When people talk about mergers and acquisitions, what generally comes to mind is a picture of bankers in red braces making deals, and everyone drinking champagne when the deal is done. While that might not quite be reality, it is true that the focus is generally on the first part of the process - negotiating and closing deals. Unfortunately, this ignores the majority of the work involved in an acquisition.
In our previous articles, we looked at the activities involved in Doing the Right Deal - finding, selecting and approaching your target. This time, we are going to look at the second phase - Doing the Deal Right.
This phase is the harder part of the process - actually achieving the benefits that were established as your reason for doing the deal. This is the Integration phase, and covers:
- Planning the business changes required
- Executing the Day 1 transition and Day 100 transformation plans
- Executing the Synergy project to achieve the deal Value Drivers
- Managing the Integration programme
- Tracking and reporting on the benefits and costs of the deal
- Dealing with the risks and issues that come up
While the first phase of a deal can be pushed through very quickly, Integration can be a much longer term prospect. The planning should start long before the deal is done. While there is often a focus on the first 100 days, the full execution may run on for many months if not years.
If there is one piece of advice you should take away from these articles, it is that you should not underestimate the effort involved in Integration.
What is Integration?
Put simply, Integration is the execution phase of the deal. Without Integration, you simply have ownership of two businesses which will run in parallel.
The purpose of Integration is to execute the vision of the future which was described in the Strategic Rationale, and set out in the Deal-on-a-Page as described in Part 2 of this series:
There are four ways in which all or part of the business may be integrated:
- Parallel Running - The businesses or individual functions operate independently and in parallel.
- Full Absorption - Activities in the target are transferred under the control of the buyer, using their processes and tools.
- Merge and Adjust - There is consolidation of functional activity, but certain capabilities of the target are retained where these drive specific value.
- Transformation - Changing how the buyer operates due to specific acquired capabilities, or because there is a further reason for change such as system capacity needing to be upgraded.
The complexity of the Integration effort depends on the level of change that will be required.
For example, a deal where the Strategic Rationale is to improve performance may need significant changes to the operating model of the acquired business in order to make this happen. If there are Synergies from combining the two businesses, e.g. growth by cross-selling, or savings by combining operations, then change to the buyer may also be needed.
If there are no direct Synergies from integrating the operations of the acquired business with the buyer, this may limit some of the change needed. Similarly, if there is unique differentiating value in the acquired company which must be protected, too much Integration may damage the value of the deal.
In every case, the Value Drivers for the deal will determine what additional activity is required to deliver the planned benefits.
The Tartan Toffee Company's acquisition of Scottish Shortbread Limited is likely to go ahead. Terms have been agreed, and the timing has been set-out.
As this is a relatively simple deal between two similar companies, The Tartan Toffee Company is planning a mixed type of Integration. All of the back-office functions such as HR and Finance will be combined into one team, based in the Tartan Toffee offices. This is a Cost Synergy Value Driver, and uses the Full Absorption Integration approach.
Production will be kept separate. As the office space has been freed up in the Scottish Shortbread location by co-locating the back-office, this provides an opportunity for the production floorspace to be increased. This in turn, allows for a new mixed product line (Toffee Shortbread) to be set-up using the Scottish Shortbread production methods. The sales of this product are planned to be a revenue growth Value Driver for the deal. This function is using the Merge and Adjust Integration approach.
Integration planning is not as simple as creating a project plan for all expected Integration activities. To get to this stage, there needs to be a clear understanding of:
- Operating Model Change - The operational projects needed to transform the business.
- Synergy Projects - The projects behind the Value Drivers for the deal, i.e. what will be done to reduce cost and drive growth in the combined business.
- Project Interdependencies - Linkages and dependencies between projects, e.g. new IT requirements or changes for realising Synergy benefits.
- Communication Plans - What and how to communicate with both internal and external stakeholders.
- Transition Service Agreements - Any services that are being provided by the previous owner of the acquired business as a temporary measure, e.g. IT or Facilities Management.
No one person or team within the business can develop these in isolation. The owners of the individual activities must be identified, briefed and take accountability for their scope.
Each owner must have a clearly defined set of outcomes. These can be used to produce the plan to achieve these goals; estimates of the associated cost; and the risks, assumptions and dependancies to achieve them.
The team in charge of Integration Governance pulls together all of this information and creates a cohesive project. They will use good project management discipline to:
- Create and track a Milestone Project Plan
- Track the Risks, Issues, Assumptions and Dependancies
- Report to the Management team, Investors and other Stakeholders
- Calculate and track the Integration Budget
- Track the closure of Transition Service Agreements
In a larger organisation or Integration programme, an Integration Programme Manager will be supported by a dedicated Project Office, and other specialist roles such as Communications. Smaller deals will rely on the Programme Manager and other part-time support.
