daimler benz principles and practises 04_managing risks in mergers and acquisitions

8/2/2019 Daimler Benz Principles and Practises 04_Managing Risks in Mergers and Acquisitions

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Chapter – IV

Managing Risks in Mergers, Acquisitions

and Strategic Alliances

“There is a serious problem facing senior executives who choose acquisitions as acorporate growth strategy. My study reveals that fully 65 per cent of major strategicacquisitions have been failures. And some have been truly major failures resulting indramatic losses of value for the shareholders of the acquiring company. With market values and acquisition premiums at record highs, it is time to articulate demanding standards for what constitutes informed or prudent decision-making. The risks are too great otherwise.”

- Mark L Sirower 1.

Understanding the risks in mergers and acquisitions

A combination of factors - increased global competition, regulatory changes, fast changingtechnology, need for faster growth and industry excess capacity - has fuelled mergers andacquisitions (M&A) in recent times. The M&A phenomenon has been noticeable not onlyin developed markets like the US, Europe and Japan but also in emerging markets likeIndia. In 1998, worldwide mergers and acquisitions were valued2 at $2.4 trillion. In 1999,this figure increased3 to $3.4 trillion. In 2000, the pace seemed to slow down, with only theGlaxo Wellcome – SmithKline Beecham merger valued at over $50 billion. However, thetotal value of the deals worldwide crossed $3.5 trillion. Much of this activity took place inthe first half of 2000. The recent merger proposal by HP and Compaq is a clear indicationthat merger mania is well and truly alive.

Like capacity expansion, vertical integration and diversification, a large merger or

an acquisition is a strategic move since it can make or break a company. However, mergersand acquisitions involve unique challenges such as the valuation of the company beingacquired and integration of the pre merger entities. Valuation is a subjective matter,involving several assumptions. Integration of the pre-merger entities is a demanding task and has to be managed skillfully. So, it makes sense to devote a separate chapter to cover the risks associated with acquisitions4 and how to manage them.

Mark Sirower, an internationally acclaimed expert in the field of mergers andacquisitions found that two thirds of the 168 deals he analysed between 1979 and 1990,destroyed value for shareholders. When he looked at the shares of 100 large companies thatmade major acquisitions between 1994 and 1997, Sirower found that the acquirer’s stock,on an average trailed the S&P 500 by 8.6%, one year after the deal was announced. 60 of these stocks under-performed in relation to the market, while 32 posted negative returns.Many of the companies acquired were often sold off later, sometimes at a loss.

1 The Synergy Trap.2 According to Security Data Co.3 The Economist , July 20, 2000.4 In this chapter, we use the terms, mergers and acquisitions interchangeably though there are some

important differences. (See glossary).



Consider Kimberly Clark’s acquisition of Scott Paper in 1995. This acquisitionmade Kimberly-Clark the world’s largest tissue maker. One year later however, sales weredown and profits and operating income had shrunk. By 1999, the merged entity was trailingthe S&P 500 Stock Index. AT&T gave several seemingly valid reasons for its acquisitionof NCR. But after five years of incurring losses, amounting to more than $2 billion, AT&T

accepted that the acquisition would not work. In 1995, it decided to spin the company off.Quite clearly, mergers and acquisitions involve heavy risks. In their excitement andenthusiasm to close the deal fast, managers throw caution to the winds. Later, there is a gap between expectations and actual performance and shareholders’ wealth is eroded. Thischapter covers some of the important risks in M&As and provides a framework for dealingwith them.

Why mergers are risky

Major acquisitions have to be handled carefully because they leave little scope for trial anderror and are difficult to reverse. The risks involved are not merely financial ones. A failedmerger can disrupt work processes, diminish customer confidence, damage the company’sreputation, cause employees to leave and result in poor employee motivation levels. So theold saying, discretion is the better part of valour, is well and truly applicable here. Acomprehensive assessment of the various risks involved is a must before striking an M&Adeal. Circumstances under which the acquisition may fail, including the worst casescenarios, should be carefully considered. Even if the probability of a failure is very low, but the consequences of the failure are significant, one should think carefully beforehastening to complete the deal. According to Eccles, Lanes and Wilson5, most companiesfail to undertake a thorough risk analysis before making an acquisition. Which is why they

end up burning their fingers.The strategic implications of a merger should be understood carefully. Otherwise,the shareholders’ wealth will be eroded. As Mark Sirower 6 puts it neatly, “When you makea bid for the equity of another company, you are issuing cash or claims to the shareholdersof that company. If you issue claims or cash in an amount greater than the economic valueof the assets you purchase, you have merely transferred value from the shareholders of

5 Harvard Business Review, July –August 1999.6 The Synergy Trap.

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IdentifyingSynergies Valuation

Integration

Strategic Issues in Mergers & Acquisitions



your firm to the shareholders of the target – right from the beginning.” In an acquisition,the acquirer pays up front for the right to control the assets of the target firm, with the hopeof generating a future stream of cash flows. If demanding standards are not set to facilitateinformed and prudent decision-making, the investment made will not yield commensuratereturns.

Table I

Some top M&A deals in 2001

Target Acquirer Value of deal

($ million)

AT&T Broadband & Internet (US) Comcast (US) 57,547

Hughes Electronics (US) Echostar Communications (US) 31,739

Compaq Computer (US) Hewlett Packard (US) 25,263

American General (US) American International Group (US) 23,398

Dresdner Bank (Germany) Allianz (Germany) 19,656

Bank of Scotland (UK) Halifax Group (UK) 14,904

Wachovia (US) First Union (US) 13,132

Benacci (Mexico) Citigroup (US) 12,821

Telecom Italia (Italy) Olivetti (Italy) 11,973Billiton (UK) BHP (Australia) 11,511

Compiled from various sources

There are two main reasons for the failure of an acquisition. One is the tendency tolay too much stress on the strategic, unquantifiable benefits of the deal . This results inover-valuation of the acquired company. The second reason is the use of wrong integration strategies. As a result, actually realised synergies turn out to be well short of the projectedones.

Many companies are confident about generating cost savings before the merger.But they are unaware of the practical difficulties involved in realising them. For example, a job may be eliminated, but the person currently on that job may simply be shifted to

another department. As a result, the head count remains intact and there is no costreduction.

Many firms enter a merger hoping that efficiency can be improved by combiningthe best practices and core competencies of the acquiring and acquired companies. Culturalfactors may however, prevent such knowledge sharing. The 1998 merger of Daimler Benzand Chrysler is a good example. Also, it may take much longer to generate cost savingsthan anticipated. The longer it takes to cut costs, the lesser the value of the synergiesgenerated.

Revenue growth, the reason given to justify many mergers, is in general moredifficult to achieve than cost cutting. In fact, growth may be adversely affected after amerger if customer or competitor reactions are hostile. When Lockheed Martin acquired

Loral, it lost business from important customers such as McDonnell Douglas, who wereLockheed’s competitors. So, companies must also look at the acquisition in terms of theimpact it makes on competitors. The acquisition should minimise the possibility of retaliation by competitors. Some M&A experts look at revenue enhancement as a softsynergy and discount it heavily while calculating synergy value.

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Tata Tea: Tetley acquisition runs into problems

In mid 2000, India’s largest tea company, Tata Tea announced it was buying the UK-based Tetley for £271 million in a leveraged buyout. Tetley, which earned a net profit of £35 million in 1998 on sales of £280 million was the third largest brand in the global $600 million packaged tea market - behind

Unilever’s Brook Bond and Lipton. Tata Tea viewed the acquisition as a quick way to gain access tomarkets in the US, Canada, Europe and Australia. It also looked at the opportunities created by Tetley’sestimated weekly purchase of three million kg of tea from 10,000 estates in 35 different countries.Besides, Tata Tea hoped to gain packaging expertise from Tetley.

Tata Tea did not pay cash upfront. Instead, it pumped £70 million of equity into a special purposevehicle. Then it leveraged the equity to borrow £235 million from the market. Tata Tea hoped that cashflows from Tetley would be adequate to pay off the debt. At the time of finalising the deal, there were press reports that Tata Tea was probably overpaying7 - it had offered £100 million more than the secondhighest bidder.

To service the debt, Tetley needed to generate cash flows of at least £48 million per year,whereas it generated only £29 million in 1999. Tata Tea had hoped for a quantum jump in cash flowsafter the acquisition. But unfortunately for Tata Tea, retail tea prices in the UK market fell. Moreover, the popularity of tea continued to decline in the UK while the market share for natural juices and coffee went

up. By September 2001, the deal was running into short-term financial problems. The Tatasannounced they would bring in an additional £60 million as equity. This would facilitate retirement of expensive debt and reduce interest charges by about £ 8 million per year. If cash flows touch £40 million,the risk of not being able to service the debt will be eliminated. This will however not be an easy task.Tata Tea Managing Director, R K Krishna Kumar recently admitted 8 that additional investments will beneeded to revive demand.

Companies making an acquisition not only have to meet the performance targets themarket already expects, but also the higher targets implied by the acquisition premium.When they pay the acquisition premium, managers are essentially committing themselvesto delivering more than what the market expects on the basis of current projections. This is

a point which is often forgotten.Even when the numbers do not justify an acquisition, executives may insist ongoing ahead for strategic benefits that cannot be quantified. In the heat of finalising thedeal, what is conveniently overlooked is that most strategic benefits ultimately should bereflected in some form of cost reduction or revenue growth. Similarly, rushing ahead tofinalise a deal before a competitor does so, is not always a wise move. In many cases, itmakes sense to allow the competitor to pay a higher price and weaken its competitive position rather than rush into the deal.

Acquisitions involve changes and often have a destabilising effect. During theintegration of the pre-merger entities, stress, tension, uncertainty and an exodus of employees are likely. To avoid this, building a climate of trust among the employees of the

merging entities is extremely important. Most companies underestimate the difficultiesinvolved in integrating the pre-merger entities. A recent example is the ICICI – ICICI bank merger.

7 Business World, September 10, 2001.8 Business World, September 10, 2001.

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International Paper: Aggressive acquisitions strategy creates problems

The paper industry has been known to go through boom and bust cycles. Size and market share arecritical in the paper industry, whose products look more like commodities than brands. John Dillon, theCEO of International Paper (IP) the world’s largest paper company looks at acquisitions as a way to

control prices. After paying $7.1 billion to acquire office paper company Union Camp in early 1999, IP purchased its rival, Champion Paper Corp for $9.6 billion in June 2000. These expensive acquisitions leftIP with a debt of $15.5 billion, (50% of capital and four times cash flows) towards the end of 2000.Dillon has been divesting non-core businesses such as petroleum and minerals to pay for the acquisitions.The markets however, remain cynical about IP’s moves.

IP is yet to prove it can integrate its acquisitions and realise the synergies it has projected beforeits acquisitions. It has been slow to close down factories, an important step in reducing industry capacityand consequently improving prices. In October 2000, Dillon announced that he would be shutting 1.2million tonnes of capacity or 5% of total production.

Much more however needs to be done. Reaction to the Champion deal has been lukewarm. Thecompany’s stock price has fallen during the period 1995-2000. IP’s growth-by-acquisitions strategy maywell turn out to be risky, especially at a time when the US economy has gone into a recession.

A disciplined approach to acquisitions is necessary to weed out unviable deals. AsEccles, Lanes and Wilson put it9, “Over half the deals being done today will destroy valuefor the acquiring company’s shareholders. What’s the reason for the disparity betweenthese simple lessons and these poor results? We believe that far too many companiesneglect the organizational discipline needed to ensure that analytical rigour triumphs over emotion and ego.”

