Overcoming the synergy odds in a merger
The open secret about mergers and acquisitions (M&A) is that most deals fail to generate the synergies that companies expect when they announce a merger. In a Bain & Company survey of 352 global executives, overestimating synergies was the second most common reason for disappointing deal outcomes.
One of the causes of this misplaced optimism is well known: Companies set aggressive targets to justify a deal price to financiers. But a Bain analysis comparing deal announcements with the performance of more than 22,000 companies has revealed another, even more fundamental contributor to rampant overestimation. Most merging companies entering a deal don't have a clear understanding of the level of synergies they can expect through increased scale.
Instead, they typically make broad estimates based on prior deal announcements, without considering whether the cost structure of the combined entity is realistic based on benchmarks of like-sized companies. For example, if two $100-million companies merge, they rarely know what the resulting cost structure will look like based on their industry's existing $200 million companies. We found that across most industries we analysed, on average 70% of companies announced higher synergy estimates than would be expected just by companies getting bigger.
But the best companies justify higher targets and provide a roadmap for achieving them. They use the disruption caused by M&A to pursue broader changes such as adopting zero-based budgeting and incorporate new ways of working that help them surpass rivals to become cost leaders.
That approach requires merging companies to be far more disciplined about calculating expected synergies. It also requires them to use industry benchmark data to get a firm grasp on each company's costs, understanding how much can be gained from scale alone, as well as from the effects of improving costs.
Few companies illustrate this approach better than AB InBev, the world's largest brewer created from the 2008 merger of Anheuser-Busch and InBev. AB InBev announced anticipated synergies that were higher than what could be expected from scale alone, but it entered the merger with both a track record for high synergies and a solid plan to back up its claim. It ultimately beat the ambitious announcement by generating synergies of $2.25 billion, much more than what could have been expected from scale.
On average, merging consumer products companies increase EBITDA (earnings before interest, tax, depreciation and amortisation) by 3.2% of target net sales. In the case of the AB InBev merger, those synergy gains contributed a 16.8% improvement over a three-year period following the transaction.
A diversified industrial company formed by the merger of two giants serves as another example of excellence. The merged company used the acquisition process to get everybody on board for transformation. Based on industry benchmarks, the merged company would have expected to achieve scale synergies representing just 1-2% of combined revenues. It did far better. All told, the acquisition delivered synergies amounting to more than 5% of revenues.
In both situations, the merging companies used a deal thesis and rigorous due diligence to pinpoint where scale synergies and best-practice benefits would have the most substantial effect. A deal thesis spells out the reasons for a deal — generally no more than five or six key arguments for why a transaction makes compelling business sense. Knowing what you hope to achieve is the first step in clearly identifying where the deal can create value, which few things are critical to delivering that value and how quickly you need to move on each. For example, by conducting a deep business analysis of all target companies, the industrial company pinpointed where overlap of costs and customers would generate the greatest scale benefits, beyond traditional general and administrative functions.
In our experience, too few companies enter a deal really knowing how they measure up against competitors. But when the two industrial goods companies merged, they relied on function-by-function benchmarks to know where to expect the greatest synergies. They examined costs down to the sub-function level — in areas such as tax and treasury, for example — to identify potential synergies.
Instead of just looking at the cost of a specific function such as field human resources, they also considered such benchmarks as the HR employees-per-field headcount — anything that could be contributing to the gap against the best performers. That allowed the combined companies to set aggressive goals and see where each had strengths that could be adapted to help the combined entity perform above industry benchmarks.
The disruptive nature of M&A and the integration process opens up the opportunity to implement a broad performance improvement agenda across the organisation. Winning companies identify areas they are optimising beyond pure scale benefits. The merged industrial company approached the goals of integrating and optimising with different organisational oversight, tools and goal setting.
For integration, the focus is on making sure the businesses come together seamlessly and don't miss a beat in performance. When the goal is optimising, teams are given more aggressive cost targets and benchmarks for where the potential savings are likely to reside. They're provided with financial support and resources to help identify opportunities and to execute.
In its acquisitions, AB InBev establishes integration, oversight and change management programmes from the outset. It then sets targets and ensures the right tools and processes are put in place to manage costs across the organisation. For example, the company sets standards and benchmarks for best-practice brewing operations. It also standardises sales and delivery routines, relying on the best approaches, either from AB InBev or the acquired company.
The ultimate result: When it acquired the stake in Grupo Modelo that it did not yet own last year, a considerable part of the earnings value came from new performance improvements, not from typical synergies.
Written by Laura Miles, a Bain & Company partner in Atlanta; Suvir Varma, a partner in Singapore; and Sharad Apte, a partner in Bangkok. Follow @BainInsights on Twitter.