Source: AON Risk Services, Edition 3, 1998.

Anti-trust issues
An important risk in the case of mergers and acquisitions is anti-trust action. Whenever a big merger deal is announced, competition authorities view it with suspicion. If they feel that the merger will limit competition, they may impose several restrictions on the new company. World Coms planned $115 billion takeover of Sprint in June 2000, and the recently announced deal between GE & Honeywell were blocked by the European Unions competition authorities. (See Box item on the GE-Honeywell deal in Chapter VII). When a company is big and enjoys an overwhelmingly large market share, competition authorities tend to watch it very closely. Take the case of Microsoft. The global software giant has by and large concentrated on acquiring small companies or has taken minority stakes in large companies. The image of the company makes a difference here. A company like Cisco, with a very positive, friendly image will be viewed more positively by the anti-trust authorities than Microsoft, which is perceived to be a tough no-non-sense competitor. A more detailed discussion on anti-trust issues is included in Chapter VII.

Managing risks in strategic alliances

Acquisitions are different from strategic alliances. While an acquisition involves gaining control of another corporate entity, a strategic alliance is a more flexible and open-ended arrangement, in which the different partners retain their individual identities even if they exchange equity stakes. Strategic alliances offer more flexibility than acquisitions. In an acquisition, an unduly high premium may be paid. Another problem with acquisitions is that only a part of the acquired business may be valuable, and along with it may come undesirable parts. Where uncertainties about the market size and technology are large, acquisitions can be

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very risky. Strategic alliances are much more flexible than acquisitions, because they generate more options.
Guide to a happy merger Question the logic: Ask how exactly the combination will generate synergies. Specify roles clearly: Arrive at an agreement over the degree of integration and define clearly the roles of top leaders. Design the integration process carefully: Combine the pre-merger entities in ways that preserve the anticipated sources of strategic leverage. Dont escalate commitment carelessly: Avoid making additional acquisitions to justify the deal. If one deal does not click, cut losses and withdraw, instead of throwing good money after bad. Dont give autonomy without a clear logic: In some cases, the acquired company must be allowed to operate with a great degree of independence. In other cases, this should not be so. Autonomy should be given based on the merits of the situation, not just because the acquired company demands it. Apply what has worked in the past: Core practices that have contributed to past success, must be applied to the new business. Dont be carried away by favourable short-term results: In many cases, it makes sense to grant autonomy to the acquired companys managers only after a period of sustained excellence. Dont give key jobs to top executives who missed out on promotions earlier: Such a move often creates problems. These executives may be upset at having been overlooked for the top job. As a result, trust may become a problem over time. Dont compromise on values: No matter how good the numbers look, if the core values of the merging entities clash, the merger is heading for big trouble. Source: David A Wadler, The New York Times, 1998.

But, strategic alliances are also more difficult to manage. A McKinsey study of 49 multinational alliances conducted in the early 1990s revealed that two thirds of these had run into serious problems in the first two years. Joel Bleeke and David Ernst 22, McKinsey consultants, have mentioned that in many alliances, one of the partners opts out. In 1990, Porter argued that strategic alliances involve significant costs in terms of coordinating, reconciling goals and sharing profits, and could at best be transitional. Thus, one needs to understand the pros and cons before going ahead with a strategic alliance. Much time and effort have to be invested in managing alliances to make them succeed. According to Gary Hamel, Yves L Doz and CK Prahalad23, an alliance is nothing but competition in a different form. Since the partner might take unfair advantage of the situation, the strategic objectives should be clearly defined and the company must understand how these objectives may be influenced by the hidden agenda of the partners. In the late 1980s, Schwinn, Americas largest bicycle manufacturer tied up with Giant of Taiwan, since it needed additional capacity to meet the soaring demand. The bicycles made by Giant turned out to be cheaper and better than those made in the US. From thereon, Giant went from strength to strength. By 1992, Schwinn had gone bankrupt, while Giant emerged as one of the leading bicycle manufacturers in the world. Typically, alliances involve a delicate balancing act between control and autonomy. It is often the attempt made by one partner to dominate the other that leads to

22 23

Harvard Business Review, January February, 1995.

Harvard Business Review, January February, 1989.

