It Handbook On Mergers Acqui 130975

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Handbook for Mergers and Acquisitions

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It Handbook On Mergers Acqui 130975

  1. 1. Research Publication Date: 16 December 2005 ID Number: G00130975 IT Handbook on Mergers, Acquisitions and Divestitures Robert Mack Gartner provides comprehensive guidance for IT organizations on the planning, preparation and activities required during the six phases of the merger-and-acquisition process — from initial candidate screening to post-transformation review. © 2005 Gartner, Inc. and/or its Affiliates. All Rights Reserved. Reproduction and distribution of this publication in any form without prior written permission is forbidden. The information contained herein has been obtained from sources believed to be reliable. Gartner disclaims all warranties as to the accuracy, completeness or adequacy of such information. Although Gartner's research may discuss legal issues related to the information technology business, Gartner does not provide legal advice or services and its research should not be construed or used as such. Gartner shall have no liability for errors, omissions or inadequacies in the information contained herein or for interpretations thereof. The opinions expressed herein are subject to change without notice.
  2. 2. TABLE OF CONTENTS 1.0 Overview...................................................................................................................................... 5 2.0 Introduction .................................................................................................................................. 6 2.1 M&A Business Drivers.................................................................................................... 6 2.2 Why Mergers Fail ........................................................................................................... 8 2.3 The M&A Approach: Three Models .............................................................................. 10 3.0 M&A Process Stages: An Overview .......................................................................................... 11 4.0 Stage 1 — Screening ................................................................................................................ 12 4.1 Screening Activities ...................................................................................................... 12 4.2 What IT Can Do............................................................................................................ 13 4.3 Key Actions................................................................................................................... 13 4.3.1 Constructing Cost Scenarios........................................................................ 15 4.3.2 And Then There is Time ............................................................................... 17 5.0 Stage 2 — Initial Candidate Evaluation..................................................................................... 17 5.1 Action Items Resulting From Screening ....................................................................... 17 5.2 Preliminary Analysis ..................................................................................................... 18 5.3 What IT Can Do............................................................................................................ 19 6.0 Stage 3 — In-Depth Candidate Evaluation: Due Diligence....................................................... 19 6.1 Due-Diligence Assessment Criteria.............................................................................. 20 6.2 What IT Can Do............................................................................................................ 20 6.2.1 Preparation ................................................................................................... 21 6.2.2 On Site.......................................................................................................... 22 6.2.3 Wrap-up........................................................................................................ 24 6.2.4 Remember the Strategy ............................................................................... 24 6.3 What to Do When Target Access Is Limited................................................................. 25 7.0 Stage 4 — Closing the Deal ...................................................................................................... 25 7.1 Negotiation ................................................................................................................... 25 7.2 Due-Diligence 2 ............................................................................................................ 25 7.3 Transition Planning....................................................................................................... 26 7.4 What IT Can Do............................................................................................................ 27 8.0 Stage 5 — Executing the Merger/Acquisition............................................................................ 28 8.1 The Integration Process ............................................................................................... 29 8.1.1 Integration Planning...................................................................................... 29 8.1.1.1 The Core Transition Team ........................................................... 29 8.1.1.2 Defining the Scope of Work to Be Done ...................................... 30 8.1.1.3 Schedule Development ................................................................ 30 8.1.1.4 Personnel ..................................................................................... 31 8.1.1.5 Communication............................................................................. 31 8.1.1.6 Balancing Long-Range Strategy with Current Tactics ................. 32 8.1.2 Early Projects ............................................................................................... 33 8.1.3 Business-Process-Originated Projects......................................................... 34 8.1.3.1 Business Projects: Absorption Model........................................... 35 8.1.3.2 Business Projects: Stand-Alone Model ........................................ 36 8.1.3.3 Business Projects: Merger of Equals Model ................................ 36 8.1.4 IT Infrastructure Operations Projects ........................................................... 37 8.1.4.1 IT Infrastructure Operation Projects: Absorption Model............... 38 8.1.4.2 IT Infrastructure Operation Projects: Stand-Alone Model ............ 38 Publication Date: 16 December 2005/ID Number: G00130975 Page 2 of 65 © 2005 Gartner, Inc. and/or its Affiliates. All Rights Reserved.
  3. 3. 8.1.4.3 IT Infrastructure Operation Projects: Merger-of-Equals Model .... 38 8.1.5 Employee Change Projects.......................................................................... 39 8.1.6 Building a 90-Day Plan ................................................................................. 39 8.2 Sample Template for Stage 5....................................................................................... 39 8.3 What IT Can Do............................................................................................................ 41 9.0 Stage 6 — Operational Review ................................................................................................. 42 9.1 Determining Whether Acquisition Value Expectations Will Be Met.............................. 42 9.2 Determining How to Improve the Process.................................................................... 44 9.2.1 Was It Based on a Faulty Assumption? ....................................................... 45 9.2.2 Was It the Result of Poor Execution?........................................................... 45 9.2.3 Was It a People Problem?............................................................................ 46 9.2.4 Can It Be Corrected Now, and Is It Worth It?............................................... 47 9.3 What IT Can Do............................................................................................................ 47 10.0 Divestitures .............................................................................................................................. 48 10.1 Creating New Systems and Modifying Established Ones .......................................... 49 10.1.1 Developing the New System ...................................................................... 49 10.1.2 Modifying the Remaining System............................................................... 50 10.2 Duplicating or Spinning Off a System......................................................................... 51 10.3 Providing a System as a Service................................................................................ 52 11.0 Software to Manage M&A Activity ........................................................................................... 52 11.1 Software Tool Criteria................................................................................................. 53 11.2 M&A Software Candidates ......................................................................................... 54 11.2.1 Valchemy (valchemy.com) ......................................................................... 54 11.2.2 FastFuse (fastfuse.com)............................................................................. 55 12.0 What Acquired IT Organizations Can Do ................................................................................ 56 12.1 Stage 3 and Stage 4 IT Actions for Target Enterprises.............................................. 56 12.1.1 Asset Evaluations ....................................................................................... 57 12.1.2 Business Operational Reviews................................................................... 57 12.1.3 Evaluations of People................................................................................. 58 12.2 Stage 5, IT Actions for Target Enterprises ................................................................. 59 13.0 Due-Diligence Checklist .......................................................................................................... 59 13.1 General Information.................................................................................................... 59 13.2 IT Standards/Architecture........................................................................................... 59 13.3 Business Process/Applications .................................................................................. 60 13.4 Application Portfolio.................................................................................................... 60 13.5 Application Change in Progress/Backlog ................................................................... 61 13.6 IT Operations Infrastructure ....................................................................................... 61 13.7 Operations Capability ................................................................................................. 62 13.8 Data Centers .............................................................................................................. 62 13.9 Financial ..................................................................................................................... 62 13.10 Contracts .................................................................................................................. 62 13.11 Assets ....................................................................................................................... 63 13.12 Intellectual Property.................................................................................................. 63 13.13 Organization/Sourcing .............................................................................................. 63 13.14 Internal Staff Skills and Competencies..................................................................... 63 13.15 Externally Sourced Skills .......................................................................................... 64 13.16 Organizational Change Management....................................................................... 64 Publication Date: 16 December 2005/ID Number: G00130975 Page 3 of 65 © 2005 Gartner, Inc. and/or its Affiliates. All Rights Reserved.
  4. 4. LIST OF TABLES Table 1. Sample Template for M&A Integration .............................................................................. 40 LIST OF FIGURES Figure 1. M&A Activity, 1999 to 2004 ................................................................................................ 7 Figure 2. Change Absorption Rate .................................................................................................. 10 Figure 3. Strategic Fit: Business Model Combination Options........................................................ 14 Publication Date: 16 December 2005/ID Number: G00130975 Page 4 of 65 © 2005 Gartner, Inc. and/or its Affiliates. All Rights Reserved.