Porter 10 argues that acquisitions make sense only when three conditions hold good:

• The acquired company’s management is more keen on withdrawing, thancontinuing to run the operations. So, the minimum price, it expects, is quite low.

• The market for companies is imperfect and does not eliminate above-average returns through the bidding process.

• The buyer has unique abilities and competencies which it can use to managethe acquired company’s business far more efficiently and effectively.

The collapse of Indiainfo.com

The experience of Indiainfo.com highlights the risks involved in the kind of reckless acquisitions andalliances made by dotcom businesses in India. During the period December 1999 – February 2000,Indiainfo kicked off its launch in the Indian market with an ad blitz that cost Rs. 11-15 crore andannounced that it would catch up with leader Rediff.com. When founder Raj Koneru brought somesenior professionals into the management team, venture capitalists expressed their happiness. Impressed

by the company’s vision and aggressive plans, Morgan Stanley decided to pay $11.5 million to acquire a7% stake. But, managing the rapid growth proved difficult. A cultural clash between the erstwhileentrepreneurs whose websites had been taken over by Koneru and the new breed of professionalmanagers made matters worse. While these entrepreneurs were known to live frugally, the professionalsled a fancy lifestyle. Meanwhile, Koneru plunged headlong into acquisitions without detailedconsultations with his senior team. In many cases, payments were made in cash. One deal involved a payment of Rs 200 crore ($45 million) to VSNL, India’s leading Internet Service Provider, so that every

9 Harvard Business Review, July-August 1999.10 Competitive Strategy.

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time a VSNL user would log on, he would land on the Indiainfo home page. Senior executives first cameto know about the deal at a press conference! Koneru apparently estimated that the increase in trafficwould take the company’s valuation to about $1 billion. Koneru also made a big mistake in deciding to postpone his IPO. The reason for the delay was probably preoccupation with integrating the acquisitionswhich had been made at a furious pace, one after the other. The huge expenditures on advertising,salaries and acquisitions added up to Rs. 30 crores by September 2000. Many senior executives began to

desert the sinking ship.

Identifying the synergiesThe aim of an acquisition is to make the merged entity more valuable than the sum of thevalues of the pre-merger entities. As mentioned earlier, synergies can add value only if themerged entity registers a performance that is better than what is already reflected in themarket prices of the pre-merger entities.

In almost two out of three acquisitions, the acquirer’s stock price falls after the dealis announced. This is a clear indication that the markets tend to be cynical about therealisation of the synergies projected. One reason could be that the markets have alreadydiscounted the expectation of an improvement in the operating performance of the acquired

company. In extreme cases, the markets may even feel that by diverting resources fromstronger divisions, for the purpose of realising synergies, value may be subtracted, rather than added. At a more strategic level, acquisitions, by engaging the top management in theintegration process may allow competitors to leap ahead. Boeing faced a major crisis in its production line in the late 1990s, when its attention was entirely focussed on its integrationwith McDonnel Douglas. (See Box item on pg. 9)

Much of the risk in an M&A deal arises from the acquiring company’s inability toidentify and quantify synergies accurately. Often, the synergies which are highlighted, donot materialise, while those which may have been completely overlooked become veryimportant. Usually, it is years after the acquisition that it becomes clear whether the price paid for the acquisition was the right one or not. Alex Mandi, who negotiated the

acquisition of Mc Caw Cellular on behalf of AT&T recalled,11

“Everybody said we’d paidtoo much. But with hindsight, it’s clear that cellular telephony was a critical asset for thetelecommunications business and it would have been a tough proposition to build that business from scratch. Buying Mc Caw was very much the right thing to do.”

As mentioned earlier, it is easier to achieve cost reduction than to boost sales.According to Dennis Kozlowski, CEO of Tyco International12: “You can nearly alwaysachieve them because you can see up front where they are … But there’s much more risk with revenue enhancements; they are much more difficult to implement.” Kozlowski addsthat people are often too optimistic about revenues. When Citibank merged with Travelers,the merged entity quickly reaped profits from cost cutting, but its expectations on crossselling different financial services to customers did not quite materialise. However,

achieving revenue enhancement through an acquisition, though difficult, is not impossible.When the specialty chemical company, Rohm and Haas acquired Morton, it aggressivelyused the acquired company’s expertise in polyurethane adhesives and powder coatings andits access to new markets, to generate more sales. The Time Warner-Turner BroadcastingSystem merger was also quite successful in this regard. The AOL-time Warner merger hasalso shown a lot of promise for cross selling, though it is too early to pass a final judgment.

11 Harvard Business Review, May-June 2000.12 Harvard Business Review, May-June 2000.

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Arriving at the premiumOne of the most thoughtful analyses of the premium involved in acquisitions is provided byPorter 13. Porter points out that an efficient market precludes the possibility of the newcompany generating more returns than what the pre-merger entities generated before the

merger. If the management of the acquired company is sound and the company itself has a bright future, its market price would already have been bid up. On the other hand, if itsfuture is bleak or the management is weak, the stock price could be low, but the infusion of capital and effort required to turn it around could also be massive. As Porter puts it: “To theextent that the market for companies is working efficiently, then, the price of an acquisitionwill eliminate most of the returns for the buyer… The market for companies and theseller’s alternative of continuing to operate the business, work against reaping above-average profits from acquisitions. Perhaps, this is why acquisitions so often seem not tomeet managers’ expectations.”

While acquiring a company, firms must be careful about irrational bidders withnon-profit motives or those who are pursuing the deal purely because of the idiosyncrasies

of the top management. In the race to the finishing line, companies may end up paying toohigh a price because of the influence of such bidders. The board should exercise somecontrol in such situations.

According to Sirower, the acquiring company must consider the following whileworking out the premium:

• Market expectations about the acquired company, when considered alone.

• Impact on competitors and their possible responses

• Tangible performance gains from the merger and the management talentnecessary to achieve the gains

• Milestones in the implementation plan

• Additional investments which will be necessary

• Comparison of the acquisition with alternative investments.

The Time Warner –Turner Broadcasting System Merger

The Time Warner (TW) – Turner Broadcasting System (TBS) merger of 1995 has been one of the moresuccessful mergers of our times. The two CEOs, Gerald Levin of TW and Ted Turner of TBS becameunlikely partners in a merger deal that few expected to click. At the time of the merger, TBS was inserious financial difficulty. After buying MGM in 1986 for its content, TBS had accumulated a lot of debt. TBS was also dependent for distribution on two cable systems companies, Tele-communications In(TCI) and TW, which had been investing heavily in cable infrastructure. Meanwhile, TW’s competitive position was threatened by the merger of Walt Disney and Capital Cities / ABC.

When the merger was announced, analysts were cynical and few thought that Levin and Turner would be able to work together. The two companies had significant differences in management style.TBS managers went by instinct, while TW was more methodical. TBS managers initially feltuncomfortable when their decisions were subjected to a rigorous analysis.

But gradually, the two parties realised the benefits that could be reaped from the merger. Cablenetworks could buy material from the movie business and leverage the publishing assets like Time andSports Illustrated. A brand like Batman could be exploited by the movie studio, publishing and cabletelevision. Many brands not only gained more visibility but also generated more revenues.

With a presence in both content and distribution, the merged entity could change the relationship between the two to its advantage. In the past, movies, reached the cable stations very late, typically six to

13 Competitive Strategy.

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eight years after they were released. In other words, cable was regarded as the ‘end of the line’. With itsclout in distribution, TW could now bring movies to the cable network much faster. This increasedsubscription and cable advertising revenues.

Investors’ perception of the merger improved rapidly. TW developed the image of a formidablemedia company with a presence in publishing, movie and television production, music, cable systems,cable networks and a small television broadcast network. The strategy of using different media platforms

to distribute the same piece of content seems to have worked. Now, TW has entered a new phase after the merger with America Online. (See Box Item on pg. 8).

Behavioral issues also affect the way in which the premium is arrived at. A study by Wharton professor, Julie Wulf 14 has revealed that CEOs often strike deals that benefitthem personally, but are not in the interests of the shareholders. CEOs of poorly performingcompanies and of companies in industries which are rapidly consolidating, are moreconcerned about retaining their position on the board rather than negotiating the best dealfor their shareholders. The board has to ensure that senior management’s personal interestsdo not supersede the interests of shareholders, while fixing the premium.

Stock Vs Cash dealsThe way the deal is financed determines how risk is shared between the buyer and theseller. In general, there are two types of financial risk faced during an acquisition – the fallin the share price of the acquiring company from the time of announcement of the deal toits closing, and the possibility of synergies not being realised after the deal is closed. In acash deal, the acquiring company assumes both the risks completely. In a stock swap,where a fixed value of the acquiring company’s shares is offered to the acquired company,the first risk remains with the acquiring company, but the second risk is shared by the twocompanies. In a stock swap where a fixed number of shares is offered to the acquiredcompany, both the risks are shared between the two companies.

The method of financing the deal is influenced by several factors. If the acquirer

feels its shares are undervalued, it prefers a cash deal as any fresh issue of shares wouldfurther erode the wealth of existing shareholders. If the acquirer is very confident aboutactually realising the projected synergies, a cash deal makes sense. Where such confidenceis lacking, a stock deal allows the risk to be at least partially hedged. In general, a fixedvalue offer is an indication of greater confidence on the part of the acquirer than a fixednumber of shares and tends to be better received by the market. A fixed share offer,ironically enough, by minimising the pre-closing market risk for the acquirer, acts as a kindof self fulfilling prophecy and drives the share price downwards.

IntegrationMany mergers fail at the integration stage. So, it is important to understand the risks

involved in integration and the ways to manage these risks. All acquisitions must beginwith a strategic vision, which should serve as a guide for the integration process. Thereshould also be an operating strategy which addresses the issue of how the value chain performance can be improved, whether competitors will react aggressively, and if they do,how they can be dealt with. Vision and operating strategy must be backed by proper systems and processes to align the behavior of managers with corporate objectives. Someoperations should be tightly integrated while others should be left alone. What to integrate

14 knowledge.wharton.upenn.edu. January 4, 2000.

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and what to leave alone is a matter of judgement but there are some guidelines, that could prove useful. We will cover this point later in the chapter.

The AOL Time Warner Merger

On January 10, 2000, America Online (AOL) and Time Warner (TW) announced that they were

merging. For all practical purposes, the deal was a reverse takeover by AOL. While the icon of theinternet world had just 20% of TW’s revenues and 15% of its workforce, its large market cap made it thesenior partner. AOL shareholders received one share in the merged entity while TW shareholders got 1.5shares for each of their existing shares. AOL shareholders owned 55% and TW shareholders 45% of thenew company. Effectively, AOL paid a premium of 71% over the market value of TW. The combinedentity was valued at $350 billion.

Though the two companies were confident of boosting revenues, many analysts expressedconcerns that the merger would slow down AOL and rob it of its entrepreneurial drive. AOL however,remained confident that TW’s cable network and content would generate new growth opportunities.

Before the announcement of the deal, TW shares traded at a multiple of 14 times EBITDA(Earnings Before Interest Tax depreciation and Amortisation ) while AOL shares traded at a multiple of 55. The immediate reaction to the deal was negative. By January 12, the combined market capitalisationwas actually lower at $260 billion, compared to $270 billion before the announcement. The market value

of AOL shares fell by 19% while that of TW shares went up by $22 billion.AOL which had a strong brand and enjoyed a large customer base was clearly one of the pioneers

in the new economy. However, anticipating the rapid commoditisation of the Internet access business,AOL realised it needed the ‘pipes’ of cable television to carry Internet content. Moreover, AOL did notreally have much content of its own. It decided to move fast and make full use of its high marketcapitalisation. In October 1999, Steve Case, CEO of AOL called TW CEO, Gerald Levin to discuss themerger, Levin sensed an opportunity as his company’s stock was not doing particularly well in themarket. In December 1998, TW had been worth more than AOL. But by December 1999, AOL’s worthwas 2.5 times that of TW. Quite clearly, TW was on the decline. Case also sweetened the deal for TW byinviting Levin to be the merged entity’s CEO.

