by Richard Z. Gooding, Ph.D.
By the year 2000, alliances are expected to account for more than 20% of the revenue of the average large company. In spite of their popularity and anticipated future growth, many deals are not living up to their expectations. In a recent survey of 124 companies, 44% reported that they did not gain access to new markets, grow market share or add product the three years after the mergers closed. In fact, 55% of all alliances fall apart three years after conception. And, only 23 percent recover the costs of walking down the corporate aisle. Mergers and acquisitions fare even worse: roughly 70% ultimately fail.
The reason for this high failure rate lies in the way managers think. In making growth decisions, they use shortcuts that create decision traps that cause managers to ignore, overlook, and rationalize critical information. Growth strategies do not fail because of the unknown -- they fail because managers are unwilling to confront what is known.
Critical Thinking Need Not be Negative ThinkingIn my study of "bad" business decisions, I asked executives "What's the worst strategic decision you ever made?" Eighty percent of these CEOs described a failed effort to expand into a new product or market. In hindsight, they acknowledged that the cause of failure was predictable if critical information had not been overlooked.
The premise of Strategic Risk Analysis is that there is a difference between negative thinking and critical thinking. Instead of seeking confirming information, the goal of risk analysis is to uncover possible flaws and stumbling blocks -- to delineate the risks rather than focusing solely on the benefits. "Most people spend their time looking at acquisitions from the standpoint of how good they are," says Kenneth Donohue, President of CCL Container. "But the strategic approach is tell me everything bad that could happen, and do we have a plan in case it does happen?"
Strategic Risk Analysis helps companies systematically gather disconfirming information from a multitude of perspectives. Only by uncovering potential reasons that an acquisition, merger or alliance won't work, can companies begin to truly evaluate whether the venture can be successful. Understanding the risk in advance and addressing them can also minimize unpleasant surprises.
A basic assumption of the process is that there is a person on the company's management team who knows why the alliance, merger or acquisition might not work. But, quite often it is difficult to pinpoint who that person is upfront. So, to ensure this individual is part of the analysis, it is advisable to include not only top executives, but also those who report directly to them, in the risk analysis process.
Strategic Risk Analysis ProcessThe day-long process is divided into three primary steps:
(1) Strategic Risk Profile: The management team, including top executives and their direct reports, meet in a facilitated brainstorming session to identify all the potential reasons the acquisition, merger or alliance won't work. The issues are grouped together in categories to make it easier to understand and evaluate them.
(2) Risk/Response Matrix: Potential risks are then put to the following test: What is the probability that this problem will cause the project to fail? If this problem did occur, what is the likelihood that your company will have the ability to respond? Based upon the responses, risks are prioritized, beginning with those that are most critical to the success of the venture. Once prioritized, four different categories of "events" emerge. They are:
Killer Events: Events that are likely to kill the deal now or later.
Controllable Events: Events that are likely to happen, but the company has the capability to respond to them.
Nuisances: Events that are unlikely to happen, but company resources are available to respond to them if needed.
Ambushes: Events that are not expected to happen, but that will likely result in a failed venture if they do.
(3) Feedback and Decision-Making: This information is then presented to the management team. Depending on the focus of the session, the team may use the information in different ways. If the company is just beginning its due diligence effort, the feedback is used to generate specific action items for the due diligence team. If completed after due diligence, the team uses the information to make a go/no go decision about the project. If the analysis is conducted after the deal is done, the information is used to develop action items for an integration plan.
Strategic Risk Analysis in ActionMany companies have successfully used the Strategic Risk Analysis process to focus on the critical issues and determine the best course of action for their company. Looking at a few examples will illustrate how the process is best used.
MicroAge, Inc., a $4 billion hardware/software distributor was considering a $20 million acquisition. Despite favorable reports from the due diligence team and the fact that upper management was negotiating an offer, many in management disagreed about the potential merits of the acquisition.
A string of recent, failed acquisitions had resulted in millions of dollars in write-offs. Recognizing that the right decision in this deal was crucial, MicroAge, Inc. sought team consensus in support of their final decision. Using the Strategic Risk Analysis process, the company was able to realistically evaluate their potential for success and achieve consensus.
The Strategic Risk Analysis challenged management to identify and evaluate key assumptions about their existing acquisition opportunity that they had not previously considered. Non-senior management, who were not normally involved in the decision-making process, raised several new issues, and a number of critical concerns were also uncovered. In the end, one issue was of such concern that with the team consensus, MicroAge, Inc. CFO Jim Daniel decided to walk away from the pending $20 million deal. As Senior Vice President, Warren Mills, puts it, "It wasn't the decision I wanted, but it was the best decision for the company."
Axxess Technologies, Inc.
Historically, Axxess Technologies had specialized in supplying duplication equipment to high-volume mass-market merchandisers. Now it was considering the acquisition of another company whose manual equipment was older and more difficult to operate. But, the venture would enable Axxess to enter new markets.
Two key troubled-spots were highlighted immediately. First, because the potential target company was in direct competition with Axxess, information about the pros and cons of the venture was limited. Second, the target company was a union shop and twice the size of Axxess.
Involving all members of management, the company held a Strategic Risk session to give team members the opportunity to "kick the tires" and air any concerns before the deal was finalized. Participants ultimately felt they had raised all the potential concerns and found reasonable answers to potential challenges. According to Steve Miller, President of Axxess Technologies, "The process was a great way to close the loop and present issues, to have reasonable answers on how to get around hurdles that might arise." The group recommended moving forward with the acquisition, which was completed shortly thereafter. Axxess is now in the process of integrating the two operations. "The process brought us together as a unit and got everyone behind the effort", says Miller.
D&J Wood Resources
D&J Wood Resources, a distributor of wood products and hardware to the commercial building trade, was considering the acquisition of a similar business. Over the last few years the two companies had many informational discussions about a possible acquisition. With the (pending) decision of the target company's CEO to retire and sell the business, the talks between the two had become serious.
The planning team at D&J Wood Resources used the Strategic Risk Analysis process to analyze potential concerns about the new project. While management agreed that 90% of the concerns or challenges uncovered were not new, they were surprised by the level of importance these issues took on once they were red-flagged by the staff.
The team was able to focus specifically on the issues that needed to be addressed. Given their concerns, they decided to postpone the acquisition until the timing was better. The company they were considering acquiring has subsequently experienced its own problems. According, to Dave Dudley, President, "History tells us that we made the right decision." D&J Wood Resources has since invested in other more favorable growth opportunities.
A Little Preventive Medicine Goes a Long WayAs companies are striving to find a competitive advantage, an ill-conceived merger, acquisition, or alliance affects not only a company's bottom line, but the health of its core business as well. Failed growth strategies such as these undermine company resources in terms of personnel, finances and morale. By taking a preventive, critical --- but not negative --- look, potential risks and challenges are uncovered. Companies are then able to make better-educated, well-informed decisions about moving forward with their proposed ventures.
Richard Gooding is the founder and president of Strategic Advantage, Inc., based in Phoenix, Arizona. As a specialist in strategic planning, Richard helps executives develop and implement strategic plans that achieve their company’s long-term objectives. For more information, he can be reached directly at (602) 759-7562, or via email DRRZG@HOME.COM.