  5. 5. STRATEGIC PLANNING ASSUMPTION(S) Through 2010, 70 percent to 90 percent of Gartner's clients will be involved in some form of merger and acquisition activity as an acquirer, a target or part of a divestiture (0.8 probability). ANALYSIS 1.0 Overview During the next five years, 70 percent to 90 percent of Gartner's clients will be involved in some form of merger and acquisition activity as an acquirer, a target or part of a divestiture (0.8 probability). For many of these transformations, IT organizations will help determine success — or failure. This research provides a guide for how IT organizations can effectively support a merger or acquisition. We give an overall view of what happens in each phase. We examine the factors that dictate the strategy and rationale of the mergers and acquisitions (M&A) transaction, which help to set the agenda for the IT organization's action. We then provide guidance on what IT organizations can or must do during each phase of the M&A process, using a six-stage framework that highlights the enterprise and IT activities appropriate for each stage: 1. Screening: During this phase, the enterprise's finance, marketing or business development groups consider acquisition candidates. Because financial models influence the decision process, realistic cost/benefit analyses for the IT management aspects of potential targets are important for managing the eventual expectations of IT contributions. 2. Initial candidate evaluation: At this point, a specific candidate has emerged and the bidding process begins. Typically, there is little in-depth IT information available, but judicious use of public information can provide educated guesses for inclusion in the financial model. 3. Detailed candidate evaluation (that is, due diligence): This is probably the most- important stage for the IT organization. It provides the initial opportunity to obtain factual information to estimate the IT-related costs and risks of the transformation. 4. Closing the deal: The parties agree to the final contract terms and conditions. Because the IT transformation effort is typically greater than perceived, the quality of due diligence will serve well in keeping the realities in perspective during this negotiation period. 5. Executing the M&A: After the deal is done, the transformation begins — that is, tackling the operational business transformation processes and preparing employees for the new operational environment. 6. Operational review: A post-transformation review helps companies determine what went well and what didn't. By building this knowledge over time, the enterprise can reap the benefits of its M&A experience in future transformations. IT and business managers must carefully examine the impact of a merger or acquisition on established projects and infrastructures. Choosing the systems to integrate and the timeline for their integration will depend on strategic, cultural and competitive considerations. The larger the acquisition, the more complex the integration process becomes and, therefore, how effective an Publication Date: 16 December 2005/ID Number: G00130975 Page 5 of 65 © 2005 Gartner, Inc. and/or its Affiliates. All Rights Reserved.
  6. 6. organization is in planning and execution will determine its success. A carefully implemented and managed M&A process, as discussed in this report, ensures the likelihood that the enterprise will achieve intended benefits from the acquisition. 2.0 Introduction Too often, mergers, acquisitions and divestitures can pose a quot;forced marchquot; for IT managers. Commonly lost in the M&A process is the strategic objective — that is, enabling a new business model and/or culture to emerge — a transformation for which IT will be a critical component. An M&A focus is typically one of several strategic initiatives a company can pursue and, as such, must be viewed in the larger context of strategy management. Gartner research dedicated to presenting this larger picture from the IT perspective are: • quot;Six Building Blocks for Creating Real IT Strategiesquot; • quot;Real IT Strategies: Steps 1 to 4 - Laying a Foundationquot; • quot;Real IT Strategies: Steps 5 to 8 - Creating the Strategyquot; • quot;Real IT Strategies: Step 9 -- Managing Transformationquot; The goals of the M&A process are the same as taking two buildings and combining them into one — or, alternately, to moving them closer together and building bridges across various levels. In this process, the IT infrastructure and business process applications combine to create the new enterprise structure and its bridges. It is critical, therefore, for IT managers to understand the strategic factors governing M&A activity, and the key considerations that enterprises and their IT organizations will face during each phase of the process. This section sets the topic in perspective by examining strategic considerations, such as M&A business drivers and pitfalls, as well as the various forms of M&A. Subsequent sections will explore each of the six phases of the M&A process in detail. The final three sections cover divestiture, software to manage the entire M&A process and what to do if you are being acquired. 2.1 M&A Business Drivers The security market meltdown in 2000 had a negative impact on M&A activity worldwide (see Figure 1). The number of international deals was approximately twice that of the U.S., while the value total is similar — that is, more, smaller deals. Publication Date: 16 December 2005/ID Number: G00130975 Page 6 of 65 © 2005 Gartner, Inc. and/or its Affiliates. All Rights Reserved.
  7. 7. Figure 1. M&A Activity, 1999 to 2004 Number Value of Deals ($ in Billions) 30,000 U.S. 27,500 Non-U.S. 25,000 2,500 22,500 2,250 20,000 2,000 17,500 1,750 15,000 1,500 12,500 1,250 10,000 1,000 7,500 750 5,000 500 1999 2000 2001 2002 2003 2004 1999 2000 2001 2002 2003 2004 Source: Thomson Financial Even with the slowdown, the underlying drivers have not gone away. For example, a 2005 Bain & Company survey of 960 global executives found that 55 percent agreed that quot;acquisitions will be critical to achieving our growth objectives over the next five years.quot; The drivers for M&A can be classified into several categories, but at the heart of each is growth, as the survey indicated. There is no denying that senior management teams are driven to increase the size of their organizations because growth is viewed as successful. As most organizations grow, the quot;law of large numbersquot; causes them to run into a quot;growth wallquot; in their internal operations, and they are forced to look outside for help. The mind-set becomes quot;buy or die.quot; It isn't unusual to see a corporation report revenue growth of 12 percent to 15 percent, with only 5 percent to 8 percent of that growth coming from internal operations and the rest coming from acquisitions. Gartner has identified numerous M&A drivers and objectives. Multiple objectives for a single acquisition are not uncommon, and the following list is not meant to imply an order of preference. Economies of scale (market share): The most-significant driver is a business leader's desire to leverage increased size to reduce the per-customer costs incurred by the enterprise. Typically, M&A driven by this goal are executed in the same or similar markets, thereby reducing the time and cost of integration, and leveraging increased size, geography or product reach. This approach is sometimes referred to (although not by its participants) as quot;buying market share.quot; The typical promise to shareholders is that consolidation will improve savings, which will increase earnings, often through the merging of IT infrastructures, consolidation of production, and reduction of operations or selling, general and administrative (SG&A) costs. Customer demand (market awareness): As consumers become more knowledgeable and demand lower costs and better service, competition for customers increases. At the same time, Publication Date: 16 December 2005/ID Number: G00130975 Page 7 of 65 © 2005 Gartner, Inc. and/or its Affiliates. All Rights Reserved.
  8. 8. customers are more in control of the terms of this competition than ever. Increasingly, acquisitions are being driven by the objective of capturing more customers to ensure a constant revenue stream, or to expand the market within which new products and services can be delivered. This facilitates cross-selling and common branding — common tactics for growth strategies. Changing business models (market/channel creation): Many businesses are rethinking not only how they interact with customers, but also who their customers are. This has led many to acquire companies that provide complementary products and services to expand a one-stop- shopping concept. Globalization: An expanding global economy has increased opportunities not only to ship product/service build/deliver offshore, but also to tap the global workforce to supplement internal staff or to extend the enterprise. As a result, activity has increased for acquiring offshore subsidiaries and service organizations to extend the enterprise's business or to add needed skills. quot;Going globalquot; means that the time to establish and grow foreign businesses, especially in unknown markets, far exceeds that needed to execute an acquisition strategy. The consolidation of currencies and policies in Europe has contributed to increased M&A activity there, making it potentially more profitable to create North American/European business models. Diversification: Companies often pursue acquisitions to fulfill a need externally, rather than in- house. They often need to obtain external competencies that cannot — or, for reasons of economy, should not — be developed internally. Such competencies include: • Knowledge (for example, intellectual capital, skills or innovative techniques) • Products (for example, to build a wider range of products and services that address convenience-based competition and keep the customer from looking elsewhere) • Technology (for example, infrastructure, processes and capital) Ego: The vision of business leadership is an important component in M&A activity. It is worth considering the degree to which the restructuring serves the personal agenda of the enterprise's leadership, or helps establish senior management's place in history. Scavenging for value: Numerous acquisitions are made with the sole intention of imposing new management and cost-cutting practices, then reselling the company. This has been the practice of venture capital firms for some time, and is not the typical acquisition strategy of most other businesses. 2.2 Why Mergers Fail It has been widely reported that M&A failure rates are high —from 30 percent to 70 percent, depending on studies' methodologies and definitions of quot;failurequot; (which range from quot;brokenquot; to quot;didn't achieve expectationsquot;). The most-thorough study was conducted by Robert F. Bruner, recently named dean of the University of Virginia's Darden School. During his 20-year study, Bruner reviewed 130 scientific studies of M&A performance that considered stock market returns at the announcement of deals through the subsequent five-year period. The study results for buyers were startlingly simple: one-third reported M&A destroyed value, one-third claimed they broke even and one-third found M&A created real economic value. If two-thirds conclude M&A losses or a break-even stat, then that doesn't bode well for this strategic option. It emphasizes that senior management should carefully review those potential causes of failure to ensure their strategic M&A choices do not fail. The most-common causes for M&A failure are. Publication Date: 16 December 2005/ID Number: G00130975 Page 8 of 65 © 2005 Gartner, Inc. and/or its Affiliates. All Rights Reserved.