22

the break-up of an alliance. As Kenichi Ohmae24 puts it, You cannot own a successful partner any more than you can own a husband or a wife. Alliances often create new strategic options for the partners, who may start controlling the tasks and competencies most critical to the success of the alliance. As a result, the sharing of benefits may become lopsided. It is precisely because of such difficulties that strategic alliances have to be conceived and structured carefully. Before going ahead with an alliance, companies should carefully analyse the value chain to determine which activities should be retained internally and which can be shared with partners. It is also important to examine carefully whether the scope of the alliance should be limited to start with and expanded over time. A related issue is whether to choose one partner for many activities or different partners for different activities. Unintended leakage of knowledge is a big risk in strategic alliances. While friendly relations between the partners are desirable, information leakage must be discouraged by putting in place proper controls and firewalls. Indeed, occasional complaints from the partner that lower level employees are not providing the necessary information should be viewed as a positive indication. The company which systematically monitors the type of information the partner is requesting and the extent to which these requests are being met, may well turn out to be the ultimate winner. A systematic and pragmatic approach right from the negotiation stage can minimize risks in strategic alliances. The executives involved in the negotiation should be allowed sufficient time to get to know each other and to develop personal equations. Free and frank discussions and realistic targets will help the firm avoid future disappointments. The partners should painstakingly identify potential problems and devise ways to solve them. Crisis situations should be anticipated and a code of behaviour prescribed for dealing with them. It may also be useful to maintain written records of informal and oral commitments and agreements. These records can be referred to, as and when disputes arise. Like in many other business activities, top management commitment holds the key to the success or failure of an alliance. When senior executives of the companies involved are willing to invest time and effort in building strong personal relationships with each other, the chances of success multiply. The success of a strategic alliance depends critically on the partners commitment to learning. When top management sends out clear signals that learning is very important, employees take the message seriously. The top management should also properly brief the lower level employees on what can be learnt from the partner and how this knowledge will strengthen the companys competitive position. Employees can be trained and encouraged to ask probing questions such as: Why is their design better? Why are they investing in a technology when we are not doing so? Companies can also learn more about the competitive behaviour of their partners - how they respond to price changes, how they launch a new product, etc. Management of expectations is a crucial issue in strategic alliances. When two partners view an alliance differently, they may have different expectations. For example, one may treat it as an acquisition while the other may believe it to be an equal partnership. One way of bridging this gap is for each partner to put itself in the others
24

The Borderless World, p 119.

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shoes. The partners could also share with each other, the problems they have faced in the past while managing alliances. At the same time the differences between the past experiences and the new situation should be appreciated. People who will be actively involved in the negotiation should be carefully selected. Managers who are familiar with the cultural differences and command respect in their respective organizations will come off as more credible when they interact with their counterparts in the partner company. Alliances can run into rough weather for various reasons. The size of the market may have been overestimated at the time the alliance was formed. If technology is changing rapidly, the value of the alliance for each partner may change dramatically over time. The actions of competitors can turn a potentially attractive alliance into a weak arrangement. Regulatory changes, in industries which governments view as strategic, may totally upset the initial calculations of alliance partners. For all these reasons, partners may switch loyalties. The right approach to deal with these potential problems is to think and act flexibly. According to Hamel and Doz25: Calls for commitment make good rhetoric but are a poor basis for action. Commitment increases only over time and an uncritical belief in commitment is naive and misleading. People being largely risk averse, will always be tempted to hedge commitments and keep their options open in the face of uncertainty. Alliance partners must appreciate that their objectives are bound to change with time and not cling to the initially set objectives. Indeed, if the partners are alert, unforeseen opportunities for knowledge generation and sharing can be tapped. One common reason for conflicts is that one partner may have skills that are not easily transferable, while the other may have expertise which can be more easily picked up. The design of a component or a product can normally be learnt through a manual or an engineering drawing. On the other hand, manufacturing skills are more intricate, typically developed over a period of time and combine several competencies. A discrete, stand-alone technology, such as the design of a semi conductor chip, can be more easily transferred than a process competence. Japanese companies often tend to learn more from their American partners because their manufacturing skills are less transferable than the design skills of western companies. Contrary to popular notions, absence of conflicts may not necessarily imply that the alliance is succeeding. It is quite possible that the two partners have given up or one partner is dominating the other. Occasional conflicts may reflect a more normal situation. The trick obviously lies in managing these conflicts tactfully.

Concluding Notes
In this chapter, we have tried to understand the risks associated with mergers, acquisitions and strategic alliances. In their anxiety to close the deal or in their enthusiasm to grow, companies often strike deals of questionable merit. A dispassionate analysis of the potential benefits and pitfalls involved is important before going ahead with a merger or a strategic alliance. Board members have an important role to play here, especially the external directors. CEOs must be thoroughly grilled and asked to explain the benefits of the merger. Once the decision to go ahead with the merger is announced, the focus shifts to integration. This is a task which is underestimated by most companies.
25

In their book, Alliance Advantage.

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In the final analysis, it is the efficiency with which the integration process is managed that decides whether the projected synergies materialise. The difficulties in planning and executing acquisitions and alliances make them very risky. Managers should never underestimate these risks when they strike such deals.

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Case 4.1 - The Daimler Chrysler Merger

Introduction
On May 6, 1998, two of the worlds leading car manufacturers, Daimler-Benz and Chrysler, agreed to combine their businesses to form the third largest automobile company in the world in terms of revenues, market capitalization and earnings (fifth in terms of the number of units of passenger-cars and commercial vehicles sold). In the new company, called DaimlerChrysler (DCX) Juergen E Schrempp and Robert J.Eaton the CEOs of Daimler and Chrysler respectively were named co-CEOs. Both appeared confident that the merger would generate various synergies and growth opportunities. Schrempp remarked26, The two companies are a perfect fit of two leaders in their respective markets. Both companies have dedicated and skilled workforces and successful products, but in different markets and different parts of the world. By combining and utilizing each others strengths, we will have a pre-eminent strategic position in the global marketplace for the benefit of the customers. We will be able to exploit new markets, and we will improve return and value for our shareholders. This is a historic merger that will change the face of the automotive industry. According to Eaton, Both companies have product ranges with world class brands that complement each other perfectly. We will continue to maintain the current brands and their distinct identities. What is more important for success is our companies share a common culture and mission. both clearly focussed on serving the customer.. both have a reputation for innovation and quality.. By realizing synergies we will be ideally positioned in tomorrows market place.