After the merger was announced, the Federal Trade Commission (FTC) began to interrogate thesenior executives of the two companies to determine whether the merger would come under the purviewof anti trust legislation. Case and Levin refused to accept a demand by FTC to regulate the placement of

AOL-TW content. However, they agreed to report any complaints from competitors if they were deniedAOL-TW content.

“Low hanging fruit” synergies were quickly identified. CNN.com programs could be featured onAOL, while AOL discs would be bundled with TW product shipments. Warner movies could be promoted on AOL-owned Moviefone. The merged entity could offer books, movies, magazines andmusic to customers on TV, paper, PC, cell phone or any of the other wireless devices.

Even as the FTC was in the process of approving the merger, integration efforts began. Inter-divisional committees were set up to facilitate the integration. Efforts to generate cross sellingopportunities in the areas of subscriptions, advertising and promotions began. An attempt to sell TIME’smagazines through AOL was very successful.

A year later, the merger was showing signs of trouble. The projected revenue growth of 12-15%and $1 billion in cost savings looked way off target. According to Merrill Lynch estimates, growth wouldonly be 11%, while losses would cross $5 billion due to merger write-offs. A slowing US economy and a

sharp cutback on ad spending by companies was hitting growth. By early 2001, AOL’s stock haddropped by 48% to $37.50. (See graph showing the stock price movement).One positive feature of the merger is that the transition at the highest level of management has

been smooth. Levin has been clearly in charge of both day-to-day operations and key strategic and personnel moves. Case has disengaged from day-to-day operations to concentrate on macro level issues.In an email to Fortune15 , Case said that the management set-up kept him informed about what washappening and allowed him to provide his perspective where required, without in any way meddling withthe day-to-day operations.

15 July 23, 2001.

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It is now clear that the fortunes of AOL-TW are closely tied to the erstwhile AOL group. Manyof the top executive positions have gone to AOL. Most of its senior executives are still around, 18months after the merger was announced. While AOL’s performance in the first quarter of 2001 wasgood, TW has continued to struggle due to falling advertising revenues. Moreover, making Hollywoodmovies remains an unpredictable, low margin business.

The markets perceive the integration to be still incomplete. In response to the 2001 second

quarter results, the share price declined by 9% even though EDITDA jumped by 20% over the previousyear. Cultural differences continue to be a formidable barrier to the integration process. As the Economist 16 recently reported: “There is a wide cultural gap between the restless 20 – somethings fromAOL and New York institutions such as the 78 year old Time Inc… There is much grumbling among journalists (at Time Warner)… about a new tightness with money and the fears, this has prompted for editorial quality.”

AOL feels things are moving in the right direction. As an example of the synergies beinggenerated, it cites a recent Madonna world tour arranged by Warner Brother Records, in which AOLsubscribers can buy advance tickets and see unreleased photos and videos. AOL remains confident thatits community can be persuaded to buy a range of entertainment products.

AOL Time Warner

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Merger

The 1986 merger of Borroughs and Sperry illustrates some of the difficultiesinvolved in the integration of pre-merger entities. The two computer makers who cametogether to form Unisys, felt that the merger would generate economies of scale, improveefficiencies and boost price competitiveness. The integration of the distribution systems

was however a disaster. The companies had different order-entry and billing procedures.After the attempted integration, equipment orders were executed late and customers werefrequently frustrated by delayed delivery. By November 1990, the stock price of Unisyswas only $3 per share. About 90% of shareholder value had been destroyed.

The 1986 acquisition of Republic Airlines by Northwest Airlines also ran intointegration problems. The two computer systems could not be synchronised. Integration of

16 July 21, 2001.

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crew and gate scheduling and human resources functions also ran into serious problems.Republic’s employees, on an average, drew lower salaries than those of Northwest. Lowmorale led to a deterioration in customer service. In August 1987, a Northwest planecrashed after taking off from Detroit. Matters continued to worsen till 1989, when Northwest was bought out by a group of private investors.

Personal chemistry, especially at the top, matters a lot during the integration of the pre-merger entities. In general, it is advisable not to have two bosses. Decisive leadership is best provided by a single individual, not by a two-man team or a committee. Indeed, if twoco-CEOs are named after the merger, there will ensue a period of uncertainty during which people wait to see who finally gains the upper hand. In the Citicorp-Travellers Groupmerger, Sandy Weill of Travellers has taken control, ousting Citicorp’s John Reed and inthe Daimler Chrysler merger, Jurgen Schrempp has gained ascendancy over Chrysler’s BobEaton. In both cases, until a clear leader emerged, things were in a state of flux andemployees remained confused.

Tatenbaum17 has argued that, a top Human Resources (HR) executive must beinvolved in the negotiations before a merger deal is finalised. HR managers usually enter

much later, to deal with issues like compensation. Instead, if they join the discussions at anearly stage and conduct a cultural audit, potential trouble spots can be identified, very earlyon. Tatenbaum provides seven guidelines for managing the integration process.

• The integration team should build organisational capability by retaining talentedmanpower. Tatenbaum’s research reveals that 47% of the senior managers in anacquired firm leave within the first year of the acquisition and 72% within the firstthree years.

• Downsizing activities must be managed smoothly and sensitively. Otherwise, they mayfuel a large scale exodus of people. A related issue is finding the right roles for the people. Cisco for example tells employees clearly what their new jobs will be after themerger and to whom they will report.

•Systems and procedures that are implemented must be in line with the strategic intentof the acquisition. For example, bureaucratic procedures can be highlycounterproductive if the acquired company is known to have a flexible, entrepreneurialculture.

• The integration team must identify the cultural traits that are consistent with the business goals of the merged entity and take steps to spread them across the twoentities. The team must manage cultural differences by collaborating with managersthroughout the organisation. Superordinate goals can be set to motivate the two entitiesto work together.

• Post merger drift tendencies should be minimised by managing the transition quickly. If decisions and changes are not implemented fast, the acquirer may become focussed on

internal issues and lose sight of customers and competitors. Decisions about lay-offs,restructuring, reporting relationships, etc must be made within days of the deal beingsigned and communicated quickly to the employees. However, care must be taken toensure that people are treated with respect and sensitivity.

• Hearing of employees tends be selective during the early days of a merger, whenanxiety levels are high. So, some messages may have to be repeated. Besides internal

17 Organizational Dynamics, Autumn 1999.

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communication with employees, management must also keep external stakeholderssuch as customers, vendors and the community informed.

• When a company has decided to pursue a strategy of growth by acquisitions, clearlydefined integration plans can be helpful. The company should identify the team whichwill conduct the due diligence and the team which will plan and implement the merger.

Checklists must be prepared to indicate the tasks and suggested deadlines. Cisco, whichmakes acquisitions at regular intervals, uses a standard business process for managingacquisitions.

The Boeing – Mc Donnell Douglas Merger

In 1993, the US government announced that its military procurement budget was being cut by 50% andinformed defence contractors that they must consolidate. One company which looked at the turn of events with concern was Mc Donnell Douglas (MD), a leading manufacturer of military aircraft.Meanwhile, the much stronger Boeing realised that its excessive dependence on the cyclical market for civil aircraft was risky. To address this concern, it acquired a major stake in Rockwell International, adefence supplier.

When MD realised its competitive position was deteriorating rapidly, it even consideredacquiring the defence businesses of Hughes Electronics and Texas Instruments. At this point, Boeing

CEO, Phil Condit and MD CEO, Hary Storecipher felt that the time had come to revive merger talkswhich had failed in 1995. Boeing knew that if MD went ahead with other acquisitions, it would be priced beyond its own reach. So, it rushed to close the deal. The merger was announced in December 1996 andreceived approvals from competition authorities in the US and Europe by August, 1997.

After the merger, Boeing ran into problems on account of a factor it had totally failed toanticipate. In the wake of competition from Airbus, it had aggressively booked orders by slashing prices.When demand rose sharply, Boeing’s production system was thrown out of gear. Due to a parts shortage,much work had to be done outside the normal production system. By September 1998, Boeing was in bigtrouble. It had to take a charge of $4 billion. Quite clearly, the task of implementing the merger haddistracted the attention of the top management from operational issues.

In February 1999, Boeing’s share price reached a low. Condit warned his top management thatthe company was a potential takeover target. These were rumours that GE had its eyes on Boeing, but GEdenied them. Boeing made some changes in senior management and put in place a new organisation

structure with different businesses focussed on different customer needs. It decided to tap new businessessuch as broad-band communications, satellite navigation for air traffic controllers and services such asrunning airforce bases. Boeing also realised the importance of sharing knowledge and leveraging itsresearch capabilities across the organisation. Phantom Works, the R&D centre of MD became the focal point for new initiatives to improve manufacturing processes across the group. The idea was to integratethe expertise of Boeing, MD and Rockwell, through both short-run and long-run programs.

Looking back, it is quite evident that the Boeing-MD merger was not really well planned. Theintegration process was faulty and consumed a lot of precious management time. Core functional areasdid not receive the attention they needed. Most of the synergies realised came by sheer chance than byany great planning. An important lesson from the Boeing – MD merger seems to be that synergies oftencome in areas where they are least expected.

Source: This box item draws heavily from the article, “Building a new Boeing,” The Economist,

August 10, 2000.

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Understanding the role of communicationCommunication plays an important role during the integration of the pre-merger entities.Genuine communication increases the perceived benevolence of the management andconsequently promotes trust. It minimises the negative reactions of employees in theacquired company. As a popular saying goes, the certainty of misery is better than themisery of uncertainty. Lack of communication increases uncertainty and weakens the

confidence of employees in the management. A good communication strategy is necessaryto ensure that rumours are not allowed to fill the information gap. Employees must beinformed about the acquiring company, the proposed changes and the impact of thesechanges on the employees. All efforts should be made to reassure the employees of theacquired firm and make them understand the intentions and philosophy of the acquiringcompany. In the case of cross-border acquisitions, the role of communication is even morecritical.

Immediately after the acquisition, employees need to know what will happen totheir job, their colleagues and their company. It is only through honest communication thattheir anxieties can be set at rest. Here, the quality of communication is the over-ridingfactor. Later, when employees have to adjust to the changes, frequency of communication

becomes important. Frequent communication however does not mean that all details must be communicated, especially when the management itself is not clear about what willhappen. A high level of transparency will send the right signals to the employees even if allthe information cannot be shared with them.

Acquirers also need to demonstrate to the employees of the acquired company thatthere will be consistency and openness in the new environment. When Intel acquired Chips& Technologies in 1997, it decided to integrate it with one of its divisions, though it had atfirst announced that it would keep it as a separate unit. Many key people left and the

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benefits of the acquisition were sharply undermined. Similarly, when IBM acquiredtelecommunication equipment maker Rolm in 1984, it made the mistake of dictating termsto the acquired company’s employees. Some key technical employees left. The takeover was not effective and IBM sold Rolm to Siemens.