  9. 9. Vision vs. Strategy: quot;Visionsquot; are repeatedly mistaken for strategies. Visions are lofty ideals, basically setting up an infinite number of choices for the company to achieve. Strategies, however, focus on implementing tactical projects to achieve measured objectives. For example, quot;to be No. 1 in our industryquot; is a vision, while quot;doubling our market share by expanding X family of productsquot; is a strategic objective. A strategy recognizes resource constraints and directs enterprise activity to maximize the deal's effectiveness. It's not unusual to read that the purported strategy for an acquisition is quot;to become the most dominant player in the market.quot; Clearly, this doesn't provide direction for how to structure or execute the merger. An effective M&A strategy addresses the desired business model, critical success factors, how to achieve competitive advantage and how to create shareholder value. Failure often occurs when, part way through the implementation, no one is certain what the business model should be and how it should operate. Unless quickly corrected, these situations can result in the merger becoming uneconomical or, even worse, detrimental to its survival. Culture Shock: Culture essentially refers to decision making — that is, how individuals will deal with each other as they perform their roles. It is defined by the decision processes that will be used in the new organization, popularly known as quot;governance.quot; Most public relations messages regarding mergers focus on how wonderful the new organization will be, and how well everyone will work together. In reality, most mergers turn into acquisitions, with the acquired organization forced to adopt the acquirer's decision processes. These processes are embedded in all business management practices — for example, decentralized vs. centralized management, authoritative vs. team-based management, strong vs. weak financial control, the treatment of people as valued resources vs. expendable commodities, and defined vs. ad hoc processes. Failure sets in when these processes disenfranchise groups of employees, making them feel like they are on the outside looking in or, worse, if they judge the processes as being quot;stupid.quot; Mergers are intense, complex activities and need everyone pulling in the same direction. Like a strategy, if this point is ignored, a quick remedy will be needed to keep the merger from grinding to a halt. Overpayment: A company that finally understands it paid too much for the acquisition also realizes that expectations were set too high. Unfortunately, it must acknowledge lower-than- expected revenue or higher-than-expected costs. The IT organization's involvement is more closely associated with the cost side. Failure in this case is financial and usually does not mean that the merger cannot be completed, but it means that the benefits couldn't be achieved. Inadequate Due Diligence: The three failure factors mentioned above can be mitigated through effective due diligence — that is, understanding risk and reducing it to its minimum. The acquirer gets to probe into an acquisition's assets and operations, forming an opinion of its value and creating a basis for all implementation plans. Failure sets in when the execution slows or stops after encountering the reality of the unknowns missed during due diligence. Poor Execution: This means that the acquisition process has not been managed properly. In these cases, Gartner often sees a lack of senior management involvement, resulting in decisions not getting made in a timely fashion and thus prolonging the agony. A PricewaterhouseCoopers report (quot;Evolving Approaches to M&A integrationquot;) published in 2004, based on a roundtable discussion among 11 well-known Silicon Valley companies active in M&A, underlined this point. Virtually all of the participants admitted that their early M&A activity gave little thought to integration, with the result being a chaotic inefficient aftermath. They all have since transformed their programs to an execution framework that actively engages management at all levels in both companies using repeatable but adaptable processes. Ignoring Customers and Business Partners: A business is acquired because it has a market value defined by its customers and business partners. This value must be preserved and, Publication Date: 16 December 2005/ID Number: G00130975 Page 9 of 65 © 2005 Gartner, Inc. and/or its Affiliates. All Rights Reserved.
  10. 10. therefore, requires a careful balance between getting the integration done and getting it done right. When integration alone becomes the driving focus, then customers and business partners may see a loss of value to themselves, prompting them to sever relationships with the merged company. Negative Market Response: This occurs when the acquirer fails to anticipate what others may do to counteract the deal's benefits. Executing an acquisition can take six months to three years, and during this period the acquirer is committed to a course of action. If the market is at a flex point and can move in a different direction, the competition can trump the acquisition by changing the game, leaving the acquirer with a bad investment. This is less likely to happen in a known market (that is, one in which the acquirer already competes), but it is more likely to occur when an acquirer enters a market as a neophyte. Too Much Change: Every organization has its own absorption threshold after which less, not more, change can be assimilated (see Figure 2). Management can improve this capacity for change through effective change management, but the extent of this improvement will also be limited. Enterprises executing mergers often set high expectations for achieving a high degree of change within a short time frame. Figure 2. Change Absorption Rate 100% Change Management Effect Percentage of organization's capacity for Absorption Threshold change 0% Amount of change that can be absorbed in a given period (volume, velocity, complexity) Source: Gartner (December 2005) Failure occurs when organizations are pushed past their thresholds — the transformation slows, and the more that senior management presses, the less gets accomplished. This is most obvious when companies are working on radically changing their business models, while simultaneously making acquisitions. Unfortunately, there isn't a measure for an organization's change capacity, but most employees know what they can handle, at which time management needs to slow down and evaluate what they are asking employees to do. 2.3 The M&A Approach: Three Models At an early stage — certainly by Stage 3 — most companies will identify the best approach for integrating the organizations. Gartner has identified three principle models for corporate consolidation, specifically as they affect business processes. Publication Date: 16 December 2005/ID Number: G00130975 Page 10 of 65 © 2005 Gartner, Inc. and/or its Affiliates. All Rights Reserved.
  11. 11. 1. Absorption: The acquired organization is completely absorbed by the acquirer. The acquirer's business processes dominate, and the acquired organization must adopt them. This focuses the IT effort into one of understanding how much difference exists between the target organization's former business processes and the new ones it must accommodate. These differences typically center on how the business sells to its customers and the associated underlying contracts. 2. Stand-alone: The acquired organization remains independent. In this approach, the company being acquired remains a separate, stand-alone organization with only some integration of support services (for example, phones, networks and data centers) to achieve economies of scale. Financial reporting is the one business process that typically must conform to the buyer. This is, by far, the least-disruptive model. 3. Merger of equals: A best-of-breed organization is developed from both parties. In this approach, the strongest components of each organization are used to build a new business model. Each business process in the merging companies is evaluated, and the best are selected and integrated into a new set of processes to serve the new business model. This model entails the highest degree of change and risk. These are mutually exclusive models but can be combined in a merger event. For example, one business unit may be targeted for divestiture and, therefore, run as a stand-alone unit, while the others are absorbed. Divestiture activity could take place within any of the models. For a divestiture, a choice of models is again made, but by the new acquiring organization. 3.0 M&A Process Stages: An Overview The M&A process consists of six stages, each of which has a distinct purpose and depends on the stages that precede it. • Stage 1 — Screening: Most acquisition opportunities don't just quot;come alongquot;; usually, the acquiring enterprise has had a small group working internally, searching for opportunities. The participants typically are involved in finance, marketing or business development. • Stage 2 — Initial Candidate Evaluation: In this stage, a specific candidate has emerged and the negotiation process starts. Typically, little in-depth IT information is available at this point, but judicious use of public information can provide educated guesses for inclusion in the financial model. • Stage 3 — Detailed Candidate Evaluation: The principal activity in this stage is due diligence. The IT organization must be involved at this stage because it gives them an opportunity to see how the target truly operates its business. This is also the final opportunity to obtain the factual information needed to estimate the costs of the transformation and to understand the underlying risk before the deal is closed. • Stage 4 — Closing the Deal: The agreement is not truly a quot;dealquot; until the final contract terms and conditions have been hammered out. This is where quot;the squeeze is applied,quot; and cost takeouts often grow to justify the offer price. For the IT organization, the transformation effort is usually greater than perceived. The quality of due diligence will serve well in keeping realities in perspective during negotiation. • Stage 5 — Executing the Merger/Acquisition: There are four phases to this stage: 1. Intensive planning for business and IT projects, and the resolution of personnel- related issues Publication Date: 16 December 2005/ID Number: G00130975 Page 11 of 65 © 2005 Gartner, Inc. and/or its Affiliates. All Rights Reserved.