Chrysler
In 1993, the Chrysler board had appointed Robert Eaton, then a senior General Motors (GM) executive, as the new chairman and CEO, following the legendary Lee Iaccocas retirement. Eaton divested unrelated businesses to concentrate on car and truck making activities. He emphasised quality and efficiency, strengthened the balance sheet by reducing debt and increased Chryslers commitment to new product development. By 1995, Chryslers position had significantly improved. Chrysler reported net earnings of $2.4 billion in 1993, $3.7 billion in 1994 and $2 billion in 1995. In 1997, Forbes which selected Chrysler as the Company of the Year. mentioned27: No company in recent years has faced greater odds than Chrysler. Starting as a weak number three in a murderously competitive business facing competitors with far greater resources, Chrysler management devised a disciplined strategy out of chaos and rose to the top of the American car industry in profitability. Eaton received praise from analysts for making Chrysler a customer oriented company and for developing a close knit team of talented managers driven by a clear vision.

26 27

Press release, May 7, 1998. Fling Jerry, Company of the year Chrysler, Forbes, January 13, 1997, pp. 83-87.

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Daimler Chrysler
120 100 US $ 80 60 40 20 26.07.98 26.10.98 26.01.99 26.04.99 26.07.99 26.10.99 26.01.00 26.04.00 26.07.00 26.10.00 26.04.01 26.07.01 26.10.01 26.01.01 Merger

Date Closing Stock Price

Daimler Benz
When Juergen Schrempp had taken over as Daimlers CEO in May 1995, the company was facing a crisis. To some extent, Schrempp himself was responsible for this state of affairs. To cite an example, he had supported the acquisition of Fokker, the Dutch airplane manufacturer. However, price wars, unfavorable exchange rates and global recession had resulted in massive losses. Fokker slid into bankruptcy less than three years later. Schrempp however, made up for these mistakes through ruthless restructuring. He announced that Daimler would return to its roots as a car maker and began divesting unprofitable businesses. These divestitures, helped in reducing headcount and sharpened the business focus. The Aerospace division alone lost around 40,000 people through layoffs, attrition and divestiture. Even the Mercedes division, which had employed 180,000 people in 1991, saw its manpower strength fall to 140,000 by 1995. After restructuring Daimler, Schrempp set about revitalizing the culture and promoted what he called value driven management. Each of Daimlers 23 business units had to earn a return of at least 12% on the capital employed (ROCE). During the first half of 1997, Daimler showed a remarkable improvement with ROCE of 9%. In 1997, Daimler generated revenues of DM 124 billion and net profits of nearly DM 6 billion.

The merger
In the early 1990s, Daimler executives noticed that their traditional markets were becoming saturated and started looking for new growth opportunities. The price of the vaunted Mercedes marque was beyond the reach of most customers in emerging markets. If matters were allowed to drift, Mercedes would remain a niche player and lose its competitive strength. So Daimler began to look for a partner to broaden its appeal and

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give it the scale it needed to retain its technological strengths. After considering various car manufacturers in the world, Daimler executives decided that Chrysler topped the list because its product line and geographical reach were both complementary. In 1995, Daimler and Chrysler began exploratory talks, and discussed ways of dealing with their weaknesses in the rapidly growing Asian markets and, to a lesser extent, South American markets. They proposed to set up a new, jointly owned project code-named Q Star that would operate outside the US and Europe to develop vehicles, build factories, and establish dealer networks in new markets. The talks however ran into a stalemate over issues of responsibility and money -- who would manage which projects and how the costs would be allocated. Chrysler, however, realized very soon that it was too thinly staffed to boost overseas sales by deploying managers around the world. Moreover, due to smaller volumes, its R&D cost per vehicle was higher than that of its formidable rivals, GM and Ford. Clearly, Chrysler was too small to take on its bigger rivals. It made sense to have a partner. Meanwhile, Daimler was having its own problems. After building a plant in Alabama to assemble the M-class sport-utility vehicle, many defects/problems appeared during its first year of production, making it the most defect-ridden vehicle in its class. The German manufacturer had to spend about $180 million in 1997 to retrofit an innovative small car called A-class, because it lost balance when turning around corners at high speeds. The company formed a partnership agreement in 1997 with Swatch28 to develop a two-seater, plastic-bodied city car called Smart. But the co-venture dissolved in acrimony. Meanwhile, larger manufacturers like Toyota and Volkswagen, were building competitively priced premium cars such as Lexus and Audi. On the positive side, Schrempp had restructured Daimlers non-auto businesses, adopted US GAAP accounting principles and listed Daimler on the New York Stock Exchange. This would greatly facilitate any transatlantic deal. The ground realities they faced, motivated Daimler and Chrysler to get back to the negotiating table. In January 1997, Schrempp met Eaton at Chrysler headquarters during the Detroit Auto Show. But doubts about the deal again arose when Ford chairman Alex Trotman approached Schrempp in Detroit in January 1998 for a joint venture. Top executives from Ford and Daimler held two days of discussions in London in March. Daimler had never viewed Ford as a possible partner since it was big enough to survive on its own. The London meeting was successful. However, a second meeting, was cancelled at the last minute after Trotman informed Schrempp that the Ford family did not want to lose management control. After the talks with Ford broke down, the negotiations between Daimler and Chrysler proceeded smoothly. On March 2, 1998, Eaton and Schrempp met in Lausanne, Switzerland, to discuss issues like governance and organization structure for the merged entity. In April, working teams went into details and reached agreements on big issues (Computer operations would be centralized the Chrysler way, with a Chrysler executive in charge) to small issues (Business cards would be wider and longer, European style). On May 6, Daimler and Chrysler signed the merger agreement which was announced worldwide the following day. On May 14, the Daimler supervisory board agreed to the merger. In July, the European and American competition authorities gave
28