France Telecom: Growth by acquisitions leads to huge debt burden

With its traditional telecom business shrinking due to deregulation and intensifying competition, FranceTelecom (FT), has been strengthening its presence in faster growing segments such as mobile phones andinternet services. Under CEO Michel Bon, FT has purchased Orange, the mobile phone services provider for $40 billion, Free Serve, Britain’s biggest internet service provider, for $2.5 billion and Equant, thedata services provider, for $4 billion. The government controlled FT is now Europe’s second largest cell phone company after Vodafone. It has joined T Online and Telefonica as one of the leading ISPs inEurope. FT generates (early 2001 figures) almost 20% of its revenues outside France, compared to only2% five years back. Acquisitions have bolstered FT’s market share, but resulted in a debt burden of some$53 billion. The company faces a cash crunch at a time when it has to invest heavily in next generationwireless networks, which have long gestation periods. Investors are worried about FT’s financial healthand have driven down the share price by almost 60% during the period early 2000 to early 2001. Bonhimself has admitted, ‘It’s frightening.’ Only time will tell whether FT will be able to manage the risksarising out of its aggressive acquisition strategy.

Source: Carol Matlack and Stanley Reid, “France Telecom’s $53 billion burden,” Business Week,

January 8, 2001, pp. 22-23.

France Telecom

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The Bayerische Vereinsbank – Hypobank Merger

In July 1997, the two Bavarian banks, Bayerische Vereinsbank and Hypobank merged to formHypo Vereinsbank (HVB). The move seemed to make sense in the context of Germany’s inefficient andfragmented banking market. The two banks were long time rivals, located close to each other. With asimilar branch network and a similar mix of businesses, they identified several opportunities to cut costs.

HVB also hoped the merger would enable it to become a major player in the German mortgage bankingmarket.However, the merger was more a reaction to the prevailing circumstances than a proactive, well-

thought-out strategy. Vereinsbank was on the verge of a hostile takeover by Deutsche Bank. It hadapproached Commerzbank for support in warding off this takeover attempt but later resigned itself to adeal with Hypobank. On its part, Hypobank even though it was making decent profits was worried about being taken over by Dresdner Bank. Bavarian politicians actively supported the merger as they wanted tocreate a national champion. This was a part of their grandiose plan to convert Munich into a financialcentre that could rival Frankfurt. The government offered a one-off tax waiver on the exchange of sharesinvolved in the transaction. Without this concession, the merger might not have gone ahead.

It was quite clear that several issues had been left unresolved at the time of the merger.Moreover, there was tension in the air due to rumours that Vereinsbank’s ultimate goal was a takeover of Hypobank. Albrecht Schmidt, the head of Vereinsbank, took charge of the merged entity. Vereinsbank took nine of the 14 seats on the Board of Management and also gained control over many keydepartments. Ebenhard Martini, the Chief of Hypobank decided to move on to the more ornamentalSupervisory Board. (Under German laws, limited companies typically have two boards, a Board of Management, vested with executive powers and a Supervisory Board which oversees the functioning of the Board of Management).

These moves were however, consistent with Martini’s delegating philosophy and Schmidt’shands on management style. Martini’s hands-off-approach could also have been due to Hypobank’s non performing assets (NPA) in the property business. These assets had resulted from Hypobank’s aggressivelending in East Germany during the construction boom following German unification.

Only a year after the merger, did the seriousness of the bad loans problem become evident. InOctober 1998, Schmidt announced that loan provisions of $2.1 billion would have to be made. He alsohinted that these losses had been covered up by Hypobank. This led to a serious clash with Martini. Themerged entity’s reputation was damaged. People felt that a backroom struggle was going on between thechief executives of the pre-merger entities.

Only in October 1999, after an auditor submitted his report, was Schmidt’s assessmentvindicated. Martini and the four remaining members on the Board of Management, from Hypobank resigned. Later, Schmidt signalled peace by putting ex-Hypobankers in charge of the property divisionand giving them many of the top jobs in accounting and controlling.

Meanwhile, the integration proceeded smoothly. 500 overlapping branches were closed. Much of the systems integration was also completed in less than three years, well ahead of schedule. In May 2000,encouraged by the performance of HVB, Schmidt announced he was acquiring Bank Austria, the biggest bank in Austria.

Source: This box item is drawn heavily from the article, “A Bavarian botch-up,” The Economist,

August 5, 2000, pp. 68-69.

Understanding the importance of cultural differences

More often than not, significant cultural differences exist between the pre-merger entities.Managing these cultural differences is the strategic challenge during integration. Consider the following examples.

• The merger of UK-based Beecham and the US based SmithKline involved not only twonational cultures but also two business cultures - one very scientific and academic andthe other more commercially oriented.

• The American pharmaceutical company, Upjohn’s centralised and aggressive cultureclashed with Swedish major Pharmacia’s decentralised laid back management style.

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• After the merger between Daimler Benz and Chrysler, the Germans and Americanshave struggled to understand each other and their ways of working. Daimler’s bureaucratic engineering culture in which different departments work separately hasclashed with Chrysler’s free-wheeling, cross-functional product development approach.(See case at the end of the chapter).

•Cultural clashes can be significant in industries such as the media, where egos tend to be big. This was so in the case of the 1989 merger between Time and Warner.

• Cultural differences became an important issue when Aetna, a tradition-bound, stodgyand slow-moving organization merged with US Healthcare, generally considered to bea brash, aggressive and entrepreneurial Health Maintenance Organisation (HMO).

• Citicorp’s staid buttoned-down world of traditional commercial banking has had to takeon Traveller group’s free wheeling, deal making, investment banking culture. One pressing issue in this merger has been the overbearing attitude of investment bankerswho are typically paid much higher salaries than their counterparts in commercial banking. (See case at the end of the chapter).

• The Exxon-Mobil merger has also seen the coming together of two contrasting cultures.

Exxon is generally considered to be independent and not particularly good at managingthe media. Mobil on the other hand, is more accessible, accepts new ideas and is goodat public relations. Exxon’s slow decision-making processes focus on cutting costs,while Mobil has been known to take big risks. It moved into central Asia in theaftermath of the break-up of the Soviet Union, ahead of many other oil companies.

• Cultural problems have been an important issue in the AOL-Time Warner (See Boxitem the end of the chapter) and Norwest/Wells Fargo deals as well.

Cisco: Growth through Acquisitions

In technology-driven businesses, mergers and acquisitions (M&A) give quick access to new skills,competencies and people. Since September 1993, Cisco has acquired 73 companies. In spite of the recentslowdown of the US economy, the company has not given up acquisitions. . In 2001, (till October), Ciscocompleted four acquisitions. In October 2001, John Chambers, Cisco’s CEO announced that thecompany would buy eight to 12 small companies in the near future, primarily in the fibre optics business.

Before making a new acquisition, Cisco assesses the merits and downsides. It examines the targetcompany’s vision, its success with customers, its long-term strategy, its compatibility with its ownculture and its geographic proximity to Cisco. A team headed by Mike Volpi (Volpi), senior vice president, (Business Development and Alliances), examines the depth of talent of the target company, thequality of the management and venture funding. The engineering team examines the technology, whilethe finance executives scrutinize the company’s books.

Volpi’s team consults Cisco’s business units and customers to know more about their technological needs. Sometimes, customers influence Cisco’s acquisition strategy. For example, inMarch 1998, at the instance of US West, an important customer, Cisco acquired Netspeed, which madehigh-speed Internet access products for home users.

Cisco has a separate integration team, which tailors the integration process to suit the specificneeds of each new acquisition. The team assembles a customized packet of information that includes adescription of Cisco’s organizational structure and employee benefits and the strategic importance of thenewly acquired company. Immediately after an acquisition is announced, Cisco’s human resource and business development teams travel to the acquired company’s headquarters and meet people in smallgroups to set expectations and clarify doubts.

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Cisco’s integration team collaborates with the acquired company’s management in “mapping”employees based on their experience. In general, product engineering and marketing groups remain asindependent business units, while sales and manufacturing groups are merged into Cisco’s existingdepartments. The integration team puts the employees of the acquired company through a tailor-madeorientation program, that introduces them to Cisco’s hiring practices, its products and development projects.

On August 26,1999, Cisco announced that it was paying $6.9 billion (in a stock deal) to acquireCerent, a two year old start-up, with cumulative sales of only $10 million. Cerent’s technology integratedvoice and data traffic and zipped into optical fibres efficiently. Cisco viewed Cerent’s technology ascritical for linking the Internet and telephone systems and for taking on rivals like Nortel Networks.Chambers won over Cerent CEO Carl Russo by assuring him that all personnel decisions concerning theemployees of the acquired company would be made jointly.

Some of Cisco’s acquisitions have made a significant contribution to its growth. CrescendoCommunications, acquired for $95 million in 1993, generated revenues of $7 billion in 2000. However,not all the deals have been successful, a good example being Granite Systems, for which Cisco paid $220million in stock. Cisco’s investment in Ardent Communications, (whose product range includesintegrated voice, video and data equipment that can connect a company’s branches with its headquarters)has also not been very successful. Though Cisco obtained two seats on the board and worked closelywith Ardent’s engineers, Volpi later acknowledged that Cisco had interfered too much in the acquiredcompany’s operations and that results had not been satisfactory.

Another acquisition which has run into trouble is Monterrey (1991). When it was acquired,Monterrey was two years old and a year away from a marketable product. Recently, Cisco dropped theMonterrey wavelength router from its product line. Looking back, analysts feel the company wasacquired too early in its life. Cisco has written off $108 million from the $517 million acquisition.

Many of Cisco’s acquisitions have been funded with its highly valuable stock. However, it hasalso used cash or a combination of both stock and cash to fund acquisitions. The way in which the purchase is funded depends on the objectives of Cisco and the target company, the tax implications andfinally liquidity. Cisco’s share declined from a peak of $80.06 in March 2000 to $11.48 in early 2001.So, the company will presumably use more of its $18.5 billion cash pile, rather than its stock to makeacquisitions in the immediate future.

A recent change in the method of accounting in the US will have a significant impact on Cisco’sfuture acquisition plans. All deals have to be classified as purchases. This means goodwill, the difference between the purchase price and the value of assets, must be written off, if impaired. Cisco has

traditionally used the pooling method of accounting in which no goodwill is created. In pooling, at least90% of the purchase must be conducted in stock.

One of the reasons for the relative success of Cisco in managing acquisitions has been the clear value proposition it has brought to the table. The company has targeted small start-ups on the verge of takeoff. Using its well oiled distribution channels, it has been able to increase sales of the acquiredcompany’s products significantly, in most cases. Cisco’s broad product line has strengthened itsrelationship with customers who like one company to take care of their networking requirements.According to Howard Charney, CEO of Grand Junction Networks at the time it was acquired by Cisco 18,“Even though at moments, it was painful, what saved it was that they wanted us to become bigger by twoorders of magnitude. Our engineers could see we really had the potential to go from 5% market share to25%”.

18 Leading the Revolution.

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Kilman19, et al, have vividly described, the culture clashes which often take placeduring integration: “Picture two icebergs in the ocean, where the tip of each represents thetop management groups – primarily financial people – deciding the fate of the twocompanies and how the merger will work. As these top management groups set the merger in process, the two icebergs begin moving towards one another until the tips meet and meshas one. Such a consolidation, however, can never take place. As the icebergs approach oneanother, it is not the tops that meet, rather it is the much larger mass below the surface of

the water, the respective cultures that collide. Instead of synergy, there is a culture clash.”It was mentioned earlier that a decision regarding the degree to which the pre-

merger entities should be integrated is a matter of judgement. To a great extent, the degreeof integration depends on cultural factors. Clayton Christensen20 makes an interestingobservation on integration. He points out that an organisation has three broad types of capabilities – resources, processes and values. Resources can be easily transferred, while processes and values are deeply entrenched and are difficult to change. If the acquiredcompany’s processes and values have been the main reason for its success, the companyshould be left well and truly alone. The parent company can pump resources into theacquired company. If a company is being acquired for its resources, tight integration maymake sense. Many of Cisco’s acquisitions have been aimed at acquiring resources in the

form of products and people. The company’s acquisitions are typically start-ups, which donot have deeply entrenched values. Cisco typically transfers the acquired company’sresources into the parent company’s processes and systems. In general, management of cultural differences is a critical issue while integrating the basic work processes, andsystems. When the cultural differences are too sharp, it may make more sense to keep theacquiring and acquired entities separate.

