Research shows that most mergers end up destroying shareholder value. Some experts claim the number of destructive mergers is as high as 85%. But when they are handled right, mergers also offer companies tremendous opportunities for growth. So what can firms do to avoid the pitfalls of value destruction? Rajesh Makhija, chief marketing and M&A officer of Mphasis, a global IT services firm whose acquisition by the Blackstone Group was announced on April 4, reflects on lessons learned during his years in the M&A trenches.(Editorial disclosure: Mphasis is a corporate sponsor of Knowledge at Wharton.)
Mphasis, a global IT services provider for whom I serve as Chief Marketing and M&A officer, hit the news on April 4 with the announcement that the Blackstone Group would acquire a majority stake in the firm from Hewlett Packard Enterprises. Now the welcome object of a headline-making acquisition, Mphasis has itself been frequently acquisitive since its inception in 1998 — almost always buying firms with the desire to “grow the business.”
The portfolio of acquisitions that Mphasis has made over the past two decades has been diverse. We have bought services companies and software product companies, predominantly from India and the U.S., but also from the U.K., France and China. There have been large companies (worth more than $100 million) and niche units (of less than $5 million). All these takeovers have brought their own cultural and operational flavors to Mphasis.
The value these mergers promised largely fell into two buckets — primary business resources (i.e., customers, employees, technology, facilities etc.) and business value offerings (i.e., products or “productized” services). In some cases, Mphasis bought a firm because we initially found its business model or functional processes interesting, but eventually we could not apply these at a larger level.
M&A experts claim that an overwhelming majority of mergers destroy value, with some citing a figure as high as 85%. So how have mergers worked out for Mphasis? In my 15 years with the company, I have been witness to all our acquisitions. We have had a few duds, to be sure. Fortunately, none of them were debilitating. Still, we have also had very successful acquisitions, which delivered the catalytic boost and multiplier effect we had expected. As I look back and reflect on Mphasis’s experience with acquisitions, I believe following a few principles helped us avoid the pitfalls of many mergers that end up destroying value. Here are a few takeaways from that experience:
Layer the Value Pyramid
I believe that to make a merger work, one needs to focus on getting the fundamental value proposition right. In our experience, this approach works like a charm.
“I believe that to make a merger work, one needs to focus on getting the fundamental value proposition right.”
In fact, we learned this lesson with the first significant transaction that Mphasis engaged in, a (reverse) acquisition of BFL in 2000. Before the merger, both Mphasis and BFL were losing money. Mphasis was a high-end technology firm, which offered high-end business and technology architecture consulting services, while BFL was focused on downstream software development and had scale, quality and speed. Within a year of the merger, the merged entity — Mphasis BFL — became profitable. The reason for this transformation was that a holistic, end-to-end set of services, beginning with business needs to deployment of the complete system, could be delivered to the existing clients of both legacy Mphasis and legacy BFL.
The merged entity could not only lay out the strategy and architecture but also develop and deliver the system. There was complete ownership and accountability. This would have been impossible when both were separate companies.
A couple of recent Mphasis acquisitions appear to be delivering a similar impact to segments of our operations by following the same strategy. These include Digital Risk, a risk compliance and technology services firm that Mphasis bought in 2012, and Wyde, a firm that provides technology solutions for the insurance industry, which Mphasis purchased in 2011.
Acquire a Direct (Smaller) Competitor
This strategy offers the next-best substitute for strong organic growth. In the case of Mphasis, such acquisitions have brought us new customers, talent and more facilities. Similarity in organizational culture, business models, and geographical locations ensured that the integration was quick and smooth.
While these acquisitions did not deliver a catalytic upside — of the kind one gets with the value acquisitions I described above — they did bring benefits of economies of scale, a critical mass for larger engagements and cost savings. For a software industry player like Mphasis, acquiring critical mass was almost a necessity to even be in the running for mission-critical assignments from our clients.
“… Whenever Mphasis has left an acquired company to its pre-acquisition “business as usual” ways, we have regretted it.”