A leading Swiss watch manufacturer.

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their nod. On September 18, Chrysler and Daimler shareholders approved the merger. Chrysler stockholders received 0.547 share of DCX for each share they held. Daimler shareholders held a 57 % stake in the new company. DCX had revenues of $155.3 billion in 1998, and unit sales of 4 million cars and trucks, with a presence across several market segments. Chrysler made moderately priced cars and light trucks; Daimler made Mercedes luxury cars and heavy trucks. Chrysler was strong in North America, but weak in Western Europe, where Daimler was strong. Chryslers strengths lay in product development; while Daimlers engineering and technological capabilities were well established. The merger was projected to generate synergies of nearly $1.5 billion in 1999 and around $3.0 billion in 2000. Much of the cost-savings would come through rationalisation of purchasing and technology sharing activities.

Integration
Once the deal was finalized, Schrempp named a management team for the new company. Schrempp would share the title of co-chairman with Eaton for three years (2001) or until Eaton retired. However, management control of DCX seemed to be in the hands of former Daimler executives. The new organization structure for worldwide marketing operations, aimed to generate sales growth while protecting the identity of the companys six brands in the passenger car business (A class, M class, CLK convertible, Chrysler Concorde, Dodge Interpret and Eagle Vision), and four brands in the commercial vehicle business (Mercedes-Benz, Freightliner, Sterling and Setra). The individual brands were managed by specific brand managers. In Europe and North America, the two companies decided to maintain separate showrooms. In markets where DCX had a weak presence, such as Asia, they decided to integrate the distribution channels and cut costs by combining different functions like logistics, warehousing, technical training and after sales service. James Holden, a senior Chrysler executive became responsible for brand management and marketing for the Chrysler, Dodge, Plymouth and Jeep brands worldwide. Dieter Zetsche, a highly regarded Daimler manager was made in charge of the global brand management of Mercedes-Benz and Smart cars. Kurt Lauk became head of global brand management of the commercial vehicle brands -- Mercedes-Benz, Freightliner, Sterling and Setra (buses), as well as sales of Freightliner and Sterling products. Theodor Cunningham was asked to coordinate the worldwide integration of common systems and processes. The geographic region responsibilities were divided among Holden (North America), Zetsche (Europe, Asia, Africa, Australia) and Cunningham (Latin America). DCX also announced plans to establish a Marketing Integration Council, consisting of Cunnigham, Holden, Lauk and Zetsche. The Council became responsible for establishing central marketing services, and setting volume and profit targets. In the pre-merger phase, Daimler had assumed that the cross border nature of the transaction would not create any special problems. Daimler felt agreeing on the broad terms of the merger was more important and attached greater importance to efficiency and planning. However, during integration, cultural differences became the most critical issue.

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Daimler was characterized by methodical decision-making while Chrysler encouraged creativity and represented American adaptability and resilience. Having almost gone bankrupt before its celebrated 1979 bailout, it had turned around under CEO Iacocca, and then Eaton, to become one of the most efficient car companies in the world. Daimler, meanwhile, had long represented the epitome of German industrial might and was one of the best examples of German quality and engineering. There were major disparities in pay structures between the two pre-merger entities. Daimler had a very egalitarian pay structure. In the US, CEOs were rewarded handsomely. Eaton, earned a total compensation of $10.9 million in 1997, significantly higher than what Schrempp did. Situations such as an American manager being posted to Stuttgart, reporting to a German manager who was earning half his salary became ticklish. On the other hand, Chrysler could cut pay only at the risk of losing its talented managers. Schrempp mooted the idea of overcoming the problem through a low basic salary and high performance-based bonus. Basic pay would be lower than what Germans were used to, with more variables such as stock options. While Chrysler executives were used to higher pay, the Germans seemed to relish their perks. They liked to travel first class and stay at top class hotels over the weekends. The Germans were also used to lengthy reports and extended discussions. But, the Americans performed little paperwork and liked to keep their meetings short. The Americans favored fast-paced trial-and-error experimentation, whereas the Germans laid painstaking plans, and implemented them methodically. In general, the Germans perceived the Americans to be totally chaotic while the Americans felt the Germans were stubborn . DCX took several initiatives to address the cultural dissimilarities. Germans were encouraged to try out casual dress and also attend classes on cultural awareness. Americans were asked to make more specific plans, while the Germans were urged to experiment more freely. The Americans were impressed by their German counterparts skill in English. To reciprocate, many Americans began taking lessons in German.

