Mergers: Beating the Odds

Would you sign-up for a medical procedure that had a 50% to 70% chance of making you sicker? Would you go ahead with it anyway because you believe that you are smarter or better than the rest of those losers who get the same operation? It sounds absurd, but that is what keeps happening in corporate America with merger decisions

The wisdom of some management practices are difficult to assess with rigorous research because existing studies report clashing results (the virtues of being a “first-mover’ is a good example). But the case against the typical merger is ironclad. A 2004 article in the Strategic Management Journal by Professor David King and his colleagues did a “meta-analysis” of 93 studies covering over 200,000 mergers. This rigorous analysis of studies in peer-reviewed journals showed that, on average, the negative effects of a merger on shareholder value became evident less than a month after a merger was announced and persisted thereafter.  The upshot is to be wary of people – especially investment bankers – who push for mergers because, even if you lose, they win so long as you close the deal. As economists put it, be wary of salespeople with “perverse incentives” for you to buy their wares.

But an evidence-based approach also points to ways to beat the odds. It turns out that when big firms buy little firms, the odds of success are a lot higher. It turns out that when companies pick “targets” where that fit well with their cultures, and especially, devote intense and prolonged attention to integrating the companies, that the odds of success go up. Jeff Pfeffer and I showed how Cisco uses these and other tricks in Hard Facts to beat the odds. US News & World Report writer Justin Ewers got interested in Cisco’s merger process when he wrote a story on Hard Facts called Management Maxims in Need of a Makeover. And he tells us that writing that story got him interested in digging into Cisco’s merger process more deeply to understand why they’ve made most of the 110 acquisitions they’ve done since 1993 successful, and especially how they’ve held on to such a high percentage of the people from these acquisitions. See Cisco's Connections.   To me, the three most striking parts of Ewer’s report are

1. Cisco focuses on acquiring small companies that fit well with their culture – which increases the odds of success (Their acquisition of Linksys seems to be an exception, and as a result, has been handled differently than other mergers, but most fit this pattern).
2. Cisco treats the acquisition decision as the beginning rather the end of a long and complex process. They have a 40 person team devoted to the integration process. For example, Ewer’s describes how, in a 1999 acquisition of Cerent: “On the morning that Cisco took over the company, employees arrived at work to discover they already had new titles, business cards, bosses, bonus plans, and health plans, plus access to Cisco's computer system.” If you know about how most mergers go, this is shocking stuff!
3. Cisco sees mergers as, first, and foremost, the acquisition of people. So they focus on the developing a career path within Cisco for each person in each company they acquire.

In addition, one of the things that Jeff Pfeffer and I discovered about Cisco is that, after every merger, they stop to examine went well and what didn’t, and use that information to keep fine-tuning how they do mergers.  In other words, they treat their merger process as an unfinished prototype, and constantly try to update it in response to new and better information – an attitude and approach that is the hallmark of companies that practice evidence-based management.