At RitchieHogg, we have used variants of the following Integration Governance reporting structure on our past projects:
In large companies, there will be a hand-over from the deal team to the Integration team. However, smaller businesses are more likely to have a single team working across both phases. It is important to acknowledge that the roles in each phase are different.
In the early phases of the deal, the team will be focused on gathering information, building a business case and valuation, and negotiating the deal.
For the Integration phase, the focus shifts to implementation and value realisation. The required skills change to project management, organisational design and financial tracking. However, we recommend that a single accountable executive remains in place across both phases.
It is key to note that all of this Integration planning activity should be undertaken as early as possible in the process - certainly before the deal closes. Information gathered as part of Due Diligence and the business case for the deal should be used as inputs. With a strong Integration plan in place, we are ready for Day 1 of the new business.
From Planning to Transition - Preparing for Day 1
There will usually be a gap between Deal Signature, when the deal is agreed, and Deal Close, which is the actual transfer of company ownership. This gap in time allows preparatory actions to be taken - building the Integration plan and preparing the Day 1 Actions. In addition to preparing for the Integration projects driven by Synergies and operating model change, this will include the basic planning needed to ensure the acquired business can continue to operate.
Target Operating Model Planning
The Operating Model plan must be clear on how the acquired business will work on Day 1, plus any changes that will be needed for the buyer. At the functional level, (finance, HR, sales, etc.), minimal change may be needed for Day 1, but any change needed it should be planned and prepared in advance. This should include the Day 1 Organisation structure to clarify Day 1 roles and responsibilities. At the overall level, an Operating Model migration plan should be prepared, which considers how each element below will change from As-Is, to Day 1, to Day 100 and beyond:
Day 1 Action Planning
Each function should prepare a list of the activities which will be needed either on Day 1 or to be completed in advance. These will depend on the complexity of the acquired business, but may require a significant amount of preparation and planning up-front. Any Integration advisor should be able to provide a starter list of these activities for each function, but this must be customised for each company and deal.
As an example, the RitchieHogg Day 1 Actions list currently includes 742 potential actions across 13 standard functions and deal activities:
This list is continually reviewed with lessons learned from each deal.
Immediately prior to Day 1, a Readiness Assessment should be performed. This is the go / no-go decision point, based on the critical activities identified by each function and the deal lead. It will ensure that any deal risks and issues have been addressed or mitigated. Each function must sign-off their readiness, taking accountability for their part of the business continuing to operate.
Immediately following Day 1, it is critical to undertake a deal closure review. The objective of this review is to compare expectations with reality now that the company ownership has changed hands. The information which could not be shared prior to this point can be reviewed to:
- Validate Assumptions - Financial and operational assumptions must be confirmed, and any plans which depend on these updated.
- Validate Synergies - You can expect up to 50% of Synergies to be invalid or unachievable. As such, you must have a hopper of back-up opportunities which have been prioritised as the next best options.
- Re-assess Risks - Based on the updated information, each risk and issue should be reassessed for impact and likelihood. The mitigation plans should be updated to reflect these.
- Operational Readiness - The Day 1 readiness should be revisited to reassess the operational readiness of each function. Plans can be developed to put in place further change that is needed.
- Team Assessments - Each functional lead should review their team to understand the capabilities and limitations of each team member and the team as a whole. Further organisational decisions can be made and any additional retention, replacement or recruitment actions can be planned.
Ultimately, the objective on Day 1 is not to change the business. The priority must be to keep the lights on, keep customers happy and avoid any unnecessary issues. Once you are past this stage, the work to deliver the value can really start.
Transformation - To Day 100 and Beyond
The period from Day 1 to Day 100 is arguably the most critical phase of the Integration. During this time, the building blocks are put in place for the future of the organisation while there is a clear momentum for change.
The transition to the new operating model must move forward quickly. The migration plan prepared earlier for processes, staffing, technology, locations, suppliers, etc., must be progressed from the Day 1 to any future changes identified.
The speed of this migration plan will be dependent on the resources that can be assigned to it. This resource allocation will depend on what the business can afford, and what the deal value can support. It must also be prioritised alongside the Value Drivers and Synergy projects which will deliver the ultimate deal value.
In terms of the Value Drivers described in the Deal-on-a-Page, it is important to deliver some quick-wins where possible. Many of the Synergies for a deal will be relatively long term propositions before they deliver significant benefit, or may deliver benefit over a longer period, e.g. location consolidation may be constrained by lease break clauses. Therefore, where fast benefits can be identified, this should be prioritised to accelerate deal value realisation and enable some good news to be shared quickly.
Following Day 1 the Tartan Toffee Company has been able to get a better understanding of its acquisition.
They have reviewed the assumptions behind the Value Drivers, and found that serveral of their plans are not workable. For example, a plan to immediately consolidate the financial systems is not going to work, as Scottish Shortbread Limited uses a very old accounting package which cannot be easily migrated. This is reprioritised to be done later in the Integration, and they have asked their accountant for the revised costs to achieve this. As an interim step, the company accounts will be prepared separately, and consolidated at the group level later.