19 Gaining control of the corporate culture, Jossey-Bass, 1985.20 Read his book, The Innovator’s Dilemma. We referred to this book in chapter III.

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Managing high tech acquisitionsAcquisition is an important growth strategy in high tech businesses. It takes quite a bit of time to develop new technology in-house. Acquisitions not only allow a firm to make useof a new technology faster, but also bring talented manpower into the organisation.

Like in other acquisitions, due diligence is very important when high techcompanies are involved. The acquiring company needs to make sure that the capabilities of the firm being acquired are both unique and valuable. AT&T acquired NCR in 1991,hoping that telecommunications and desktop computing technologies would converge.After the acquisition, AT&T discovered that substantial differences existed between itscompetencies in switching and NCR’s Personal Computer (PC) technology. Consequently,synergies were very difficult to achieve. NCR’s PC capabilities were also weaker than whatAT&T expected. Advanced Micro Devices (AMD) conducted a thorough check on NexGen before acquiring it in 1996. Nex Gen’s unique chip design capabilities enabled AMDto develop new products and take on the mighty Intel.

All acquisitions have to be managed with a high degree of sensitivity to people. But

this is even more so in the case of high tech acquisitions. How the purchased company fitsin and the role of the employees of the acquired company need to be clearly communicated.Often, it makes sense to keep the new people together in a separate division and make theowner of the purchased company a key member of the integration team. In particular,companies acquired for their skill in developing breakthrough technologies, must generally be allowed to continue as separate entities. Very often, it is a good idea not to disturb thekey technical teams of the acquired company. By keeping people with complementarycapabilities in one place, their productivity can be significantly enhanced.

Whenever a high tech acquisition is planned, it is important to examine whether employees of the company being acquired have enough incentive to stay. Employeeswhose stock options are already vested, if they sense that their importance will diminish or

their creativity will be stifled after the merger, may decide to quit. So, hostile takeovers arealmost always bad in high tech businesses. They create suspicion in the minds of theemployees of the acquired company. Once trust is breached, retaining talented people isvirtually impossible.

When Cisco acquired Crescendo, the head of the acquired company, MarioMazzola became a rich man. But he decided to stay on rather than retire or form a newcompany. Cisco gave him plenty of responsibilities and made him the head of thecompany’s line of enterprise products.

According to Howard Charney, CEO of Grand Junction Networks, another Ciscoacquisition21, “Chambers (Cisco’s CEO) treated me like a peer. He asked me what Ithought and never talked down to me. Despite differences in size, Cisco treats every

acquisition like a merger of equals. Cisco delivered on its promise.”

Dilemmas/paradoxes in mergers and acquisitions

21 Leading the Revolution, pp. 236-237.

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Slow Vs quick change: Some advocate rapid change within the first 100 days of the merger.Others suggest a slower process that carries people along. More than speed however, compassion andgoal congruence are the more important factors .

Information sharing: Though all efforts should be made to share as much information as possible,it must be kept in mind that people caught in the process of integration will still tend to perceive that theyare not being kept fully informed.

Managing Vs coping: It is important to have a plan, but also to keep in mind that all factors maynot be fully within the control of managers. People’s fears and tensions will always disrupt organisational processes to some extent.

Strategic significance: Studies indicate that the more significant, the target is to the acquirer, thegreater the likelihood that the acquiring company will step in and take control of the situation, especiallywhen progress is below expectations. (Daimler Benz certainly seems to be doing that to Chrysler). Thiscreates antagonism among various employee groups and prevents a more iterative, evolutionary processthat seems to characterise many successful mergers.

Long-term and short-term focus: Sometimes, integration efforts tend to have an overly long-termfocus. However, it is often the handling of short-term people-related issues that tend to have the biggestimpact on the integration process.

It takes time: Mergers and acquisitions result in severe disruptions and impose a tremendousstrain on those involved. It may take up to five years for the change process to be fully completed.Expectations on both sides must be adjusted accordingly.

Source: AON Risk Services, Edition 3, 1998.

Anti-trust issuesAn important risk in the case of mergers and acquisitions is anti-trust action. Whenever a big merger deal is announced, competition authorities view it with suspicion. If they feelthat the merger will limit competition, they may impose several restrictions on the newcompany. World Com’s planned $115 billion takeover of Sprint in June 2000, and therecently announced deal between GE & Honeywell were blocked by the European Union’scompetition authorities. (See Box item on the GE-Honeywell deal in Chapter VII). When acompany is big and enjoys an overwhelmingly large market share, competition authorities

tend to watch it very closely. Take the case of Microsoft. The global software giant has byand large concentrated on acquiring small companies or has taken minority stakes in largecompanies. The image of the company makes a difference here. A company like Cisco,with a very positive, friendly image will be viewed more positively by the anti-trustauthorities than Microsoft, which is perceived to be a tough no-non-sense competitor. Amore detailed discussion on anti-trust issues is included in Chapter VII.

Managing risks in strategic alliancesAcquisitions are different from strategic alliances. While an acquisition involves gainingcontrol of another corporate entity, a strategic alliance is a more flexible and open-endedarrangement, in which the different partners retain their individual identities even if they

exchange equity stakes.Strategic alliances offer more flexibility than acquisitions. In an acquisition, an

unduly high premium may be paid. Another problem with acquisitions is that only a part of the acquired business may be valuable, and along with it may come undesirable parts.Where uncertainties about the market size and technology are large, acquisitions can bevery risky. Strategic alliances are much more flexible than acquisitions, because theygenerate more options.

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result, the sharing of benefits may become lopsided. It is precisely because of suchdifficulties that strategic alliances have to be conceived and structured carefully.

Before going ahead with an alliance, companies should carefully analyse the valuechain to determine which activities should be retained internally and which can be sharedwith partners. It is also important to examine carefully whether the scope of the alliance

should be limited to start with and expanded over time. A related issue is whether to chooseone partner for many activities or different partners for different activities.

Unintended leakage of knowledge is a big risk in strategic alliances. While friendlyrelations between the partners are desirable, information leakage must be discouraged by putting in place proper controls and firewalls. Indeed, occasional complaints from the partner that lower level employees are not providing the necessary information should beviewed as a positive indication. The company which systematically monitors the type of information the partner is requesting and the extent to which these requests are being met,may well turn out to be the ultimate winner.

A systematic and pragmatic approach right from the negotiation stage can minimize

risks in strategic alliances. The executives involved in the negotiation should be allowedsufficient time to get to know each other and to develop personal equations. Free and frank discussions and realistic targets will help the firm avoid future disappointments. The partners should painstakingly identify potential problems and devise ways to solve them.Crisis situations should be anticipated and a code of behaviour prescribed for dealing withthem. It may also be useful to maintain written records of informal and oral commitmentsand agreements. These records can be referred to, as and when disputes arise.

Like in many other business activities, top management commitment holds the keyto the success or failure of an alliance. When senior executives of the companies involvedare willing to invest time and effort in building strong personal relationships with eachother, the chances of success multiply.

The success of a strategic alliance depends critically on the partners’ commitment to learning . When top management sends out clear signals that learning is very important,employees take the message seriously. The top management should also properly brief thelower level employees on what can be learnt from the partner and how this knowledge willstrengthen the company’s competitive position. Employees can be trained and encouragedto ask probing questions such as: Why is their design better? Why are they investing in atechnology when we are not doing so? Companies can also learn more about thecompetitive behaviour of their partners - how they respond to price changes, how theylaunch a new product, etc.

Management of expectations is a crucial issue in strategic alliances. When two partners view an alliance differently, they may have different expectations. For example,one may treat it as an acquisition while the other may believe it to be an equal partnership.One way of bridging this gap is for each partner to put itself in the other’s shoes. The partners could also share with each other, the problems they have faced in the past whilemanaging alliances. At the same time the differences between the past experiences and thenew situation should be appreciated. People who will be actively involved in thenegotiation should be carefully selected. Managers who are familiar with the culturaldifferences and command respect in their respective organizations will come off as morecredible when they interact with their counterparts in the partner company.

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Alliances can run into rough weather for various reasons. The size of the marketmay have been overestimated at the time the alliance was formed. If technology ischanging rapidly, the value of the alliance for each partner may change dramatically over time. The actions of competitors can turn a potentially attractive alliance into a weak arrangement. Regulatory changes, in industries which governments view as strategic, may

totally upset the initial calculations of alliance partners. For all these reasons, partners mayswitch loyalties.The right approach to deal with these potential problems is to think and act flexibly.

According to Hamel and Doz25: “Calls for commitment make good rhetoric but are a poor basis for action. Commitment increases only over time and an uncritical belief incommitment is naive and misleading. People being largely risk averse, will always betempted to hedge commitments and keep their options open in the face of uncertainty.”Alliance partners must appreciate that their objectives are bound to change with time andnot cling to the initially set objectives. Indeed, if the partners are alert, unforeseenopportunities for knowledge generation and sharing can be tapped.

One common reason for conflicts is that one partner may have skills that are not

easily transferable, while the other may have expertise which can be more easily picked up.The design of a component or a product can normally be learnt through a manual or anengineering drawing. On the other hand, manufacturing skills are more intricate, typicallydeveloped over a period of time and combine several competencies. A discrete, stand-alonetechnology, such as the design of a semi conductor chip, can be more easily transferredthan a process competence. Japanese companies often tend to learn more from their American partners because their manufacturing skills are less transferable than the designskills of western companies.

Contrary to popular notions, absence of conflicts may not necessarily imply that thealliance is succeeding. It is quite possible that the two partners have ‘given up’ or one partner is dominating the other. Occasional conflicts may reflect a more normal situation.The trick obviously lies in managing these conflicts tactfully.

Concluding NotesIn this chapter, we have tried to understand the risks associated with mergers, acquisitionsand strategic alliances. In their anxiety to close the deal or in their enthusiasm to grow,companies often strike deals of questionable merit. A dispassionate analysis of the potential benefits and pitfalls involved is important before going ahead with a merger or a strategicalliance. Board members have an important role to play here, especially the externaldirectors. CEOs must be thoroughly grilled and asked to explain the benefits of the merger.Once the decision to go ahead with the merger is announced, the focus shifts to integration.This is a task which is underestimated by most companies. In the final analysis, it is the

efficiency with which the integration process is managed that decides whether the projectedsynergies materialise. The difficulties in planning and executing acquisitions and alliancesmake them very risky. Managers should never underestimate these risks when they strikesuch deals.

25 In their book, Alliance Advantage.

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Case 4.1 - The Daimler Chrysler Merger

IntroductionOn May 6, 1998, two of the world’s leading car manufacturers, Daimler-Benz and

Chrysler, agreed to combine their businesses to form the third largest automobile companyin the world in terms of revenues, market capitalization and earnings (fifth in terms of thenumber of units of passenger-cars and commercial vehicles sold). In the new company,called DaimlerChrysler (DCX) Juergen E Schrempp and Robert J.Eaton the CEOs of Daimler and Chrysler respectively were named co-CEOs. Both appeared confident that themerger would generate various synergies and growth opportunities.

