Achieving Expected Value in M&A — The Integration Triangle

Host:
Welcome to Insight Exchange, presented by L.E.K. Consulting, a global strategy consultancy that helps business leaders seize competitive advantage and amplify growth. Insight Exchange is our forum dedicated to the free, open, and unbiased exchange of the insights and ideas that are driving business into the future. We exchange insights with the brightest minds of the day, the most daring innovators, and the doers who are right now rebuilding the world around us.

Cristina Barquero:
Hello everyone. Welcome to another episode of the Insight Exchange podcast. My name is Cristina Barquero. I am a member of the organization and Performance Practice with L.E.K. here in Europe, and I'm very excited to be here with you today. Throughout this episode, we will discuss intricacies of merging and acquiring businesses and the importance of the integration triangle, a framework we have developed to ensure successful outcomes. To cover this topic, I'm here with two amazing colleagues. Would you like to take a moment to introduce yourselves?

Phil Roux:
Hi everyone. This is Phil Roux. I'm a partner with about 20 years experience in M&A. Always been very focused on creating sustainable value for my clients with a wide range of experience, pre-deal and post-deal across all kinds of sectors and deal sizes. I have a big passion for creating effective combined organizations and helping my clients get the value out of their M&A. I'm really excited to be here today. Thanks Cristina.

Tom Marshall:
Hi all. Really looking forward to this discussion. My name is Tom Marshall. I'm a Principal in L.E.K.'s organization and performance practice. I've got close to 15 years of consulting experience with a broad range of working with private equity and corporate clients at all stages of the transaction lifecycle. I help clients prepare for integrating acquisitions and driving synergy value realization. Like Phil, really looking forward to this discussion today.

Cristina Barquero:
Thank you both. Very excited to be discussing this topic with you. Let's dive into it. It is common to hear that mergers and acquisitions must create value. If a merger does not create value, it will eventually bring about poor results for the company than not doing the merger at all. Despite this, we know that many mergers fall short in achieving their full potential often due to a lack of pragmatic approaches. So what makes taking a pragmatic stance so critical in the context of mergers?

Tom Marshall:
Okay, happy to talk through that. There are many ways to create values through M&A activity and unfortunately as well many ways to destroy it. Without operating a pragmatic and grounded for you on how that value can be delivered, it can often be limited to really just an academic exercise that is never realized in reality. Clarity on the key elements required to deliver sustainable M&A is critical to make embarking on your M&A journey worthwhile.

Cristina Barquero:
Thank you so much, Tom. I guess our listeners might be curious to learn more about what those key elements are. Over the years, we have helped our clients gain a robust understanding of those elements using what we call the integration triangle framework. Phil, I know you have been working on this for a while. Could you maybe provide us with more details on what exactly the integration triangle entails?

Phil Roux:
Yes, I'm very happy to do that. The integration triangle really has unsurprisingly three elements to it and there's a value creation combined op model and integration strategy. So value creation about how are you going to realize the value from the deal? That can be both ensuring you deliver on the standalone potential of that target that you're thinking about acquiring, but also around how do you create synergy from the combination. That could be in terms of additional growth, it could be in terms of realizing some cost reduction, could be around more capital-related synergies, but there are multiple ways that you could be realizing value, but those need to be considered in console with these other two elements.

So combined operating model is what is that end state in the combination integrated strategy? How do you go about it? What is it going to feel like? All those three elements are super important too, and they really have to work in unison if you want to have high confidence that you can deliver on ambitious value creation plan from your M&A.

Cristina Barquero:
Okay, so now I am wondering why is it so critical to have these elements in place and what could potentially go wrong if they are not well integrated?

Tom Marshall:
Happy to talk through that. Let's start by thinking about the link between value creation objectives and the combined operating model. It's important that these two elements are connected as you need to ensure that the future combined business is actually set up in a way that will deliver the value creation goals that were the rationale behind the deal. It is key that the operating model needs to support these goals. The primary issues would be if the level of intended organizational integration is insufficient to deliver the target cost synergies. For example, we have seen times when the choice has been made to keep discrete operating units standalone to minimize the integration concerns, but this makes it harder to achieve the target level of cost synergies as they relied on removing duplication of roles across units.

It might also be the case that if there was not a coordinated planning effort, the depth of integration required to achieve synergies is not factored into the integration costs. For example, the level of process or IT harmonization required to allow two purchasing teams to operate as one. At the other extreme, it might be that the intended level of integration creates dis-synergies or risks that could actually be value destructive, but these are not actually factored into defining the value creation targets. For example, we have seen the case when significant commercial team integration was planned, but this created a risk of negatively impacting customer satisfaction or resulting in key commercial talent retention issues, all of which leads to a loss of revenues and a destruction of the value.

Cristina Barquero:
Thank you, Tom. What about the link between value creation objectives and the integration of strategy?

