Though the lasting impact of COVID-19 on mergers and acquisitions (M&A) activity in 2020 is unclear, strategic buyers are expected to continue seeking acquisitions that provide new technologies, increase their offerings, and expand customer bases. But as CEOs deal with softened economies and lowered growth prospects, cost management in general has risen in their overall priorities, putting further pressure on stakeholders to optimize expenditures associated with business integration and M&A-driven transformation.
Start Early with the End in Mind
Effective business integration cost management should start as early as M&A target identification based on public knowledge of operating models, technology environments, culture, and more. But the heavy lifting on business integration strategy formulation begins during due diligence, pre- to post-sign, when inside information increasingly can be shared regulatorily.
Business and IT executives from both the parent and the acquisition should work in partnership to design the target operating model (TOM), determining which functions to integrate to maximize synergies – revenue, cost, and working capital – as well as establish a competitively sustainable platform. Gartner highlights that when a particular stakeholder, the CIO, focuses on cost optimization in all stages of a deal, an organization stands a better chance of achieving needed synergies.
To avoid integration expenses quickly mounting and degrading deal value, the CIO in collaboration with the CEO, CFO, COO, and beyond must balance the degree, difficulty, and duration, or 3Ds, of integration. Degree ranges across a scale of ‘autonomous to fully’ and applies to each of the vertical and horizontal business capabilities. Difficulty is measured by how complex the configurability of the TOM is -- higher the customization required, higher the costs. Duration, or the speed of integration, is influenced by deal constraints, both controllable (for example, funding, talent, and technology debt) and not (for example, legal and contractual limitations). In harmonizing the 3Ds, business and IT executives must strive to optimize the operating cost posture, maintain culture and moral, and achieve growth and profitability objectives.
Severance, which typically accounts for a large part of integration costs, is an early identifiable factor. Robust governance and tracking of the talent-related expense is essential pre- and post-Day 1 and must be part of an effective integration strategy and management office.
The size and sector of an M&A transaction shed light on expected integration costs as percentage of deal value. Ranging from 1 percent to 10 percent, integration costs inflect at the $1 billion, $5 billion, and $10 billion deal size points, correlating with annual operating spend ratios. Smaller deals typically have higher proportionate costs due to regulatory filings, technology, and advisory fees, while mega deals (which have surged in the last few years) often involve lower costs relatively. Sectors with high degrees of safety and quality standards, R&D, or both usually have higher proportional integration costs.
Mastery of M&A is the New Advantage
Designing the optimal TOM and integration strategy is essential to effectively managing costs during the transaction, and sustaining profitability long after it has been completed. Planning and executing M&As must become a CEO-driven competency, whether in-house or leveraging third parties. M&A planning and execution ‘playbooks’ should specify integration model options (for example, Absorption, Best of Breed, Evolution, and Preservation), outlining when best used by strategic goal, deal size, and target sector, as well as indicating severance and 3D implications and critical Degree, Difficulty, and Duration-managing success factors. As a fast-forward mechanism for digital transformation in an era of ecosystems, finding, valuing, and integrating M&A cost effectively is the new competitive advantage.