Schrempp remarked26, “The two companies are a perfect fit of two leaders in their respective markets. Both companies have dedicated and skilled workforces and successful products, but in different markets and different parts of the world. By combining andutilizing each other’s strengths, we will have a pre-eminent strategic position in the globalmarketplace for the benefit of the customers. We will be able to exploit new markets, and

we will improve return and value for our shareholders. This is a historic merger that willchange the face of the automotive industry.”

According to Eaton, “Both companies have product ranges with world class brandsthat complement each other perfectly. We will continue to maintain the current brands andtheir distinct identities. What is more important for success is our companies share acommon culture and mission……. both clearly focussed on serving the customer…….. both have a reputation for innovation and quality…….. By realizing synergies……… wewill be ideally positioned in tomorrow’s market place”.

ChryslerIn 1993, the Chrysler board had appointed Robert Eaton, then a senior General Motors

(GM) executive, as the new chairman and CEO, following the legendary Lee Iaccoca’sretirement. Eaton divested unrelated businesses to concentrate on car and truck makingactivities. He emphasised quality and efficiency, strengthened the balance sheet byreducing debt and increased Chrysler’s commitment to new product development. By1995, Chrysler’s position had significantly improved. Chrysler reported net earnings of $2.4 billion in 1993, $3.7 billion in 1994 and $2 billion in 1995.

In 1997, Forbes which selected Chrysler as the ‘Company of the Year’.mentioned27: “No company in recent years has faced greater odds than Chrysler. Starting asa weak number three in a murderously competitive business facing competitors with far greater resources, Chrysler management devised a disciplined strategy out of chaos androse to the top of the American car industry in profitability.” Eaton received praise from

analysts for making Chrysler a customer oriented company and for developing a close knitteam of talented managers driven by a clear vision.

26 Press release, May 7, 1998.27 Fling Jerry, “Company of the year Chrysler,” Forbes, January 13, 1997, pp. 83-87.

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in the world, Daimler executives decided that Chrysler topped the list because its productline and geographical reach were both complementary.

In 1995, Daimler and Chrysler began exploratory talks, and discussed ways of dealing with their weaknesses in the rapidly growing Asian markets and, to a lesser extent,South American markets. They proposed to set up a new, jointly owned project code-

named Q Star that would operate outside the US and Europe to develop vehicles, buildfactories, and establish dealer networks in new markets. The talks however ran into astalemate over issues of responsibility and money -- who would manage which projects andhow the costs would be allocated.

Chrysler, however, realized very soon that it was too thinly staffed to boostoverseas sales by deploying managers around the world. Moreover, due to smaller volumes, its R&D cost per vehicle was higher than that of its formidable rivals, GM andFord. Clearly, Chrysler was too small to take on its bigger rivals. It made sense to have a partner.

Meanwhile, Daimler was having its own problems. After building a plant inAlabama to assemble the M-class sport-utility vehicle, many defects/problems appeared

during its first year of production, making it the most defect-ridden vehicle in its class. TheGerman manufacturer had to spend about $180 million in 1997 to retrofit an innovativesmall car called A-class, because it lost balance when turning around corners at highspeeds. The company formed a partnership agreement in 1997 with Swatch28 to develop atwo-seater, plastic-bodied city car called Smart. But the co-venture dissolved in acrimony.Meanwhile, larger manufacturers like Toyota and Volkswagen, were buildingcompetitively priced premium cars such as Lexus and Audi. On the positive side,Schrempp had restructured Daimler’s non-auto businesses, adopted US GAAP accounting principles and listed Daimler on the New York Stock Exchange. This would greatlyfacilitate any transatlantic deal.

The ground realities they faced, motivated Daimler and Chrysler to get back to thenegotiating table. In January 1997, Schrempp met Eaton at Chrysler headquarters duringthe Detroit Auto Show. But doubts about the deal again arose when Ford chairman AlexTrotman approached Schrempp in Detroit in January 1998 for a joint venture. Topexecutives from Ford and Daimler held two days of discussions in London in March.Daimler had never viewed Ford as a possible partner since it was big enough to survive onits own. The London meeting was successful. However, a second meeting, was cancelled atthe last minute after Trotman informed Schrempp that the Ford family did not want to losemanagement control.

After the talks with Ford broke down, the negotiations between Daimler andChrysler proceeded smoothly. On March 2, 1998, Eaton and Schrempp met in Lausanne,Switzerland, to discuss issues like governance and organization structure for the mergedentity. In April, working teams went into details and reached agreements on big issues(Computer operations would be centralized the Chrysler way, with a Chrysler executive incharge) to small issues (Business cards would be wider and longer, European style).

On May 6, Daimler and Chrysler signed the merger agreement which wasannounced worldwide the following day. On May 14, the Daimler supervisory boardagreed to the merger. In July, the European and American competition authorities gavetheir nod. On September 18, Chrysler and Daimler shareholders approved the merger.

28 A leading Swiss watch manufacturer.

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Chrysler stockholders received 0.547 share of DCX for each share they held. Daimler shareholders held a 57 % stake in the new company.

DCX had revenues of $155.3 billion in 1998, and unit sales of 4 million cars andtrucks, with a presence across several market segments. Chrysler made moderately pricedcars and light trucks; Daimler made Mercedes luxury cars and heavy trucks. Chrysler was

strong in North America, but weak in Western Europe, where Daimler was strong.Chrysler’s strengths lay in product development; while Daimler’s engineering andtechnological capabilities were well established. The merger was projected to generatesynergies of nearly $1.5 billion in 1999 and around $3.0 billion in 2000. Much of the cost-savings would come through rationalisation of purchasing and technology sharingactivities.

IntegrationOnce the deal was finalized, Schrempp named a management team for the new company.Schrempp would share the title of co-chairman with Eaton for three years (2001) or untilEaton retired. However, management control of DCX seemed to be in the hands of former

Daimler executives.The new organization structure for worldwide marketing operations, aimed to

generate sales growth while protecting the identity of the company’s six brands in the passenger car business (A class, M class, CLK convertible, Chrysler Concorde, DodgeInterpret and Eagle Vision), and four brands in the commercial vehicle business(Mercedes-Benz, Freightliner, Sterling and Setra). The individual brands were managed byspecific brand managers. In Europe and North America, the two companies decided tomaintain separate showrooms. In markets where DCX had a weak presence, such as Asia,they decided to integrate the distribution channels and cut costs by combining differentfunctions like logistics, warehousing, technical training and after sales service.

James Holden, a senior Chrysler executive became responsible for brand

management and marketing for the Chrysler, Dodge, Plymouth and Jeep brands worldwide.Dieter Zetsche, a highly regarded Daimler manager was made in charge of the global brandmanagement of Mercedes-Benz and Smart cars. Kurt Lauk became head of global brandmanagement of the commercial vehicle brands -- Mercedes-Benz, Freightliner, Sterling andSetra (buses), as well as sales of Freightliner and Sterling products. Theodor Cunninghamwas asked to coordinate the worldwide integration of common systems and processes. Thegeographic region responsibilities were divided among Holden (North America), Zetsche(Europe, Asia, Africa, Australia) and Cunningham (Latin America). DCX also announced plans to establish a Marketing Integration Council, consisting of Cunnigham, Holden, Lauk and Zetsche. The Council became responsible for establishing central marketing services,and setting volume and profit targets.

In the pre-merger phase, Daimler had assumed that the cross border nature of thetransaction would not create any special problems. Daimler felt agreeing on the broadterms of the merger was more important and attached greater importance to efficiency and planning. However, during integration, cultural differences became the most critical issue.

Daimler was characterized by methodical decision-making while Chrysler encouraged creativity and represented American adaptability and resilience. Having almostgone bankrupt before its celebrated 1979 bailout, it had turned around under CEO Iacocca,and then Eaton, to become one of the most efficient car companies in the world. Daimler,

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meanwhile, had long represented the epitome of German industrial might and was one of the best examples of German quality and engineering.

There were major disparities in pay structures between the two pre-merger entities.Daimler had a very egalitarian pay structure. In the US, CEOs were rewarded handsomely.Eaton, earned a total compensation of $10.9 million in 1997, significantly higher than what

Schrempp did. Situations such as an American manager being posted to Stuttgart, reportingto a German manager who was earning half his salary became ticklish. On the other hand,Chrysler could cut pay only at the risk of losing its talented managers. Schrempp mootedthe idea of overcoming the problem through a low basic salary and high performance-based bonus. Basic pay would be lower than what Germans were used to, with more variablessuch as stock options.

While Chrysler executives were used to higher pay, the Germans seemed to relishtheir perks. They liked to travel first class and stay at top class hotels over the weekends.The Germans were also used to lengthy reports and extended discussions. But, theAmericans performed little paperwork and liked to keep their meetings short. TheAmericans favored fast-paced trial-and-error experimentation, whereas the Germans laid

painstaking plans, and implemented them methodically. In general, the Germans perceivedthe Americans to be totally chaotic while the Americans felt the Germans were stubborn .DCX took several initiatives to address the cultural dissimilarities. Germans were

encouraged to try out casual dress and also attend classes on cultural awareness. Americanswere asked to make more specific plans, while the Germans were urged to experimentmore freely. The Americans were impressed by their German counterparts’ skill in English.To reciprocate, many Americans began taking lessons in German.

Problems beginDespite all these initiatives to bridge the cultural differences, problems in implementing themerger began to be noticed from the middle of 1999. In September 1999, Thomas

Stallkamp, the president of the US operations, who had played an important role inChrysler’s comeback in the early 1990s, resigned. Stallkamp had apparently argued that themerger must go ahead slowly. Many Chrysler executives were upset by Stallkamp’sresignation as he was considered to be the only senior executive prepared to stick his neck out to protect the Americans’ turf from the Germans. With Eaton expected to leave by early2000, the Americans felt threatened.

Around this time, Schrempp felt it made sense to let Chrysler and Mercedes operateas separate business units. While it minimised ego clashes, realisation of projectedsynergies became more difficult in areas such as sharing of components. Chrysler had begun to share Mercedes’ rear-wheel-drive technology. But, when it wanted to use some of these components in the Dodge Intrepid and the Chrysler Concorde, the Germans resisted

because they were not sure whether they would have enough parts to spare after taking intoaccount their own consumption.In November 1999, following criticism that Chrysler was being tightly controlled

by the Germans, James Holden, Stallkamp’s successor announced a reorganisation thatwould enable the company to get bogged down by the integration processes andconcentrate on competing with main rivals, GM and Ford. The restructuring aimed atcentralising product planning functions and enhancing control over product developmentactivities.

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In December 1999, DCX announced that sales had risen 12% driven by strongdemand for Mercedes-Benz’s S-Class luxury cars and Chrysler’s Jeep Cherokee. Vehiclesales in both North America and Europe were strong. Schrempp expressed satisfaction thatthe merged entity had consolidated and strengthened its competitive position in manymarkets. But keeping in mind its weak presence in Asia, DCX decided to form new

strategic alliances to expand its presence in the region. On March 27, 2000, DCX forged astrategic alliance with Mitsubishi of Japan. In June, it spent $428 million to acquire a 10%stake in Hyundai of South Korea.

Towards the middle of 2000, the markets were increasingly coming around to theopinion that the integration process had run into problems. Schrempp remained optimisticthough slightly defensive about the prospects for the merger 29, “At present, the merger is judged on the basis of the stock which I appreciate is not where it should be. But that’s notthe point. The point is, we are a solid company… We are now one company. It’s workingwell.”