  12. 12. 2. A focus on early transformation projects to achieve momentum (for example, infrastructure, finance and HR) 3. Tackling all the operational business transformation processes 4. Preparing employees for the new operational environment • Stage 6 — Operational Review: This is the process employed to help the newly consolidated organization get past the problems of newness and stabilize enterprise operations. The company uses a post-transformation review to learn what went well and what didn't. In this way, knowledge is built over time so that everyone involved in the M&A process can benefit from the experience by applying the lessons learned to the next event. The next sections explore these stages from two perspectives: what is happening overall, and what the IT organization can and should do. 4.0 Stage 1 — Screening A key contributor to M&A failures is the lack of a clearly defined strategy or the failure to communicate the strategy completely and effectively. The screening stage is focused on defining the goals, strategies and initiatives of the acquiring enterprise or business unit. In larger companies, this is typically the responsibility of business-unit management, with the participation of the enterprise business development team. In smaller companies, this activity typically is managed at the enterprise level. It is relatively rare for anyone from the IT organization to be directly involved at this stage. Most of the available information at this stage is financial or demographic; there is almost nothing of an operational nature in the public domain. 4.1 Screening Activities Key enterprise activities during the screening phase include: • Develop the business strategy that will become the bounded framework for candidate selection. • Identify and prioritize potential markets or business areas of interest. • Evaluate the enterprise's own strengths and weaknesses. Risk will be proportionate to the organization's ability to support its extension into other markets (for example, global). • Select and prioritize possible acquisition candidates. • Seek service providers to help with the acquisition activities to strengthen M&A capabilities (that is, offset weaknesses). • Conduct an initial investigation of an acquisition candidate (that is, gathering information about the target enterprise) that may include a preliminary, exploratory meeting with the candidate's management or other principal players. Individuals in a specific business unit or the business development team may undertake this investigation. The person responsible should write a set of standard questions about the situation. • Schedule preliminary quot;get acquaintedquot; and quot;determine mutual interestquot; discussions with company's initial contact. Among the many ways to execute a search is to use Gartner's target attractiveness indicator (TAI). This tool leverages Gartner's Magic Quadrant research. TAI adds the financial metric enterprise value multiple and positions companies in a market segment based on two axes Publication Date: 16 December 2005/ID Number: G00130975 Page 12 of 65 © 2005 Gartner, Inc. and/or its Affiliates. All Rights Reserved.
  13. 13. (Ability to Execute and Completeness of Vision) of the Magic Quadrant. The resulting graphic presents companies on a comparative basis, thereby facilitating the decision as to whether to pursue an acquisition and identifying the level of due diligence required (see quot;Growth Through M&A Is Not a Panaceaquot;). 4.2 What IT Can Do Every merger comes down to integrating the operations of two or more companies, and this is where the IT organization gets involved. The ultimate success of a merger will greatly depend on understanding the operational variables involved. At the center of all acquisition efforts is a spreadsheet — or a software package, if more sophisticated tools are used — that models the financials of the deal. At this early stage, financial data will be limited and, therefore, many estimates will be used to fill out the picture. Using the spreadsheet, a buyer will attempt to predict cash flow streams that will balance revenue and expenses, providing the basis for an eventual price. A good place for the IT staff to begin supporting this stage is to lend their expertise on what it costs to provide and run the IT infrastructure to support the enterprise's operations. Much of this knowledge will feed the estimates used in the spreadsheet. At this stage, a sense for which of the three M&A models will define the acquisition's approach should emerge. Each has a dramatically different cost profile that will affect the values used in the spreadsheet: • In the absorption approach (that is, complete absorption by the acquirer), the candidate is typically within the acquirer's industry. In this case, the IT organization's financial data is likely to be accurate and should be the primary source of estimates. • The stand-alone approach (where the acquired organization remains independent) would simply use the candidate's own financials, although some infrastructure consolidation estimates could be used in areas such as telephones, data networks and data centers. Reliable savings are difficult to estimate at this early stage; therefore, Gartner recommends waiting until Stage 3, due diligence, letting target costs represent a conservative estimate of IT cost. • The merger-of-equals approach is the most difficult for which to estimate reasonable integration costs. Again, Gartner recommends waiting until Stage 3, when necessary information becomes available. The important IT contribution for Stage 1 is to determine appropriate cost estimates, enabling the buyer to evaluate the candidates. Because financials can be quot;set in stonequot; quickly — often long before necessary details are known — it will behoove the IT organization to get its perspective on quot;what it will really take to do the jobquot; incorporated into the financial-planning process as early as possible. 4.3 Key Actions The IT organization's contribution in this phase is to develop two sets of financial estimates: IT transition cost and ongoing IT operating cost. These costs will be affected by differences between the acquirer and acquiree's business models; therefore, a framework is needed to guide financial model development. For absorption and merger of equals, the principle factor affecting costs is the degree of business process integration. Since IT organizations can't see inside potential target companies to evaluate this, one needs a publicly available approximation. Business-unit structure and management style offer such an alternative. Within this, the critical dimension of Publication Date: 16 December 2005/ID Number: G00130975 Page 13 of 65 © 2005 Gartner, Inc. and/or its Affiliates. All Rights Reserved.
  14. 14. decision control as it shifts between the business unit and the enterprise provides a good correlation with the degree of business process/application integration. To keep this simple, we select three models from the spectrum of decision control (see Figure 3) or process integration. At one extreme is centralized management, where decisions and applications defer to the enterprise's needs, typically resulting in well-integrated applications. At the other extreme is decentralized management, where the business unit is in control and the typical result is duplicate applications spread across all the business units. In between is a federal model that selectively shares responsibilities and applications. Cost, value and effort will vary in each M&A and divestiture activity based on how these business model types match up between target and acquiring organizations. Figure 3. Strategic Fit: Business Model Combination Options Decision Control (Process Integration) Centralized Selected Sharing Decentralized (Enterprise) (Federal) (Business Unit) Target M&A Model You Enterprise Absorption Enterprise Federal Equals Federal Business Unit Stand-Alone Business Unit Source: Gartner (December 2005) Between the target and acquirer business models we need to put the M&A model used —that is, how will the merger be implemented? There are theoretically lots of pairings, but only a few will be relevant to your organization. Select a few that best represent the real options to be used in your M&A and divestiture activity, and then develop more-detailed financial models for each. The exception is a merger of equals, where a general-purpose estimating cost model will not work because it's too complex. These are rare events and should be managed individually. Some exploratory thoughts based on acquirer business model: • Enterprise — An organization that has an integrated business model will typically absorb the target. Therefore, the effort required will increase as the target business model shifts from enterprise to federal to business unit. For example, if the same vendor software (for example, SAP or Oracle) is used in an enterprise-to-enterprise situation, then the absorption effort will be straightforward. Publication Date: 16 December 2005/ID Number: G00130975 Page 14 of 65 © 2005 Gartner, Inc. and/or its Affiliates. All Rights Reserved.