Examples of such acquisitions include Kshema Technologies in Bangalore, which was acquired in 2004, and Princeton Consulting, located in London, which was also taken over in 2004. These organizations which, just like Mphasis, were predominantly focused on delivering technology services, had their origin, customer and employee base in geographies in which we were already operating — the U.S., India and the UK — and had similar revenue and cost-basis operating models. After acquisition, different divisions of these organizations were aligned and smoothly subsumed under respective similar units of the Mphasis organization, thus making cultural integration a non-issue. Each of these firms have now become seamless parts of the Mphasis system, driving new revenue lines and enhancing existing ones.
Never Leave the Acquired Company Alone
After a merger, a few experts argue that, the acquirer should leave the target firm alone so as not to risk destroying value. This is often the case when a large company buys an entrepreneurial start-up, the argument being that you don’t want the bureaucracy of the larger firm to stifle the entrepreneurial verve and creativity of the start-up. In our experience, though, whenever Mphasis has left an acquired company to its pre-acquisition “business as usual” ways, we have regretted it.
We learned a couple of bitter lessons. In one instance, a profitable firm that Mphasis had acquired began to bleed significant sums of revenues after the merger – a situation that worsened as it was left to its devices. This persisted for years.
But after Mphasis intervened by replacing key managers and making other significant changes — the unit has become one of the most profitable in the Mphasis ecosystem. The primary changes involved applying the mature and proven business processes from Mphasis, and of managing and delivering to client expectations. These were not easy decisions, often they had significant transformative impact on the acquired organization operating model and personnel. Once we reversed course, we found success.
“Ultimately it boils down to having a key executive who is fully focused and dedicated to the integration process and to making sure that all the goals of the merger are met.”
To be sure, there have been a few deserving cases, like a software product development unit, where Mphasis management decided to let the acquired companies operate independently. We decided that Mphasis would provide the financial investments required to develop the product or offerings, with the objective of preserving the key attributes of the acquired companies. However, whenever we combined portfolio offerings between “legacy” Mphasis and the acquired units — or brought larger engagements to them — they were found wanting.
Mphasis over the years has focused a lot of effort on improving the client management model for large and mission-critical engagements. These include elements like change management, risk mitigation and engagement governance. When we grafted these and similar best practices, which have worked successfully in the Mphasis service model, onto the core attributes of the acquired units, we were able to realize the intended benefits of acquisition. The grafting often took place by having Mphasis executives take roles and responsibilities across multiple levels of the acquired organizations.
Structure and Plan Post-merger Operations Right
Often part of the payout for the leadership of the acquired firm is tied to its financial performance in the first couple of years after the buyout. Locking in hard terms tends to hinder the company from effecting the merger smoothly. We did not want to be construed as obstructing the management of the acquired units from delivering the performance during the contract period, thus opening up a can of “financial” worms. We have now realized that the actual physical and operational merger needs to be effected as planned and visualized for the merged entity at the time of acquisition. The financial structuring after the merger should support the integration effort so that the intended benefits can be realized faster.
Integration and Transition Are Not Part-time Jobs
Integration does not happen “on the job.” Someone has to make it happen deliberately. Every merger leads to change. It is usually massive for the firm that has been acquired, but it is significant for the acquiring company too. Change is hard. The importance of a well-planned integration approach is widely known, though still not executed well as widely. The success or failure of an acquisition is, essentially, determined by how well the integration and transition plan is executed.
We learned this lesson too the hard way at Mphasis. Initially, after an acquisition, an executive was asked to be plan the integration of both organizations while also tackling other jobs. Not surprisingly, it did not work. Ultimately it boils down to having a key executive who is fully focused and dedicated to the integration process and to making sure that all the goals of the merger are met.
If any company makes a half-hearted effort by giving someone part-time responsibility to integrate the two companies following the merger, it makes matters worse. This can delay or, worse, even negate the potential synergies that are supposed to materialize after the merger. But once post-merger integration gets the attention it deserves, even after the delay of a few years, it unlocks tremendous value as was intended before the acquisition.
Over the years, Mphasis has gone through numerous acquisitions and four major ownership changes. We have gone from private equity to public ownership to EDS/ Hewlett Packard and then to the intended acquisition by Blackstone now underway. It has been a great ride so far.
With Blackstone likely to take the wheel, the journey continues.