Problems begin
Despite all these initiatives to bridge the cultural differences, problems in implementing the merger began to be noticed from the middle of 1999. In September 1999, Thomas Stallkamp, the president of the US operations, who had played an important role in Chryslers comeback in the early 1990s, resigned. Stallkamp had apparently argued that the merger must go ahead slowly. Many Chrysler executives were upset by Stallkamps resignation as he was considered to be the only senior executive prepared to stick his neck out to protect the Americans turf from the Germans. With Eaton expected to leave by early 2000, the Americans felt threatened. Around this time, Schrempp felt it made sense to let Chrysler and Mercedes operate as separate business units. While it minimised ego clashes, realisation of projected synergies became more difficult in areas such as sharing of components. Chrysler had begun to share Mercedes rear-wheel-drive technology. But, when it wanted to use some of these components in the Dodge Intrepid and the Chrysler Concorde, the Germans resisted because they were not sure whether they would have enough parts to spare after taking into account their own consumption.

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In November 1999, following criticism that Chrysler was being tightly controlled by the Germans, James Holden, Stallkamps successor announced a reorganisation that would enable the company to get bogged down by the integration processes and concentrate on competing with main rivals, GM and Ford. The restructuring aimed at centralising product planning functions and enhancing control over product development activities. In December 1999, DCX announced that sales had risen 12% driven by strong demand for Mercedes-Benzs S-Class luxury cars and Chryslers Jeep Cherokee. Vehicle sales in both North America and Europe were strong. Schrempp expressed satisfaction that the merged entity had consolidated and strengthened its competitive position in many markets. But keeping in mind its weak presence in Asia, DCX decided to form new strategic alliances to expand its presence in the region. On March 27, 2000, DCX forged a strategic alliance with Mitsubishi of Japan. In June, it spent $428 million to acquire a 10% stake in Hyundai of South Korea. Towards the middle of 2000, the markets were increasingly coming around to the opinion that the integration process had run into problems. Schrempp remained optimistic though slightly defensive about the prospects for the merger29, At present, the merger is judged on the basis of the stock which I appreciate is not where it should be. But thats not the point. The point is, we are a solid company We are now one company. Its working well. Meanwhile, DCX faced some serious problems in the key North American market. Competition from Japanese and European manufacturers had resulted in shrinking margins for Chryslers mini vans and sports utility vehicles. Chrysler had miscalculated the demand for their aging minivans. When it introduced its new model, its price was perceived to be too high in relation to the old vans which had flooded the market. So, Chrysler had to offer big incentives for vehicles sold in 2000. During the second half of 2000, Chrysler lost $1.8 billion. In hindsight, Chryslers fundamentals had probably been much weaker at the time of the merger, than widely perceived. As 2000 progressed, it became evident that Schrempps decision to allow Daimler and Chrysler to operate separately, had put paid to any plans to generate synergies. As the Economist30 put it: When they merged, Daimler-Benz and Chrysler said that together they would create tremendous synergies. That these have not materialised is partly because of the decision to keep the European and American operations, Mercedes-Benz and Chrysler, working separately, after full integration plans became bogged down. The German side is acting as if it is still alone, partly for fear of sullying the imperious Mercedes brand with the rugged Chrysler image. At one level, arms length operations might have made sense. But insiders say this strategy has been taken to extremes. According to an expert quoted in Business Week31 : Theyre erring too much on the side of caution If they continue to operate as separate companies, they wont achieve the same kind of global reach as Ford, which shares some parts among its upscale brands with the lower-cost Ford brand. Business Week32, would later remark, Both the Germans and the Americans have been out of synch(ronisation) from the start. The two proud management teams resisted working together, were wary of change and werent
29 30 31 32

Business Week, August 7, 2000. October 12, 2000. August 7, 2000. September 17, 2001.