  15. 15. • Federal — The shared components are usually at an administrative support level, such as finance, HR or purchasing. Typically, a business unit will make the acquisition and, therefore, will likely adopt the absorption or stand-alone model. A conspicuous exception has been the financial services market, where business models remain federal and the high-profile mergers have executed a merger-of-equals approach. • Business Unit — The principle issue is how many business units in the target and in the acquirer will map to each other. The transition potentially requires disassembly and assembly processes to execute. For example, an enterprise-model target would have to be deconstructed to then be absorbed into the appropriate business units of the acquirer, each with its unique systems. 4.3.1 Constructing Cost Scenarios We introduce the concept of cost scenarios in this stage. The objective of later stages is to refine these estimates and get them as accurate as possible. This methodology is designed to work for the absorption type model only. The stand-alone type will have some IT operations savings, but the savings is typically not large and is only reasonably definable in Stage 3, due diligence. Up to that point, target operating costs represent a conservative estimate of IT operating costs. The merger of equals is too complex in their individuality to be reduced to a dependable cost- estimating model. Stage 3 offers the first opportunity to evaluate reasonable IT merger costs. The best available data to use in estimating IT acquisition costs lies within the acquiring company. By applying Gartner's methodology, the IT organization can develop representative cost models for finance to use in its considerations of target companies. Three unique financial sets of IT data are needed: 1. Capital costs to execute the acquisition 2. Expenses to execute the acquisition 3. Ongoing operating cost We will first discuss baseline cost models and then apply them to the option sets identified by the dashed lines in Figure 3. The methodology uses acquirer cost profiles that are known — that is, the information it acquires itself and adjusts based on the rather limited publicly available information. A foundation set of scalable parameters based on publicly available information includes: • Revenue — Because the target is probably in the same industry, revenue can be translated to the number of transactions that, in turn, drive the scale of the IT infrastructure to support business operations. This represents the basic cost that the remaining parameters would increase or decrease by adding, subtracting or multiplying. • Number of employees — This drives costs associated with the employee desktop infrastructure. It overlaps with the base cost but represents a distinct cost pool and introduces a degree of conservatism. • Geographical presence — This determines the degree of overlap with the acquirer's geography. If a match, then it becomes largely a network and computing capacity issue. The less overlap present poses new issues of extending the network or adding new support capability and, possibly, computing centers, especially if it involves several countries. Publication Date: 16 December 2005/ID Number: G00130975 Page 15 of 65 © 2005 Gartner, Inc. and/or its Affiliates. All Rights Reserved.
  16. 16. • Sophistication — This is an option to introduce a factor to cover the possibility of the target having a better operating environment than the acquirer. It introduces additional conservatism to the estimate. • M&A model mapping — Figure 3 shows the possible complexities that need to be accounted for. Although these five parameters interact, they are valuable for estimating costs. There are two ways to build a financial cost model: designate a value for each variable that can be multiplied by the number of employees, for example, or build a table of representative values for parameter ranges. The single-factor method has a drawback in that it can't recognize the nature of some IT costs not being a straight line, but a series of steps. Using a table enables the IT organization to deal with all the parameters, factoring in subliminal issues surrounding cost buildup while giving the financial people an easily used set of numbers. The model will consist of five tables, one for each of the variables described above. A row in each table has four columns: 1. A variable value range (for example, 1,500 to 2,000 for the employee table) 2. The associated capital cost 3. The associated conversion cost 4. The ongoing operational cost The first step in filling in the tables is to estimate the three cost values for acquiring and integrating through absorption a company like yours. These values become the anchor row in each table from which all other entries are based — that is, scale up or down from your baseline entries. The key to each table is the variable description that defines each row. Determine what is a reasonable cost estimate for that range. When the estimate doesn't seem right for either extreme, then define a new range. The tables based on revenue and employee count are straightforward because they deal with specific numbers. The values in these tables would be populated by estimating absorption costs for companies that are larger or smaller than yours. Geography ranges can be defined by a set of the most likely combinations beyond your base — for example, Western/Eastern Europe or North/South Asia — with their detailed descriptions placed in footnotes. Some combinations may force you to consider placing additional computing centers in other regions. Remember that the basic premise of this model is to provide conservative estimates of potential future costs, not exact costs. Ranges for the sophistication factor could be defined by scenarios describing operational differences known in the industry whose cost value is simply a number (for example, 1.2) representing how much better operationally the acquired company is than your company. These multiples would be the cost variable entries for each row. The M&A model mapping factor is a multiple that increases the costs based on which path in Figure 3 is being followed. The baseline multiple of 1.0 is for the path where you and the target have the same business model. Generate a row for each path that it seems you will encounter, and add appropriate multiple entries for each cost value. For a specific target, the financial staff would develop a cost scenario based on the five tables. • Find the appropriate key description in each table using publicly available information. Publication Date: 16 December 2005/ID Number: G00130975 Page 16 of 65 © 2005 Gartner, Inc. and/or its Affiliates. All Rights Reserved.
  17. 17. • Select the associated costs from the revenue, employees and geography tables and create three subtotals. • Multiply each of these subtotals by their corresponding sophistication factors. • Multiply each of the original subtotals by their corresponding M&A model mapping factors. • Add the two calculated sets of costs to get final cost scenario totals for capital, conversion and operations. Admittedly, these values may not hold up as more is known. For example, capital expenditures are dependent on actual IT infrastructure capacity at the time of acquisition. These are intended to be conservative, initial estimates that will be refined as more information becomes available in later steps. 4.3.2 And Then There is Time The companion to cost is time; however, schedules are one of the most perplexing things to deal with in an acquisition. Management is understandably eager to complete it quickly. They want all the benefits as soon as possible. There never seems to be enough time allocated to executing the merger. However, companies that spend quot;too much timequot; contemplating a deal may lose out to competitors. Logically building a framework on which to construct a hypothetical transition time schedule has great value. The value generated for transition cost correlates to the people time associated with executing the merger. Developing an appropriate divisor that represents the cost of the people pool available will yield project duration. To do this: • Develop a standard employee cost for a fixed duration, such as a month or year. • Develop a standard outside source cost for a fixed duration. • Estimate the number of people who can be made available for the project from each source, inside and outside the company. • The product of each set is summed, with the result being a standard cost for a fixed duration. • Divide this standard cost into the total transition cost and project duration is the result. This is a rather crude method but is relatively simple for a financial analyst to use. Guidelines can be added to alert an analyst to times when IT should be involved with the estimation. 5.0 Stage 2 — Initial Candidate Evaluation This stage begins when a specific candidate has emerged and the bidding process starts. As in Stage 1, in-depth IT information is not typically available, but judicious use of public information can provide educated guesses for inclusion in the financial model. 5.1 Action Items Resulting From Screening Stage 2 starts with a series of steps resulting from the activities performed in the screening phase. These steps include: • Debrief the initial contact, and quot;brainstormquot; possibilities with business development staff. Consider integration with established company priorities. Publication Date: 16 December 2005/ID Number: G00130975 Page 17 of 65 © 2005 Gartner, Inc. and/or its Affiliates. All Rights Reserved.
  18. 18. • Analyze each acquisition candidate to determine whether to proceed, defer action or remove it from consideration. • If the decision is to proceed, consolidate information from the initial contact. • Schedule initial meetings and invite appropriate participants from: • Sales (for example, U.S., Europe and Asia/Pacific) • Marketing • Finance • Legal • Market research • IT organization • HR • Facilities 5.2 Preliminary Analysis In the preliminary analysis, the target enterprise is mapped against the business-unit requirements. Initial synergies, market opportunities, and quot;stalking horsequot; revenue and growth assumptions are articulated. Typical questions you should answer during this phase are: • Does this candidate offer products similar to ours? • What are the gaps, and how significant are they? • To what extent do these products account for the candidate's total revenue? • How much profit is derived from these products' revenue? • Does this candidate sell products in a manner similar to ours? • How do the geographies line up between the organizations? • Is this candidate engaged by us now, or has it been during the past 12 months? • What is this candidate's culture and how is it different from ours? • Will this acquisition lead to market consolidation or will it extend our breadth? • Does this company have a quot;good reputationquot;? • Does it have significant brand equity? • Is any significant legal action pending against this company? • What is the likelihood of retaining key people? • Is there a possibility that some part of the candidate enterprise will be divested? • What does the industry think of the candidate's management team? Publication Date: 16 December 2005/ID Number: G00130975 Page 18 of 65 © 2005 Gartner, Inc. and/or its Affiliates. All Rights Reserved.