However, they have identified several additional opportunities and quick wins to record deal benefits more quickly. These include:
- Cancelling open recruitment vacancies - The staff numbers shared in Due Diligence assumed that these vacancies would be filled with new recruits. The Tartan Toffee Company can meet these requirements with existing staff, so they have cancelled these vacancies immediately reduce the future costs of the business.
- Research & Development tax credits - The Tartan Toffee company has previously used R&D tax credits to support the development of new products. After analysing the books, it is identified that there is development expense in Scottish Shortbread Limited which can be used to claim further credits. This one-time benefit will offset some of the one-time Integration costs.
One factor which can deliver these quick wins is the termination of Transition Service Agreements. As mentioned above, these are services which continue to be delivered by the seller to the acquired business at an agreed cost. Where these can be terminated quickly by transitioning to services provided by the buyer, or establishing new capabilities within the acquired company, these external payments can be eliminated. This has a direct benefit on cashflow as well as any EBIT improvements.
All this activity must be tracked, managed and reported to management and investors through Integration Governance. In addition, the wider organisation and other stakeholders should be kept informed through the communication plan. This should use the right methods for the each audience, e.g. town-hall meetings for employees or direct face-to-face updates for key customers and suppliers.
Finally, during this phase it is critical that the focus on delivering the baseline performance of the business is not lost. The business must continue to deliver good quality service to customers. There is frequently a dip in performance following closure of a deal. It is easy for management to concentrate on the delivery of the Integration at the expense of the ongoing business. However, they must ensure that the business continues to deliver during this turbulent time.
Day 100 is a key Integration milestone to demonstrate control and make the initial changes to the business. However, it is unlikely to be the end of the Integration programme. The long-term Operation Model will involve further change to both businesses. Likewise, it is certain that the Integration benefits will not have been fully delivered by Day 100, so it is important for the Integration programme to continue running beyond this point.
Manage What You Measure
At the heart of a successful Integration is understanding of the progress, costs and benefits of the plan. This should be broadly established at the planning phase, and refined in the early post-deal phase.
Cost should be tracked through the Integration budget. This is made-up of the cost of operating model change, Value Driver project costs, and any other costs such as external advisors which are needed to achieve the deal benefits . Each Integration project should report their costs monthly or as required by finance, to be rolled up and compared to the planned Integration budget.
Benefit realisation must be captured using the metrics and key performance indicators (KPIs) identified for each project. The metrics for each project should be defined with the associated financial benefits, e.g. a reduction in headcount will have an average value per FTE removed, or percentage sales growth will be compared to a sales baseline as at Day 1. The basis of these metrics must be established as part of the project definition and selection, e.g. number of of employees and their average cost on Day 1.
Again, these benefit metrics should be reported by the project owners monthly or as required to provide the overall picture of benefits and comparison to the business case. Not all projects will deliver financial benefits, so where this is the case, the qualitative benefits or other business change should also be captured for reporting.
Both the costs and financial benefits of the Integration are consolidated into the overall financial reporting of the business. For example, we used the following model for a Vehicle Rental business Integration, which we describe in more detail in a case-study:
Projects should be planned at a detailed level by the accountable owners. However, for reporting to the Integration Programme Manager, progress against this plan should be rolled-up to the critical milestones for each project. This may be rolled-up further to the functional level where there are multiple projects in a function, in order to provide reporting at a summary level of detail to the business leaders.
Tracking is a continual process, and should be formally reported to the key stakeholders at regular intervals. The approvers of the acquisition must be regularly updated on status, and given the chance to influence the direction of the Integration project. For example, they may choose to redirect resources from Synergies to operating model projects or assign additional budget in order to deliver results more quickly. These approvers may be a Deal Board, steering group, senior managers of the business, or others such as shareholders and external investors.
We recommend that the reporting cycle should be no less than monthly for the first quarter after the deal has completed. This enables any initial issues to be addressed quickly. After the first three months, quarterly reporting will generally be sufficient and allows clear demonstration of progress. Overall, the results of the acquisition should be tracked for two years, though the Integration project activities may have been completed before this period is complete.
It is also important to understand the baseline performance of the business. This baseline establishes the how each business would perform without the acquisition, and must be maintained at least at this level. To do so requires management to focus their attentions on maintaining this performance. For this reason, we strongly recommend that a dedicated team is assigned to manage the Integration where possible. External support in the form of project managers or functional interim managers may be needed for this, and the cost for this should be included in the Integration budget.
You can do a deal in a day - if you are willing to take the risk. However, Integration is a much longer term prospect, with many challenges that need to be overcome in order to realise the planned benefits. By making sure you have the plans in place, and the capabilities and time to execute them, you have a much greater chance of Doing the Deal Right.