Meanwhile, DCX faced some serious problems in the key North American market.Competition from Japanese and European manufacturers had resulted in shrinking margins

for Chrysler’s mini vans and sports utility vehicles. Chrysler had miscalculated the demandfor their aging minivans. When it introduced its new model, its price was perceived to betoo high in relation to the old vans which had flooded the market. So, Chrysler had to offer big incentives for vehicles sold in 2000. During the second half of 2000, Chrysler lost $1.8 billion. In hindsight, Chrysler’s fundamentals had probably been much weaker at the timeof the merger, than widely perceived.

As 2000 progressed, it became evident that Schrempp’s decision to allow Daimler and Chrysler to operate separately, had put paid to any plans to generate synergies. As theEconomist30 put it: “When they merged, Daimler-Benz and Chrysler said that together theywould create tremendous synergies. That these have not materialised is partly because of the decision to keep the European and American operations, Mercedes-Benz and Chrysler,working separately, after full integration plans became bogged down. The German side isacting as if it is still alone, partly for fear of sullying the imperious Mercedes brand withthe rugged Chrysler image. At one level, arm’s length operations might have made sense.But insiders say this strategy has been taken to extremes.”

According to an expert quoted in Business Week 31 : “They’re erring too much onthe side of caution… If they continue to operate as separate companies, they won’t achievethe same kind of global reach as Ford, which shares some parts among its upscale brandswith the lower-cost Ford brand.” Business Week 32 , would later remark, “Both the Germansand the Americans have been out of synch(ronisation) from the start. The two proudmanagement teams resisted working together, were wary of change and weren’t willing tocompromise. Daimler and Chrysler have combined nothing beyond some administrativedepartments, such as finance and public relations… Mercedes executives worried their buyers might feel cheated if they shared parts with the American auto maker, Chrysler resented the implication that its technology was inferior”.

By late 2000, DCX’s market capitalisation was less than that of Daimler-Benz before the merger. Many Chrysler executives had left the company, dissatisfied with the

29 Business Week, August 7, 2000.30 October 12, 2000.31 August 7, 2000.32 September 17, 2001.

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way the merger was progressing while some had been fired. The Germans seemed to begaining the upper hand with Schrempp even admitting that the marriage of equals was onlya sales pitch to make the deal palatable to the Americans. So, it did not come as a surprisewhen Schrempp announced plans to scrap the automotive and sales councils the twocompanies had set up after the merger and replace them by a tightly knit executive

committee, consisting only of Germans. This committee was empowered to make all keystrategic decisions and coordinate production and marketing activities across the group’sdivisions. Schrempp hoped the move would speed up decision making on many issuesincluding sharing of technology among Chrysler, Daimler & Mitsubishi and Hyundai.

Schrempp also fired Jim Holden and replaced him with Dieter Zetsche as CEO of the Chrysler division. Cost cutting initiatives were renewed and suppliers asked to reduce prices by 5% immediately. Quality improvements, particularly for trucks were introducedat a furious pace. Marketing programs were rationalised and coordinated efforts initiated toemphasise that Chrysler’s cars were “cool”. Zetsche also started attempts to strengthenrelations with the dealers. Initiatives to share platforms and parts among Chrysler,Mercedes, Hyundai and Mitsubishi gathered momentum.

Daimler however, understood that the Americans still had an important role to playin managing the US operations. Partly by design and partly by circumstances, a German – American Management team began to evolve. Key members of the management team,Schrempp, Zetsche and Wolfgang Bernhard were Germans but Americans like JamesDonlon (Corporate Controller), Gary C Valade (Global procurement & supply chief),Thomas Sidlic (Procurement and supply chief of Chrysler) and Richard Schaum (Head of Product Development and Quality) were also given important roles. Zetsche himself admitted the need for insights from the Americans in the efforts to turn around Chrysler 33:“I would be the first to say that I’m not smarter than the people who are here.”

As Business Week 34 reported, “For all the talk about the Germans invading theexecutive ranks of Chrysler, Schrempp has sent only a pair of workout guys to handle the biggest workout in the automotive world. For the rest of the team, he is relying on Chrysler veterans who have been plucked from relative obscurity following a rash of high-rankingdefections… The presence of so many Americans points to something else: a tacitacknowledgement by the Germans that they have a lot to learn about the workings of amass-market giant like Chrysler.”

Future Outlook The German-American team faced stiff challenges In 1998, Chrysler had made more profits per vehicle than other major car manufacturers. In 2000, Chrysler’s operating profitdeclined sharply by 90% to $500 million on a sales turnover of $64.2 billion. In 2001, it isexpected to lose at least $2 billion. Chrysler’s US market share has been shrinking (13.5%

in September 2001, from 16.2% in 1998) and is in danger of losing the No. 3 position inthe US to Toyota. In August, 2001, Chrysler spent an average of $2,389 per vehicle incustomer incentives, more than that of GM or Ford. Zetsche’s plans to move towards aneveryday low pricing strategy have not materialised. Following the September 11 attack onthe WTC, first GM and then Ford started offering free financing on their cars. Chrysler hadto follow suit.

33 Business Week, January 15, 2001.34 January 15, 2001.

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On February 26, 2001, DCX announced it would make a loss in the range of Euro2.2 – 2.6 billion. Schremp however remained optimistic that by 2003, the company would be making profits in the range Euro 8.5 – 9.5 billion. On October 31, 2001, Standard andPoor downgraded DCX’s credit rating, making it the weakest among the Big three. TheDCX share after peaking at $108 in January 1999 traded at about $35 as on October 31,

2001. In the first three quarters of 2001, Chrysler lost an estimated $1.7 billion. But thestrong performance of the Mercedes-Benz luxury car business is expected to generate thetargeted operating profit of $1.1 billion during the year.

Meanwhile, DCX’s supervisory board has passed a vote of confidence inSchrempp’s leadership by extending his contract35 by two years and that of his close ally,Jurgen Hubbert, who heads the Mercedes-Benz car division also by two years. Schremppremains confident that the implementation of the merger, though incomplete will proceedsmoothly. The choice of a German like Zetsche to manage Chrysler seems to have brightened the prospects for the American partner. Zetsche’s good relationship withStuttgart may result in faster access to German technology for Chrysler cars. The firstChrysler vehicle to use Mercedes parts extensively will be the Crossfire, a two-seat

roadster to be launched in 2003. Zetsche has indicated plans to install a wide array of Mercedes parts in Chrysler cars by 2004.Many formidable challenges still remain for DCX. As a recent report in the

Economist 36 , has summed up: “Daimler has to integrate two struggling companies and inthe process reform itself. The stately product-development process that suffices for aluxury brand has to be speeded up for the more competitive markets that Mercedes,Chrysler and Mitsubishi now find themselves in. Mr Schrempp is a tough boss who clawedhis way up from garage mechanic, fixing lorry engines, to the top rank of German business. Now belatedly, he needs to get to grips with the nuts and bolts of what is, in effect, a three-way merger.” Problems remain to be addressed in critical areas such as component sharing.According to Hubbert37, “One million Mercedes customers a year are willing to pay a premium for something that is better than what the competition is delivering. We have to be very careful to make sure they feel that what they’re getting for their money is unique.”Indeed, this will be a tricky issue as the premium Mercedes charges is crucial to the well being of the group. DCX just cannot afford to do anything that will hurt the image of itsMercedes cars.

35 The announcement was made on September 27, 2001.36 March 1, 2001.37 Business Week, November 12, 2001.

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Case 4.2 - The Citicorp Travelers Group Merger

IntroductionIn April 1998, the financial services giants, Citicorp and Travelers Group announced theywould merge to form Citigroup with a market capitalisation of $160 billion and assets of

$700 billion. Citigroup would sell a range of products to individuals, corporates andgovernments across the world. It would operate in diverse businesses such as traditional banking, consumer finance, credit cards, investment banking, securities brokerage and assetmanagement, and property, casualty and life insurance. The two companies indicated thatthis would be a merger of equals. John Reed, the Citicorp CEO and Sandy Weill, theTravels Group CEO, were named co-CEOs of Citigroup.

Citicorp and Travelers before the merger Citicorp (Citi) and Travelers had come to the merger table with different backgrounds. Citihad become the leading consumer bank in the world by the 1990s. It had largely dependedon organic growth. Travelers had grown through acquisitions. Citi had struggled with the

few acquisitions it had made, a notable example being Qeutron, the securities data firm.Weill, on the other hand, was a seasoned expert in implementing acquisitions. In 1986,after quitting American Express, Weill bought Commercial Credit, a small consumer lending firm. Over a period of time, through a series of mergers, this became Travelers, aninsurance and brokerage conglomerate. Its subsidiaries included Salomon Barney(brokerage services, investment banking and underwriting); Commercial Credit (consumer loans); Primerica Financial Services; Travelers Bank Credit cards and Travelers Life andAnnuity. Weill believed in moving fast after an acquisition, select a management teamcarefully and drive under managed businesses to their full potential.

SynergiesWhen Weill and Reed met on February 25, 1998, Reed was surprised by Weill’s merger proposal. But gradually, the Citicorp CEO realised that the two companies were incomplementary businesses with little overlaps. In the third week of March, Reed and Weillagreed to go ahead with the merger. They met leading luminaries in Washington includingPresident Clinton, Alan Greenspan and Robert Rubin to get their support.

Citi and Travelers were confident that the merger would facilitate “cross-selling” of each other’s products. The merged entity looked better placed to compete with specialistcredit card issuers, home equity lenders and mutual fund companies. These competitors,using niche marketing techniques had been steadily eroding Citi’s market share in the1990s. Also, while Travelers had an insignificant presence overseas, it had one of thestrongest distribution systems in the US. Citi on the other hand had an impressive network

outside the US. It had 464 branch offices in Europe, 166 in Latin America and 93 in Asia.The two companies also complemented each other’s customer segments. While Citi

had a younger, less affluent customer base, Travelers targeted older, more affluentindividuals. Citi could sell its CitiGold and Private Banking Services more efficiently toTravelers’ 20 million U.S. customers after the merger. Citi, could also benefit fromTraveler’s expertise in mutual funds.

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Citigroup

10

20

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40

50

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Date

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Closing Stock Price

Merger

Citi had expertise in mail and telephone distribution of cards and branch banking.Its sales force however paled before Travelers which had 10,300 Salomon Smith Barney brokers, 80,000 part time Primerica Financial Services insurance agents and 100,000 agentsselling Travelers’ insurance.

Even though cross selling remained a challenge, it seemed the two companies hadlittle to lose. There was very little duplication of activities. So, there was little danger of the pre merger entities losing any of their momentum. Another positive feature of the deal wasthat no huge premium was being paid by the acquiring company. Citicorp shareholderswould get 2.5 shares of Travelers for each Citi share they held, implying a modest premiumover Citi’s ongoing market price. So, there was a good chance of generating higher earnings after the merger.

The main hurdle in the implementation of the merger was the Bank HoldingCompany Act, which prohibited banking companies from engaging in insuranceunderwriting, an important business for Travelers. However the regulation made it possiblefor a non banking company to buy a bank, become a bank holding company, and complywith the law within a prescribed period. The law allowed two years for this to happen andalso provided for three one-year extensions at the discretion of the Federal Reserve. Citiand Travelers hoped that banking laws would be suitably amended by then. (If the existinglaws were not amended, the Fed would possibly insist on divestment of the insuranceunderwriting business within two years).

IntegrationImportant hurdles stood in the way of integrating Citi and Travelers. The compensation policies were very different in the two companies. Citi offered stock options to talentedmanagers it wished to retain. But it did not exert pressure on them to retain their holding.