  19. 19. • Do our associates know of any adverse reaction to the candidate? In the case of auctions, the process typically involves data access through a third party brokering the deal, on-site visits or, increasingly, through use of restricted-access Web sites. 5.3 What IT Can Do After you've identified a specific candidate, the IT organization can gather more-refined information. For example: • The principal focus is to enhance the accuracy of the financial estimates embedded in the controlling spreadsheet. Because not much more is known about the target, this is the chance to validate the original scaling parameters and change calculations, if appropriate. • If the candidate is in the same industry, you can garner information from contacts in the IT or enterprise community. For example, an employee who participates in a best- practice group with someone from the target enterprise may have valuable insight to deliver. • These contacts may also provide valuable quot;softquot; information, which should be reported to the business development group. This includes information about the target company's reputation, its recognition as a leader in certain areas, or key projects or initiatives that may be exceptional or in trouble. • Some employees may have worked for the candidate and have detailed knowledge of various operations that can be translated into better support cost data. • If there is a potential for divestiture, the associated costs must be added to the spreadsheet. The IT organization should establish a set of assumptions that the business development group can use when analyzing the candidate. Like mergers of equals, the divestiture issue is a relatively infrequent component of M&A. Most acquirers will not offer to buy that part of the company. However, if the divestiture is under consideration, bring the IT organization into the deliberation to get a better idea of the issues and cost. • If it appears that this will be a hostile takeover, remember that quot;hostilequot; is just a term meant to reflect the opposition of the target's board and senior management, and does not extend below that. Because a confrontational attitude will increase the risk of failure during integration, the people involved in the merger must take as nonhostile an approach as possible. 6.0 Stage 3 — In-Depth Candidate Evaluation: Due Diligence Every acquisition goes through a due-diligence process designed to gather the information needed to determine whether and how an acquisition offer will be made. Most early due-diligence activity is hidden from view, but, at some point, it usually becomes necessary for the acquiring organization to conduct an on-site visit with the acquisition target. This is probably the most-important stage for the IT organization, because it provides an opportunity to see how the target enterprise operates its business. From a business perspective, this stage focuses on three main areas: financial, business operation and legal. In addition to examining general due-diligence criteria, this section contains extensive guidance on the IT organization's role in conducting an on-site due-diligence visit with an acquisition target. This will Publication Date: 16 December 2005/ID Number: G00130975 Page 19 of 65 © 2005 Gartner, Inc. and/or its Affiliates. All Rights Reserved.
  20. 20. typically involve three perspectives: IT infrastructure operations, business process/applications and IT organization. 6.1 Due-Diligence Assessment Criteria A typical feature of successful M&A programs is the development of a series of questions or criteria designed to help companies understand the gaps between the acquirer and target organization. This gap analysis should lead to a sense (whether formal or informal) of the size of the integration effort. The ability to make these assessments is the essence of the due-diligence stage. In addition, information is collected to estimate asset value and expose potential risks — financial and operational. Because this stage does not take a long time, IT management can only make educated guesses regarding many of the issues raised. Companies that have a business strategy of growth through acquisition usually have a designated team of M&A specialists and a defined process for integration that can be activated at any point in time. If the acquisition process is always active, then the organizations that are best at acquiring businesses use a corporate project office to keep all the stages of multiple events under control. Gartner recommends that all enterprises anticipating repeated acquisitions as fundamental to their growth strategy should adopt this approach. The foundation of due diligence is a checklist or questionnaire for organizing a comprehensive evaluation of the target's assets, liabilities and capabilities. The IT organization is typically asked to contribute its list to be incorporated into the overall master checklist. Each company will often have additional entries that reflect its specific interest. We used the combined term of checklist and questionnaire because companies often use a questionnaire to solicit target answers before an on-site visit. The checklist points to areas of interest, but it can easily be converted to questions by using phrases such as quot;What does your…?quot; or quot;Provide a list of …quot;. Avoid asking questions that can be answered with a quot;yesquot; or quot;noquot; because for every quot;yesquot; answer, you'll need to ask an additional question. 6.2 What IT Can Do If the IT organization has been engaged in the first two stages, it will be in an excellent position to support the due-diligence stage. Unfortunately, Gartner has found that such prior IT involvement too often has not taken place. More typically, this is the first stage in which IT managers become aware that any M&A activity is under way. As a result, IT managers often have little time to assess and integrate all of the factors that might affect the successful transition and integration of technology-based infrastructure and applications. It is not uncommon for the IT organization to have only two or three weeks for the due-diligence phase of the M&A. In this section, we present a best-practice approach to due diligence, where target access is open, allowing for a reasonable in-depth evaluation to be made. Unfortunately, there are situations where the target company severely restricts access, limiting information gathering activity. For most acquisitions, the IT organization has one opportunity to quot;get it rightquot; — the due-diligence on-site visit. Within a typically tight time frame, the IT organization must develop credible cost and time estimates for executing the integration. It must gain agreement from each functional group regarding what applications will be used, and what modifications will be necessary to effect the transition. The due-diligence visit typically consists of three phases: • Preparation • On-site execution Publication Date: 16 December 2005/ID Number: G00130975 Page 20 of 65 © 2005 Gartner, Inc. and/or its Affiliates. All Rights Reserved.
  21. 21. • Wrap-up 6.2.1 Preparation The following organizational elements should be in place. • Enterprise leadership is committed to a strategic outcome for the M&A. • A senior-management sponsor — an individual or a steering committee composed of business and IT leaders — is responsible for overseeing the M&A's progress. • A business program manager or similar leader responsible to the senior-management sponsor is in charge of the execution of all M&A projects (including IT-related ones). • An IT program manager leads the IT team and is responsible to the business program manager. • A group of IT application specialists is responsible to the IT program manager for the execution of focused projects — for example, functional review, data integration and IT liaison with target for special projects. • An IT due-diligence leader and team, responsible to the IT program manager, consist of all the personnel necessary to assess the acquisition target's IT operating infrastructure and assets. • An acquisition target's team members will serve as interfaces for the acquiring enterprise during the due-diligence visit. Typically, IT organizations that perform due-diligence work most effectively have implemented a reasonably formal process (that is, one that can be repeated and improved on) to integrate their and the target teams' work. Careful preparation prior to the due-diligence visit will maximize the effectiveness of interaction with the acquisition team. Courteous, thoughtful questioning will lead to valuable insights on how the acquisition target operates and will provide a sound foundation on which to make preliminary integration estimates. This visit will typically be a quot;one shotquot; opportunity to get the information needed because access to further information will likely be limited once the visit is over. During the visit preparation, the acquirer appoints a team leader who selects knowledgeable people across the domain of the business processes affected. The acquisition target will usually limit the total size of the team, which can range from 10 to 50 people, depending on the scope of what is being acquired. IT people on the due-diligence team will usually include one or two experts on IT infrastructure, and one to three experts on application software. At this point, the integration approach that will be used should be known, or at least limited to two of the three potential M&A models. • If an absorption approach is expected, the focus is on understanding the changes that may need to be incorporated into the acquirer's systems and processes. • If a best-of-breed approach is anticipated, the focus will be on a strong dialogue between functional counterparts, with the objective of establishing some mutual agreement on which systems are best. A common problem is that this effort can quickly become one-sided because the acquisition target cannot examine the acquiring enterprise's systems. To offset this, a visit can be set up to acquaint the acquisition target's team with the acquirer's systems. Another option is to install some workstations at the acquisition target's site to demonstrate the systems in parallel. Publication Date: 16 December 2005/ID Number: G00130975 Page 21 of 65 © 2005 Gartner, Inc. and/or its Affiliates. All Rights Reserved.