Phil Roux:
Yeah, so Christine, I think that comes down to essentially mismatch in pace. So you've got a deal valuation model where we live in a world where with high interest rates you don't have a lot of room to maneuver in terms of your valuation and delivering on your returns. The timing of synergies is as important as the level of synergies you think you can achieve. But then if you have at a mismatch between how fast you think you can deliver the synergies and the reality of how fast you can move in terms of executing on the integration itself, you can really have some challenges, and this is a classic example in terms of cost synergies being over ambitious in terms of your valuation model about when you can get a value out of your cost synergies.

But then realizing to Tom's point, actually there's a whole bunch of process or system harmonization, that means you are going to have to wait a lot longer before you can really extract those additional savings. That can create a mismatch that can lead to impact on return on those deals. Another good example is when you see an integrations almost force fitting the pace of execution to give you synergies in the timeline that was put into a valuation model. So you may be able to do this but at what cost? That could really shake loose a lot of key talents if they find the approach you take to the integration is too blunt, not sensitive enough to the concerns of it could be of the target or even of acquiring company if some of the synergies has to be realized on that side.

A great example of in my early experience supporting two industrial businesses, it was really a merger of equals to highly complementary businesses and it was positioned as a growth player, a merger of equals a best in breed, but it very quickly became clear that the acquiring CNU leadership were focused on extracting as much cost as they could as quickly as possible. That resulted in a loss of some really key talents that meant ultimately the combination took some time before it really delivered on its growth ambitions.

Tom Marshall:
Yes, and finally there's also the need to ensure there's a connection between the operating model and the integration strategy. Phil, you've just talked about the pace of the integration and we also need to ensure that that isn't at odds with the steps that need to be taken to implement the target operating model. For example, you need to ensure that the pace set for the integration aligns with the time wanted by the key functional leads post-closed to really assess the target's team processes and approach before they make any decisions. Alternatively, you might have the case that insufficient time has been built into the integration plan and this will mean that there's not enough time to really understand how the target's core capabilities work.

The integration approach will result in a disruption of the secret source that really drives the value of the business being acquired. You also have the risk when creating a best of both type scenario like you just talked about, Phil, that the pace might not allow sufficient time for the required change management and engagement steps to ensure that talent retention and overall cultural integration goals can be achieved and that means that the value creation outcomes are at risk.

Cristina Barquero:
Thank you both for sharing your experiences. It is very interesting to understand how much these details actually matter. Perhaps our listeners are wondering how to avoid the issues you mentioned and whether there are some best practices they could follow. Could you share some suggestions with us?

Phil Roux:
Yes, of course. And obviously we don't want to make this all feel like doom and gloom and there's nothing you can do here. I think we would probably boil things down to three core elements of how you really leverage the integration triangle and roughly sum them up into you need to make sure you're getting granular enough, you need to be working on things as early as possible to form a deal in the deal process. This is not a post-close effort. And then having done all that, you need to constantly refine your views. If I take the first one just to start, in terms of granularity, you have real structure and sort of a framework to how you think about each of those elements.

Having an internal house view on how I think about and define combined operating model. How I think about and define sources of synergies or how do I calculate them, what is also required synergies is not an academic exercise? There is a calculation, but equally it's around what actually happens to realize that and that needs to be thought through in a structured way and then have some ability to succinctly craft an early view on the integration approach, the integration strategy. What in a high level is it going to feel like rough phasing, key elements, key assumptions, that sort of thing. Having enough granularity on that actually allows you then to challenge across the different views.

Does the required steps to deliver on a synergy, so you take a revenue synergy where it was academically quite simple to come up with a number, but the devil is in the details of how do you actually deliver on a revenue synergy. So what value proposition is there? Who's going to take it to the market? How do you combine the Salesforce in a way that allows you to extract that? And then ultimately how do you deliver so that it's not a promise that is not delivered on. Well, you need to then look at your combined operating model. Does it create the right combined commercial structures? Does it create the right interfaces between marketing and commercial?

Does it create the right interface between I've sold it, can I actually deliver it? And that what you deliver, if you are bringing multiple services together, you're creating an integrated offering suddenly, can you actually deliver on an integrated offering. All of these questions start to bubble up and forcing yourself to at least acknowledge all these questions early on and have thought about them when you think about that potential end state and how you get there in terms of implementing, in terms of integration, or will give you more confidence than if you try to do this at a very, very high level.

Tom Marshall:
And as you say Phil, it's important to get to this view as early as possible in the deal process. This shouldn't be a post-close activity. You need to build a perspective on these various elements as early as possible and this will ensure that you can have that discussion about the trade-offs between the three elements and ensure that they're all mutually reinforcing and that they're not conflicting with each other. It's important that you develop those alongside the value creation objectives during the pre-deal and the valuation modeling. This will allow you to make sure you've got time to ensure there's that alignment. If required, revise your views on any of the three elements

Phil Roux:
That's a great point. I would also reinforce this is not a one and done exercise, so you need to continually manage those three elements of perspective and continue to find them as you learn more through your deal process. Ideally, a few best practices that I've certainly seen is sort of a single owner for all three elements. If you have someone owning a set of a deal modeling synergy, someone else owning op model or integration strategy, and never the twain shall meet, you will create silos. So find ways to create ownership that is able to what at least some governance that is able to look at all three things in unison and really judge that they have been really thought through together.