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As a consequence, all the officers and directors at Citi put together owned less than 0.5% of the company’s stock. In contrast, Weill himself owned 1.3% of Travelers’ stock, worthabout $950 million. Travellers’ officers and directors together owned 2.45%. These stakeshad been built by Travelers’ convention of “blood oath” that prevented the topmanagement team and the directors from selling shares. One director, after being denied

permission to be relieved of the oath, had resigned from the Travelers Board just to cashhis shares.Another important difference lay in the degree of teamwork. Travelers encouraged

teamwork. Inter-divisional support in selling products was quite common. But, Citi’stalented, smart and ambitious executives were more aggressive and individualistic. Reedadmitted38: “I’ve been struggling for years to try to improve the management and energylevels within Citi. I think there is an intensity and a sales capability in Travelers that wedon’t have as well developed. This is going to improve our management DNA”.Transferring Traveler’s good practices to Citi however remained a major challenge. As Fortune39, mentioned, “The problem is going to be getting the cells transferred into a Citi biochemical makeup that has traditionally been resistant to teamwork. Citi is known for a

go-it-alone attitude bordering on outright arrogance”.Some analysts were worried that the arrangement of co-CEOs would not work out,keeping in view the big egos of Weill and Reed. They felt that it was better for both towork individually. As the integration advanced, the differences in the management stylesof Reed and Weil began to be noticed. Reed, a loner disliked talking to the press. Incontrast, Weill was more outgoing and communicative. Reed was more of an intellectualwhile Weil relied on gut instinct rather than briefing papers. As Business Week 40 put it:“Weill and Reed have little in common. He (Weill) is a street-smart personable, outgoingman who loves nothing more than talking about his latest victory. Wall Street loves Weillfor his relentless focus on the bottomline and the stock price... Reed is probably the mostvisionary banker of his generation... Much of his time is spent alone, reading and thinking.”

After the merger, most of the positions were divided among the Citicorp andTravelers managers. Half of the new board’s members came from Citibank and half fromTravelers. The Economist41 described it as a Noah’s Ark approach. The committee systemof decision making however led to delays. Animosity developed between the investment bankers of Salomon Smith Barney (a part of Travelers) and Citicorp. The investment bankers were much better paid but Citi’s corporate bankers resented this as they felt theywere handling far more sophisticated clients.

Problems beginIn October 1998, many Citigroup executives began to complain that the merger was not proceeding smoothly. Immediately thereafter, major changes in the top management were

made. Jamie Dimon, long considered Weill’s heir apparent, quit in November 1998.Apparently, Dimon had developed sharp differences with Weill. The Economist 42 felt thatDimon’s resignation was a clear indication that turf wars were gaining in intensity: “Mr

38 Fortune, May 11, 1998.39 May 11, 1998.40 June 7, 1999.41 August 26, 2000.42 November 5, 1998.

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Dimon’s departure may have strengthened clan loyalties. He received a standing ovationfrom disappointed workers on the trading floor at Salomon, By contrast, employees, fromthe old Citibank were Cock-a-hoop at the news. They saw it as a victory for their hero,John Reed over Mr Weill, the Travelers man who had until then been thought to be in thedriver’s seat.” Senior Citi executive, Victor Menezes and Weill loyalist, Michael Carpenter

were made responsible for selecting a new top management team and quickly sort out pressing problems.In July 1999, Citi’s biggest shareholder, Saudi Prince Alwaleed bin Talal expressed

his concern about the deteriorating relationship between Reed and Weill. Consequently, theresponsibilities of Reed and Weill were clearly delineated. Weill took charge of day-to-dayoperations while Reed became responsible for internet strategy. In October 1999, former Treasury Secretary, Robert Rubin joined the senior management team apparently to act as a bridge between Reed and Weill.

Around this time, Reed himself started expressing doubts about the success of themerger. He even remarked that while the wisdom of the merger was unquestionable,success in integration looked doubtful. He explained the peculiar problems which the

merger had created

43

: “Sandy and I both have the problem that our children look up to us asthey never did before and reject the other parent with equal vigour, saying Sandy wouldn’twant to do this, so what do I care about what John wants.” Moreover, Weill’s trustedlieutenants were increasingly handling most of the important jobs while Reed’s favouriteswere leaving. And in April 2000, Reed resigned, marking a final victory for Weill in the power struggle. Weill announced that a committee would be appointed to nominate hissuccessor to take over in 2002. Many analysts remained cynical. As The Economist 44 put it,“Its hard to imagine Weill retiring. When asked about succession, he often mentions AlanGreenspan, still going strong at the Federal Reserve, at 73 and points out that he is asprightly 66. And if anybody is named heir-apparent, they should watch their back. Just ask Jamie Dimon, who though widely tipped as Mr Weill’s successor, was abruptly sackedsome 15 months ago.”

Concluding NotesAt the time of the merger, many cross–selling opportunities had been identified.Difficulties in integrating technology platforms and clashes at business unit level over what products to cross-sell have slowed down the retail cross-selling efforts. In consumer finance, where it was envisaged that Travelers’ products could be sold through Citi’s globalnetwork, success has been limited. The greatest success has been achieved in an unlikely business – corporate and investment banking.

Some of the opportunities which have been tapped after the merger, include sellingof Travelers’ insurance products to Citi credit card holders with an attractive risk profile.

Salomon Smith Barney mutual funds have been sold to Citi customers. Travelers’ annuitiesare also being sold through the Citi branch network. Many wealthy Salomon Smith Barneycustomers have been given 100% mortgages by Citi, secured against their brokerageaccounts. Citi’s global network has also helped Travelers to enter emerging markets. Costshave been cut and asset utilisation has improved. Travelers seems to have introduced anaggressive sales culture in Citigroup branches.

43 The Economist, August 26, 2000.44 March 2, 2000.

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A major challenge ahead is that with the Travelers management seemingly incharge, the top management’s experience in penetrating overseas markets is limited. Weillhas a good record in turning around and expanding under-managed companies but his skillsat managing a large global corporation are still untested. Many senior executives have leftafter the merger. Many blame Weill’s inability to draw up a succession plan as the main

reason for this exodus. Quite clearly, Weill faces the challenge of convincing analysts thatCitigroup is not a one man show.

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References:

1. R H Kilman, M J Saxton and R Serpa, “Gaining control of the corporate culture,” Jossey-Bass, 1985.

2. Gary Hamel, Yves L Doz and C K Prahalad, “Collaborate with your Competitors and

Win,” Harvard Business Review, January-February 1989, pp. 133-139.3. Joel Bleeke and David Ernst, “Is your Strategic Alliance Really a Sale?” Harvard

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1997.6. Mark L Sirower, “The Synergy Trap,” The Free Press, New York, 1997.7. Ronald A Ashkenas, Lawrence J DeMonaco and Suzanne C Francis, “Making the Deal

Real,” Harvard Business Review, January – February, 1998, pp. 165-175.8. “Watch out for the egos,” The Economist , April 11, 1998, pp. 65-66.9. “Mercedes goes to Motown,” The Economist, May 9, 1998, p. 15.

10. Barnett Seaman and Ron Stodghill II, “Here comes the road test,” Time, May 18, 1998, pp. 34-37.

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for That Acquisition?” Harvard Business Review, July-August, 1999, pp. 136-146.

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September 24, 1999.16. “Three’s company,” The Economist , October 28, 1999, p. 82.17. Jeffrey Ball, “Chrysler announces shake up to show its autonomy within Daimler

Chrysler,” The Wall Street Journal , November 1, 1999.18. Alfred Rappaport and Mark L Sirower, “Stock or Cash,” Harvard Business Review,

November-December, 1999, pp. 147-158.19. Jeffrey Ball, “Stallkamp to leave Daimler Chrysler,” The Wall Street Journal ,

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Associated Press News Wires, December 18, 1999.21. Brian Carvalho, “Deal Frenzy,” Business World , December 20, 1999, pp. 20-27.

22. Toby J Tetenbaum, “Beating the odds of Merger & Acquisition failure: Seven key practices that improve the change for expected integration and synergies,”Organizational Dynamics, Autumn 1999, pp. 22-36.

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24. Daniel Okrent, “Happily ever after?” Time, January 24, 2000, pp. 29-39.25. “Wily Weill wins again,” The Economist, March 2, 2000, p. 84.26. “The Daimler Chrysler emulsion,” The Economist, July 29, 2000, pp. 65-66.

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27. Denis Carey, “Lessons from Master Acquirers,” Harvard Business Review, May-June2000, pp. 145-154.

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pp. 24-29.31. “Gaining employee trust after acquisition: Implications for managerial action,” Employee Relations, August 24, 2000, pp. 334-355.

32. “First among equals,” The Economist , August 26, 2000, pp. 63-64. 33. “Managing alliances,” The Economist , August 26, 2000, pp. 56-57.34. “Schrempp’s trap,” The Economist , November 23, 2000, p. 24.35. Robert. J Aiello and Michael D Watkins, “The Fine Art of Friendly Acquisition,”

Harvard Business Review, November-December, 2000, pp. 100-107.36. Frank Gibrey Jr., “Score one for AOL TW,” Time, December 25, 2000, pp. 78-80.37. Ronald N Ashkenas and Suzanne C Francis, “Integration Managers,” Harvard

Business Review, November-December, 2000, pp. 108-116.

38. Joann Muller, Jeff Green, Christine Tierney, “Chrysler’s rescue team,” Business Week ,January 15, 2001, pp. 18-21.39. “The great merger wave breaks,” The Economist, January 25, 2001, pp. 59-60.40. David A Light, “Who Goes, Who Stays?” Harvard Business Review, January 2001, pp.

35-44.41. “Schrempp’s repair job,” The Economist , March 3, 2001, pp. 57-58.42. Christine Tierney and Katharine Schmialt, “Schrempp, the survivor?” Business Week ,

March 5, 2001, p. 26.43. Alex Taylor III, “Can the Germans rescue Chrysler?” Fortune, April 30, 2001,

pp. 52-56.44. Frank Swoboda, “A Model Comeback?” The Washington Post , May 13, 2001.45. Vikas Bajaj, “Write-downs heighten losses of telecom firms. Acquisitions are less

valuable.” The Dallas Morning News, June 21, 2001.46. Marc Gunther, “What does AOL want? Growth, growth and more growth,” Fortune,

July 23, 2001, pp. 91-97.47. Joann Muller and Christine Tierney, “Can this man save Chrysler?” Business Week ,

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Wall Street Journal Europe, September 26, 2001.49. “Schrempp survives shares slump but unions shown the door,” Financial Times,

September 28, 2001.50. Scott Miller, “Schrempp is asked to extend tenure at Daimler Chrysler,” The Wall

Street Journal Europe, September 28, 2001.51. David R Baker, “Cisco says it still seeks to buy small companies,” The San Francisco

Chronicle, October 3, 2001.52. Jennifer Files, “Cisco to expand Fiber-optic Business,” San Jose Mercury News,

October 3, 2001.53. Jeffrey Ball, “Daimler Chrysler turnaround seems to be going in reverse,” The Wall

Street Journal , October 11, 2001.

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54. Jeffrey Ball, “Daimler Chrysler net declines 70% as losses continue at US units,” TheWall Street Journal , October 24, 2001.

55. Jeffrey Ball, “Daimler Chrysler’s credit rating is cut by S&P due to doubt on profittargets,” The Wall Street Journal , November 1, 2001.

56. Christine Tierney, “Downshifting ambitions at Daimler Chrysler,” Business Week ,

November 12, 2001, pp. 28-29.57. Katinka Bijlsma – Frankema, “On managing cultural integration and cultural change

processes in mergers and acquisitions.” Journal of European Industrial Training 2001, Issue 213/4, pp. 192-207.

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