  22. 22. • For the stand-alone option, because the focus is on the quality and integrity of the acquisition target's systems, the approach used will be akin to an audit. The time for on-site due diligence is typically limited to one week or less. Therefore, the acquisition target should be asked to gather essential information prior to the team's arrival. In addition, the acquisition target must be provided with a list of the interviews it will have to set up for the due-diligence team. IT infrastructure interviews are exclusive to the IT organization, but functional interviews should be coordinated with the business function due-diligence teams. Omitting this step will irritate the acquisition target because it is forced to do the same thing repeatedly. In addition, it is poor image management; the acquirer looks disorganized and not in control. Because the IT people needed for the on-site visit are typically not needed for the entire duration of the due-diligence process, they should be scheduled to keep the overall process manageable. The due-diligence team leader should stress the importance of professional and courteous conduct during the on-site visit, and should prepare the team with some rules of engagement. For example: • Remember that acquisition target personnel are likely to be nervous, so it is important to leave a good impression. • Be courteous at all times. • Respect their knowledge. • Don't discuss due-diligence team business in front of the acquisition target's personnel. • Never make negative or judgmental comments. • Never reveal information about your recommendations. • Remember that the target company is evaluating the potential acquirer as well. • The acquisition target will share negative impressions of due diligence with management, which will act to address them. • The wrong attitude can kill a deal. 6.2.2 On Site On arrival, the IT people need to get organized. • Locate the due-diligence team room. Acquisition targets like to limit the mobility of the team members and control their access to employees. An exclusive team room resolves these issues and gives privacy to team members. • Find the requested data, often partially available online. • Confirm the team's plan of operation with the business program manager or due- diligence team leader. • Based on preliminary planning, build a schedule of activities based on availability of the acquisition target's staff. • Meet and talk with the designated application target's lead. Review the process and time frame needed, and settle on a target work plan (what to cover when, and what information is available or missing). Publication Date: 16 December 2005/ID Number: G00130975 Page 22 of 65 © 2005 Gartner, Inc. and/or its Affiliates. All Rights Reserved.
  23. 23. • Confirm plans for functional demonstrations in conjunction with functional teams. • Establish an IT liaison with the acquisition target for supporting special due-diligence team requests. A typical day's activities for the IT due-diligence team leader include: • Prepare data for interviews. • Meet with appointments, and coordinate with functional leaders. • Push to get demonstrations of processes in operation, and obtain information about process details and people. • Develop business process flowcharts for reference by the due-diligence team. • Cycle through team members several times a day to address needs or issues, such as problems with data. • Keep checking off requested data items as they are received and completed. • At the daily debriefing session, meet with the team to refine the financial model and identify areas for further review. Come away with a quot;to doquot; list of IT activities. • Obtain functional members' impressions of application systems, and pinpoint potential integration issues. • Debrief the IT team at day's end and plan the next day's schedule. • In the evening, expand and update the integrated set of process charts, and post them in the due-diligence team room. As a result of data review, due-diligence team members will often request additional data, typically in the form of a report. To avoid traps in technology translation, the team IT support person and the acquisition target's IT liaison should talk to each other. Each group on the due-diligence team is assigned to gather specific information that will be used in the acquisition financial model. For the IT organization, these items include an IT infrastructure disposition, IT staff disposition, and application transition cost and timing estimates. The information gathered will fall into one of four categories: acquisition model financial data, functional knowledge, organization knowledge and quot;deal breakersquot; —items that, in all likelihood are rarely found by the IT organization, will terminate acquisition activity. It can be important for the team to see how, and whether, the business processes interface. Simple diagramming tools can be used to build an overall picture. These process charts can serve as a collective memory to help the due-diligence team build an overall understanding of the total business operation. Effective due diligence is all about asking good questions. Acquisition target personnel may have things to hide, but they will be obligated to answer questions truthfully. In-depth questioning on functional business processes will lead to planning the transition for each set of processes, often resulting in modifications to established systems. Gaining concurrence with due-diligence functional team members is key to understanding the true scope of the eventual acquisition integration. If the company expects to use the absorption model, then it must understand any impact on the target's customers and vendor relationships. The acquirer cannot afford to lose these clients and, Publication Date: 16 December 2005/ID Number: G00130975 Page 23 of 65 © 2005 Gartner, Inc. and/or its Affiliates. All Rights Reserved.
  24. 24. therefore, must evaluate what activities or projects must be completed to ensure client and vendor retention. The eventual list of projects will need to balance ongoing retention efforts and timely completion of the merger. Because most acquisitions require staff reductions, it is important to remember that people- related assessments are an essential part of the due-diligence process. Organizational change costs will be fed into the financial model. Conversely, the due-diligence team should be aware that, because its enterprise may be competing with other organizations that also want to acquire the target, it is being evaluated by the acquisition target as well. Part of the due-diligence team's task is to convince the target that the acquiring enterprise is the strongest candidate with whom to merge; therefore, they will have to reveal something about themselves and their company. When acquisitions become auctions and the asking price becomes inflated, the quality of the acquirer's organization can, to some extent, justify a lower offering price. 6.2.3 Wrap-up After the on-site phase is complete, create a formal report that summarizes the information supporting the early estimates posted to the financial model during the due-diligence visit. Sample sections include: • An assessment of each functional area • Recommendations for transitioning the IT infrastructure • An estimate of the IT resources and time required to effect the transition • People assessments and recommendations for IT organizational-structure changes • Estimates of transition costs 6.2.4 Remember the Strategy When an enterprise strategy emphasizes growth through acquisition, the perspective of what this entails often gets lost when working on a single event. Everyone focuses on getting the acquisition done quickly, while taking as much cost out as possible. Although cost takeout pays for mergers, the real objective is to increase revenue. If the merger model is absorption or stand- alone, then, as each event is executed, the resulting operating environment gets increasingly compromised. In the case of the stand-alone model, duplication of business processes raises the cost of doing business, which lowers revenue and defeats the overall growth strategy. Cost bloating happens in absorption as well, except the constant growth creates scaling problems that eventually erode profit. An aggressive acquisition strategy must keep in the forefront the notion that business operation of this expanding enterprise must be efficient to protect the added revenue being purchased. The solution inevitably involves increased investment in IT projects to build correctly scaled and integrated applications. Unfortunately, this means that each M&A event has to contribute to a fund that is directed at the strategic evolution of applications in support of business operations. This is a true cost of acquisition, but one that is almost always ignored. At the very least, the IT organization needs to keep management aware of the implications of its acquisition strategy. It must present a realistic picture of business operations to senior leadership. The best vehicle for accomplishing this is an IT strategy tied to the business strategy — that is, don't just chase tactical M&A events but keep the overall strategic end game in sight. During the M&A event, the company must balance acting tactically with planning strategically. Publication Date: 16 December 2005/ID Number: G00130975 Page 24 of 65 © 2005 Gartner, Inc. and/or its Affiliates. All Rights Reserved.
  25. 25. 6.3 What to Do When Target Access Is Limited The discussion so far has assumed access to the target, but there are times when that access is limited to a few high-level executives. These executives may not be knowledgeable about daily operation and therefore can't be expected to go to the depths we have presented. The most- important point is that those executives must understand they are being restricted from getting valuable information necessary to estimate the true value of the merger and the cost to execute it. They must understand that critical decisions are being pushed into Stage 5, where time becomes an enemy — the window is limited for executing the operational aspects of the merger. All that we have presented has to be resolved eventually, if not in this stage then in Stage 4 or Stage 5. The work doesn't go away simply because it wasn't done in the appropriate stage. Deferring the effort raises the risk for having to live with uninformed decisions. Because there are degrees for limiting access, there really isn't a magic quot;must doquot; list when in this situation. Be aware of what should be done, and get as much of it executed in this stage as possible. Any information is better than none, and that should be the credo in situations such as this. 7.0 Stage 4 — Closing the Deal During this stage, the deal is consummated, documents are signed and funds are transferred. Execution of this stage is usually assigned to corporate staff, although it may involve external staff. 7.1 Negotiation Negotiation is the process of defining an initial offering price for the target enterprise, and identifying nonnegotiable items (for example, an independent sales force). Factors in determining the initial offering price include: • Continuous and noncontinuous revenue streams • Historical and projected growth rates • Profitability • Impact on earnings per share (including calculations for foregone interest on the purchase price and amortization of goodwill) Participants in the negotiation process are typically corporate and business-unit business development personnel, with support from corporate financial-planning and business-unit management. Negotiation activities include: • Performing a preliminary price assessment • Developing a letter of intent 7.2 Due-Diligence 2 Once a letter of intent has been issued to, and signed by, the target enterprise, a second round of due-diligence activities commences, known as due-diligence 2. This stage includes a detailed look at terms and conditions, an examination of contracts and leases, and a review of detailed corporate financial statements, customer lists, facilities and personnel. Participants include key business-unit personnel, corporate and business-unit business development staff, and corporate departments, such as IT, finance, HR, facilities, sales, production and distribution. Areas of due diligence 2 activity include: Publication Date: 16 December 2005/ID Number: G00130975 Page 25 of 65 © 2005 Gartner, Inc. and/or its Affiliates. All Rights Reserved.