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willing to compromise. Daimler and Chrysler have combined nothing beyond some administrative departments, such as finance and public relations Mercedes executives worried their buyers might feel cheated if they shared parts with the American auto maker, Chrysler resented the implication that its technology was inferior. By late 2000, DCXs market capitalisation was less than that of Daimler-Benz before the merger. Many Chrysler executives had left the company, dissatisfied with the way the merger was progressing while some had been fired. The Germans seemed to be gaining the upper hand with Schrempp even admitting that the marriage of equals was only a sales pitch to make the deal palatable to the Americans. So, it did not come as a surprise when Schrempp announced plans to scrap the automotive and sales councils the two companies had set up after the merger and replace them by a tightly knit executive committee, consisting only of Germans. This committee was empowered to make all key strategic decisions and coordinate production and marketing activities across the groups divisions. Schrempp hoped the move would speed up decision making on many issues including sharing of technology among Chrysler, Daimler & Mitsubishi and Hyundai. Schrempp also fired Jim Holden and replaced him with Dieter Zetsche as CEO of the Chrysler division. Cost cutting initiatives were renewed and suppliers asked to reduce prices by 5% immediately. Quality improvements, particularly for trucks were introduced at a furious pace. Marketing programs were rationalised and coordinated efforts initiated to emphasise that Chryslers cars were cool. Zetsche also started attempts to strengthen relations with the dealers. Initiatives to share platforms and parts among Chrysler, Mercedes, Hyundai and Mitsubishi gathered momentum. Daimler however, understood that the Americans still had an important role to play in managing the US operations. Partly by design and partly by circumstances, a German American Management team began to evolve. Key members of the management team, Schrempp, Zetsche and Wolfgang Bernhard were Germans but Americans like James Donlon (Corporate Controller), Gary C Valade (Global procurement & supply chief), Thomas Sidlic (Procurement and supply chief of Chrysler) and Richard Schaum (Head of Product Development and Quality) were also given important roles. Zetsche himself admitted the need for insights from the Americans in the efforts to turn around Chrysler33: I would be the first to say that Im not smarter than the people who are here. As Business Week 34 reported, For all the talk about the Germans invading the executive ranks of Chrysler, Schrempp has sent only a pair of workout guys to handle the biggest workout in the automotive world. For the rest of the team, he is relying on Chrysler veterans who have been plucked from relative obscurity following a rash of high-ranking defections The presence of so many Americans points to something else: a tacit acknowledgement by the Germans that they have a lot to learn about the workings of a mass-market giant like Chrysler.

Future Outlook
The German-American team faced stiff challenges In 1998, Chrysler had made more profits per vehicle than other major car manufacturers. In 2000, Chryslers operating profit declined sharply by 90% to $500 million on a sales turnover of $64.2 billion. In
33 34

Business Week, January 15, 2001. January 15, 2001.

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2001, it is expected to lose at least $2 billion. Chryslers US market share has been shrinking (13.5% in September 2001, from 16.2% in 1998) and is in danger of losing the No. 3 position in the US to Toyota. In August, 2001, Chrysler spent an average of $2,389 per vehicle in customer incentives, more than that of GM or Ford. Zetsches plans to move towards an everyday low pricing strategy have not materialised. Following the September 11 attack on the WTC, first GM and then Ford started offering free financing on their cars. Chrysler had to follow suit. On February 26, 2001, DCX announced it would make a loss in the range of Euro 2.2 2.6 billion. Schremp however remained optimistic that by 2003, the company would be making profits in the range Euro 8.5 9.5 billion. On October 31, 2001, Standard and Poor downgraded DCXs credit rating, making it the weakest among the Big three. The DCX share after peaking at $108 in January 1999 traded at about $35 as on October 31, 2001. In the first three quarters of 2001, Chrysler lost an estimated $1.7 billion. But the strong performance of the Mercedes-Benz luxury car business is expected to generate the targeted operating profit of $1.1 billion during the year. Meanwhile, DCXs supervisory board has passed a vote of confidence in Schrempps leadership by extending his contract35 by two years and that of his close ally, Jurgen Hubbert, who heads the Mercedes-Benz car division also by two years. Schrempp remains confident that the implementation of the merger, though incomplete will proceed smoothly. The choice of a German like Zetsche to manage Chrysler seems to have brightened the prospects for the American partner. Zetsches good relationship with Stuttgart may result in faster access to German technology for Chrysler cars. The first Chrysler vehicle to use Mercedes parts extensively will be the Crossfire, a two-seat roadster to be launched in 2003. Zetsche has indicated plans to install a wide array of Mercedes parts in Chrysler cars by 2004. Many formidable challenges still remain for DCX. As a recent report in the Economist36, has summed up: Daimler has to integrate two struggling companies and in the process reform itself. The stately product-development process that suffices for a luxury brand has to be speeded up for the more competitive markets that Mercedes, Chrysler and Mitsubishi now find themselves in. Mr Schrempp is a tough boss who clawed his way up from garage mechanic, fixing lorry engines, to the top rank of German business. Now belatedly, he needs to get to grips with the nuts and bolts of what is, in effect, a three-way merger. Problems remain to be addressed in critical areas such as component sharing. According to Hubbert37, One million Mercedes customers a year are willing to pay a premium for something that is better than what the competition is delivering. We have to be very careful to make sure they feel that what theyre getting for their money is unique. Indeed, this will be a tricky issue as the premium Mercedes charges is crucial to the well being of the group. DCX just cannot afford to do anything that will hurt the image of its Mercedes cars.

35 36 37

The announcement was made on September 27, 2001. March 1, 2001. Business Week, November 12, 2001.