Constantly revisit them. Think about where and when certain assumptions become set in stone, where there are assumptions that continue to be challenged and reinforced, and what data or what information or what insight do you need to take it to another level of rigor. Typically, what we would find is the synergy elements of this triangle gets set in stone earlier because it is tied to the valuation and you will need to start thinking about that and getting alignment and sign-off from executive committees, boards, etc. relatively soon. The combined operating model integration strategy have more ability to continue to be refined as there will be other elements that play into that and that happens through the pre-closed and then even into post-closed.

But having that combined view and iterating wherever you can and then locking things down at the appropriate stage in a structured and transparent way is the other critical piece here.

Cristina Barquero:
I have no doubt that implementing those three key best practices can bring multiple advantages. I wonder what are some of the expected outcomes?

Phil Roux:
Yes. I think the benefits you'll really get from adopting this kind of approach and thinking hard about all three elements of the integration triangle are, first of all it allows you to be more ambitious in terms of your value creation targets. As we've mentioned before in the environment we have today, the ability to deliver on hurdle rates, return on investment, on M&As becoming harder and harder. So the ability to be confidently ambitious, but what you can deliver out of the deal is critical to them be able to be competitive in the M&A landscape. If you take for example, we work a lot with corporate clients where they're very used to revenue synergies being... They wouldn't even quantify them because they would be written off, particularly if they're a public company and there's going to be some sort of formal announcement that is scrutinized through a full process.

They're typically just desensitized to zero. When we work with them to think through, well actually if you go through that exercise of understanding what does that combined go to market model, what is that end market value chain participation as a combination, what are those really tangible steps you will take, and therefore what is a quite defensible assumption for some very practical scenarios around revenue synergies? Then you can get to a stage where you might actually bank on some revenue synergy, impact and evaluation and that puts less pressure on the cost synergies that you'd have in the deal as well, which is a good place to be a bit more flexibility in how you deliver that value.

As I said, you then also become much more confident that those synergy targets you've put forth, you can deliver on them as a sort of a manager in the business who may be ultimately accountable for part of this. If it's been thought through to a level of granularity that you can visualize how you go achieve it, you're more likely to put your seal of approval against it at that stage in the deal process. It also helps you just go through a more bespoke and sort of real assessment of what are the true risks and how do we mitigate them? So less of a generic or what are the typical risks and how will I worry about them, but what will be the true risks that I could imagine could happen if I think through the path we're taking and being much more confident that you have really thought about them and how you might address them in weeks and months to come.

You'll also be able to build broader buy-in because you're going through that exercise, going to the next level of detail and engaging more people to do that. You are building buy-in amongst a broader set of people that ultimately will deliver. I think that's a big bonus as well. Take for example, the support we've done in the industrial distribution that is country by country. How are you going to achieve that? And actually working in the diligence phase with each country manager to say, "Let's be very specific on all the branch overlaps that we think we're going to take action on and what is our ultimate end state footprint and what would be required in terms of systems and customer overlaps," and things like that means you can actually have country managers saying to the CEO "For my bit of this valuation, I am confident in it," which is a great place to be in terms of when you ultimately go into a negotiation.

Then also I'd say the final thing is particularly if you have a competitive process, you want to be on the front foot, you want to show that you genuinely are really excited and interested in owning this target business and that can often be a deciding factor for a target if they have multiple suitors. So having gone to this level of detail and really thought through it, you can talk in a very real and believable way about your vision for how you deliver value as a combination and sell the target on you being the right owner of that business. We had exactly that quite recently. High-take B2B business, all the synergy work. Well the digital was outside in, but we helped them get to know the target so well that when we had a formal management face-to-face, target management was super impressed with our client's management team, how well-prepared they were, how well they knew their business, and it was a genuine working discussion, not a very standoffish intro discussion. So it can make a big deal.

Cristina Barquero:
Thank you, Phil. Okay, so I see in summary, effectively aligning the three elements of the integration triangle is not just a goal, it's actually a gateway to enhanced synergy and success. Thank you so much Phil and Tom for sharing your insights with us. I hope our listeners have enjoyed the episode. If any of you is interested in learning more, do not hesitate to reach out to us. Thank you so much.

Host:
Thank you, our listeners, for joining us today at the Insight Exchange presented by L.E.K. Consulting. Links to resources mentioned in this podcast can be found in the show notes. Please subscribe or follow for future episodes wherever you listen to your podcasts. Also, we encourage you to submit your suggestions for future insights online at lek.com.