  26. 26. • Final pricing and payment • Terms and conditions • Payment and holdbacks • Management • Operations • Benefits • Employment letters 7.3 Transition Planning Transition planning begins during the initial due-diligence phase, and continues in parallel with negotiation and due-diligence 2 activities. The objective of transition planning is to develop product, operating management, budget and marketing programs for the integrated entity. Participants in transition planning include personnel from all corporate departments and business units affected by the acquisition. Areas of transition-planning activity include: • Management and staff issues • Senior management • Analysts/consultants • HR • Benefits transition • Public relations • Investor relations • Finance • Payroll • Accounting • Operations • Production • Facilities • IT organization • Product marketing • Product planning • Product integration • Branding Publication Date: 16 December 2005/ID Number: G00130975 Page 26 of 65 © 2005 Gartner, Inc. and/or its Affiliates. All Rights Reserved.
  27. 27. • Pricing • Distribution • Sales • Sales force integration • Sales management • Quota impact Tactical guidelines for effective transition planning include: • Use speed to counter anxiety and reduced productivity — that is, keep everyone busy. • Don't try to understand everything. Instead, focus on the main issues, applying the 80/20 rule (80 percent of what is important will be represented in 20 percent of what needs to be done). • Decision making is key, so organize to get decisions made quickly. Don't become a democracy — there isn't time. • Keep everyone informed of what is important. If the deal is global, this communication must be sensitive to cross-cultural issues. • Resolve organizational-structure issues as quickly as possible. People need to feel comfortable with how they fit in, and often see their value to the enterprise in these terms. • Strong leadership throughout the M&A process has proven to be one of the most- significant determinants of achieving expected results. 7.4 What IT Can Do The principal role for IT in this stage is to be the integrator among all the operating and administrative groups involved. The IT systems that support their processes form the framework for the eventual execution of the merger. The more IT can engage all the parties in serious, detailed planning, the higher the probability for eventual operational success. Obviously, a successful execution of Stage 3 lays a solid foundation for what needs to be done. Unfortunately, Stage 3 activities are often overlooked in many mergers because senior management views price negotiation as the sole remaining obstacle. IT organizations, along with its business partners, must keep applying pressure to execute as much planning at this point as possible. The single point of leverage is to talk about money, the language of Stage 4. Executing the planning activities will lead to a more-refined understanding of true transition costs that, in turn, can refine the acquisition's financial model. Most acquisition activity relies heavily on assumptions, and the more integrated planning and thinking that takes place, the more likely it is that any falsehoods underlying these assumptions will be exposed. Such falsely supported assumptions are the place where most cost quot;surprise packagesquot; will be hiding. All the analysis, assessment and planning finally makes its way to the schedule. For M&A projects, this schedule is effectively unchangeable once stated. The enterprise has too much riding on getting it executed in the time frame announced/implied to the marketplace and those being bought. The unvarnished truth is slippage, which senior management typically views as failure. Therefore, it is essential to scope out the schedule as realistically as possible and to involve all the stakeholders. Regretfully, scheduling is typically done before the merger is Publication Date: 16 December 2005/ID Number: G00130975 Page 27 of 65 © 2005 Gartner, Inc. and/or its Affiliates. All Rights Reserved.
  28. 28. finalized, once again emphasizing the critical nature of planning in this stage to shore up the practicality of public pronouncements made by management. 8.0 Stage 5 — Executing the Merger/Acquisition A common recommendation is to move quickly in executing Stage 5. Reasons for proceeding as expeditiously as possible include: • High-cost takeout creates uncertainty in the operations ranks, lowering efficiency and effectiveness. • Speed helps avoid getting caught up in lengthy decision cycles that give the appearance of losing control. • Communication, a major problem for any merger, is easier because it is always focused on doing things now and not at some vague time in the future. • Speed instills a sense of momentum that, in turn, means there will be an end. • Speed impedes competitive reaction by reducing the window of exposure. • Realizing merger value is critical. An A.T. Kearney study underlined the speed issue, finding that nonmanufacturing deals reaped 85 percent of all merger synergies in the first year and only 15 percent in the second. After that, the deal yielded negative returns. Similarly, manufacturing results were 70 percent and 30 percent. In some cases, a slower, more-gradual transition approach can be successful. This is particularly true when the merger of equals (that is, best-of-breed) model is used. Such an approach needs powerful vision at the top and strong backing along the way. It requires an acquisition price that doesn't need to be justified with a high-cost takeout. The lower the number of people facing termination, the more likely it will be that a stable transition can span an extended period and remain focused on creating a better operation and business model. Whether the slow or fast approach is appropriate depends on senior management's objectives for the M&A event. Regardless of which approach is used, keep the following pointers in mind. • Attack fear. It undermines everything. • Watch for inconsistencies with what has already been stated. It is important that management's quot;storyquot; remains consistent with integration actions. • Develop an integration process that responds to the situation, adapting to the uniqueness of each M&A event. The companies most adept at this view integration as a collection of processes, out of which a unique process set will be applied to the transition based on the nature of the transaction. • Speed is relative; it can kill. Some decisions should be made quickly, especially those that set the bounds for integration planning. However, the balance between moving quickly and taking the time to make the right decision is a delicate one, and the group must recognize that some decisions deserve more time. • Build in reverse communication. That way, the organization can be monitored to see if it is approaching its capacity for change. As capacity is being closed, noise levels and complaints build; but when actually reached or exceeded, everything often suddenly becomes quiet. Publication Date: 16 December 2005/ID Number: G00130975 Page 28 of 65 © 2005 Gartner, Inc. and/or its Affiliates. All Rights Reserved.
  29. 29. • Use an acquisition dashboard. Monitor progress over four metric areas: customers, employees, economic benefits and project risks. 8.1 The Integration Process Stage 5 is complex and encompasses the most time and activity of the six stages. To better understand what is involved, this stage is best divided into four phases, each of which affects the others. 1. Integration planning: Conduct intensive planning for business and IT projects and to resolve personnel-related issues. The planning done in Stage 3 and Stage 4 sets the foundation for this phase. 2. Early projects: Focus on early transformation projects to achieve momentum (for example, infrastructure, finance and HR). 3. Operational business process projects: Tackle all the IT components of operational business transformation. Everything has been leading up to this. 4. Employee projects: Prepare employees for the new operational environment. 8.1.1 Integration Planning Planning that wasn't accomplished in Stage 3 and Stage 4 has to be addressed here. If an integration manager hasn't been appointed by this point, selecting one will be the first order of business. The choice will depend on the merger model being used. If absorption is used, then no entity survives from the target. In this case, a manager is only needed for the duration of the project. If not treated correctly, candidates from the business can view this as a temporary halt to their careers — that is, their peers in operating business units could be seen as still moving forward. To entice the best candidates, the enterprise needs to position this role as a stepping stone to a promotion. For example, if a new combined entity is being created, this position could be positioned as an audition for the new business-unit manager job. An alternative is to draw on highly experienced retirees who like the idea of occasional three-to-nine-month projects. Integration managers practice project management, but not necessarily the traditional variety. People don't report to them, and they have direct access to senior management. Their responsibilities are to organize and define the process, facilitate integration, work with people and keep everything on schedule. Unlike traditional projects, M&A integration activities often lack detailed plans at the outset. Many things get worked out in detail as they progress, and simple methods are required to manage the rapidly changing direction. The integration manager's job is primarily about managing people: getting them to understand what needs to be done, and being creative and supportive in helping them execute the tasks. Project management can make or break a merger. Good project management is at the core of avoiding poor execution, while poor project management is one of the major reasons that mergers fail. 8.1.1.1 The Core Transition Team A core transition team must be appointed. This team should include representatives from all affected business operation and administrative areas. It is essential that each of the members of the core team is capable of making most decisions on behalf of his or her assigned responsibilities. Some of the bigger decisions (for example, involving money, affecting many people or altering the schedule) will get bumped up the management chain. If members are chosen too far up the management chain, they often won't have the Publication Date: 16 December 2005/ID Number: G00130975 Page 29 of 65 © 2005 Gartner, Inc. and/or its Affiliates. All Rights Reserved.

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