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Case 4.2 - The Citicorp Travelers Group Merger

Introduction
In April 1998, the financial services giants, Citicorp and Travelers Group announced they would merge to form Citigroup with a market capitalisation of $160 billion and assets of $700 billion. Citigroup would sell a range of products to individuals, corporates and governments across the world. It would operate in diverse businesses such as traditional banking, consumer finance, credit cards, investment banking, securities brokerage and asset management, and property, casualty and life insurance. The two companies indicated that this would be a merger of equals. John Reed, the Citicorp CEO and Sandy Weill, the Travels Group CEO, were named co-CEOs of Citigroup.

Citicorp and Travelers before the merger

Citicorp (Citi) and Travelers had come to the merger table with different backgrounds. Citi had become the leading consumer bank in the world by the 1990s. It had largely depended on organic growth. Travelers had grown through acquisitions. Citi had struggled with the few acquisitions it had made, a notable example being Qeutron, the securities data firm. Weill, on the other hand, was a seasoned expert in implementing acquisitions. In 1986, after quitting American Express, Weill bought Commercial Credit, a small consumer lending firm. Over a period of time, through a series of mergers, this became Travelers, an insurance and brokerage conglomerate. Its subsidiaries included Salomon Barney (brokerage services, investment banking and underwriting); Commercial Credit (consumer loans); Primerica Financial Services; Travelers Bank Credit cards and Travelers Life and Annuity. Weill believed in moving fast after an acquisition, select a management team carefully and drive under managed businesses to their full potential.

Synergies
When Weill and Reed met on February 25, 1998, Reed was surprised by Weills merger proposal. But gradually, the Citicorp CEO realised that the two companies were in complementary businesses with little overlaps. In the third week of March, Reed and Weill agreed to go ahead with the merger. They met leading luminaries in Washington including President Clinton, Alan Greenspan and Robert Rubin to get their support. Citi and Travelers were confident that the merger would facilitate cross-selling of each others products. The merged entity looked better placed to compete with specialist credit card issuers, home equity lenders and mutual fund companies. These competitors, using niche marketing techniques had been steadily eroding Citis market share in the 1990s. Also, while Travelers had an insignificant presence overseas, it had one of the strongest distribution systems in the US. Citi on the other hand had an impressive network outside the US. It had 464 branch offices in Europe, 166 in Latin America and 93 in Asia. The two companies also complemented each others customer segments. While Citi had a younger, less affluent customer base, Travelers targeted older, more affluent individuals. Citi could sell its CitiGold and Private Banking Services more efficiently to Travelers 20 million U.S. customers after the merger. Citi, could also benefit from Travelers expertise in mutual funds.

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Citigroup
60 50 Merger US $ 40 30 20 10 16.Jan.98 15.Jun.98 03.Nov.97 06.Nov.98 11.Nov.99 30.Jan.01 22.Jan.99 18.Jun.99 26.Jan.00 21.Jun.00 26.Jun.01 31.Aug.99 26.Aug.98 26.Nov.01 14.Nov.00 01.Sep.00 07.Sep.01 01.Apr.98 07.Apr.99 07.Apr.00 12.Apr.01

Date Closing Stock Price

Citi had expertise in mail and telephone distribution of cards and branch banking. Its sales force however paled before Travelers which had 10,300 Salomon Smith Barney brokers, 80,000 part time Primerica Financial Services insurance agents and 100,000 agents selling Travelers insurance. Even though cross selling remained a challenge, it seemed the two companies had little to lose. There was very little duplication of activities. So, there was little danger of the pre merger entities losing any of their momentum. Another positive feature of the deal was that no huge premium was being paid by the acquiring company. Citicorp shareholders would get 2.5 shares of Travelers for each Citi share they held, implying a modest premium over Citis ongoing market price. So, there was a good chance of generating higher earnings after the merger. The main hurdle in the implementation of the merger was the Bank Holding Company Act, which prohibited banking companies from engaging in insurance underwriting, an important business for Travelers. However the regulation made it possible for a non banking company to buy a bank, become a bank holding company, and comply with the law within a prescribed period. The law allowed two years for this to happen and also provided for three one-year extensions at the discretion of the Federal Reserve. Citi and Travelers hoped that banking laws would be suitably amended by then. (If the existing laws were not amended, the Fed would possibly insist on divestment of the insurance underwriting business within two years).

Integration
Important hurdles stood in the way of integrating Citi and Travelers. The compensation policies were very different in the two companies. Citi offered stock options to talented

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managers it wished to retain. But it did not exert pressure on them to retain their holding. As a consequence, all the officers and directors at Citi put together owned less than 0.5% of the companys stock. In contrast, Weill himself owned 1.3% of Travelers stock, worth about $950 million. Travellers officers and directors together owned 2.45%. These stakes had been built by Travelers convention of blood oath that prevented the top management team and the directors from selling shares. One director, after being denied permission to be relieved of the oath, had resigned from the Travelers Board just to cash his shares. Another important difference lay in the degree of teamwork. Travelers encouraged teamwork. Inter-divisional support in selling products was quite common. But, Citis talented, smart and ambitious executives were more aggressive and individualistic. Reed admitted38: Ive been struggling for years to try to improve the management and energy levels within Citi. I think there is an intensity and a sales capability in Travelers that we dont have as well developed. This is going to improve our management DNA. Transferring Travelers good practices to Citi however remained a major challenge. As Fortune39, mentioned, The problem is going to be getting the cells transferred into a Citi biochemical makeup that has traditionally been resistant to teamwork. Citi is known for a go-it-alone attitude bordering on outright arrogance. Some analysts were worried that the arrangement of co-CEOs would not work out, keeping in view the big egos of Weill and Reed. They felt that it was better for both to work individually. As the integration advanced, the differences in the management styles of Reed and Weil began to be noticed. Reed, a loner disliked talking to the press. In contrast, Weill was more outgoing and communicative. Reed was more of an intellectual while Weil relied on gut instinct rather than briefing papers. As Business Week40 put it: Weill and Reed have little in common. He (Weill) is a street-smart personable, outgoing man who loves nothing more than talking about his latest victory. Wall Street loves Weill for his relentless focus on the bottomline and the stock price... Reed is probably the most visionary banker of his generation... Much of his time is spent alone, reading and thinking. After the merger, most of the positions were divided among the Citicorp and Travelers managers. Half of the new boards members came from Citibank and half from Travelers. The Economist41 described it as a Noahs Ark approach. The committee system of decision making however led to delays. Animosity developed between the investment bankers of Salomon Smith Barney (a part of Travelers) and Citicorp. The investment bankers were much better paid but Citis corporate bankers resented this as they felt they were handling far more sophisticated clients.

Problems begin
In October 1998, many Citigroup executives began to complain that the merger was not proceeding smoothly. Immediately thereafter, major changes in the top management were made. Jamie Dimon, long considered Weills heir apparent, quit in November 1998.
38 39 40 41

Fortune, May 11, 1998. May 11, 1998. June 7, 1999. August 26, 2000.

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Apparently, Dimon had developed sharp differences with Weill. The Economist42 felt that Dimons resignation was a clear indication that turf wars were gaining in intensity: Mr Dimons departure may have strengthened clan loyalties. He received a standing ovation from disappointed workers on the trading floor at Salomon, By contrast, employees, from the old Citibank were Cock-a-hoop at the news. They saw it as a victory for their hero, John Reed over Mr Weill, the Travelers man who had until then been thought to be in the drivers seat. Senior Citi executive, Victor Menezes and Weill loyalist, Michael Carpenter were made responsible for selecting a new top management team and quickly sort out pressing problems. In July 1999, Citis biggest shareholder, Saudi Prince Alwaleed bin Talal expressed his concern about the deteriorating relationship between Reed and Weill. Consequently, the responsibilities of Reed and Weill were clearly delineated. Weill took charge of day-to-day operations while Reed became responsible for internet strategy. In October 1999, former Treasury Secretary, Robert Rubin joined the senior management team apparently to act as a bridge between Reed and Weill. Around this time, Reed himself started expressing doubts about the success of the merger. He even remarked that while the wisdom of the merger was unquestionable, success in integration looked doubtful. He explained the peculiar problems which the merger had created43: Sandy and I both have the problem that our children look up to us as they never did before and reject the other parent with equal vigour, saying Sandy wouldnt want to do this, so what do I care about what John wants. Moreover, Weills trusted lieutenants were increasingly handling most of the important jobs while Reeds favourites were leaving. And in April 2000, Reed resigned, marking a final victory for Weill in the power struggle. Weill announced that a committee would be appointed to nominate his successor to take over in 2002. Many analysts remained cynical. As The Economist44 put it, Its hard to imagine Weill retiring. When asked about succession, he often mentions Alan Greenspan, still going strong at the Federal Reserve, at 73 and points out that he is a sprightly 66. And if anybody is named heir-apparent, they should watch their back. Just ask Jamie Dimon, who though widely tipped as Mr Weills successor, was abruptly sacked some 15 months ago.

Concluding Notes
At the time of the merger, many crossselling opportunities had been identified. Difficulties in integrating technology platforms and clashes at business unit level over what products to cross-sell have slowed down the retail cross-selling efforts. In consumer finance, where it was envisaged that Travelers products could be sold through Citis global network, success has been limited. The greatest success has been achieved in an unlikely business corporate and investment banking. Some of the opportunities which have been tapped after the merger, include selling of Travelers insurance products to Citi credit card holders with an attractive risk profile. Salomon Smith Barney mutual funds have been sold to Citi customers. Travelers annuities are also being sold through the Citi branch network. Many wealthy Salomon Smith Barney customers have been given 100% mortgages by Citi, secured against their
42 43 44

November 5, 1998. The Economist, August 26, 2000. March 2, 2000.

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brokerage accounts. Citis global network has also helped Travelers to enter emerging markets. Costs have been cut and asset utilisation has improved. Travelers seems to have introduced an aggressive sales culture in Citigroup branches. A major challenge ahead is that with the Travelers management seemingly in charge, the top managements experience in penetrating overseas markets is limited. Weill has a good record in turning around and expanding under-managed companies but his skills at managing a large global corporation are still untested. Many senior executives have left after the merger. Many blame Weills inability to draw up a succession plan as the main reason for this exodus. Quite clearly, Weill faces the challenge of convincing analysts that Citigroup is not a one man show.

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References:
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