An analysis of 2,500 acquisitions by LEK Consulting shows more than 60 percent of them destroy shareholder value. Yet many corporate leaders continue to feel compelled to pursue growth through mergers and acquisitions, reasoning that failing to increase scale poses equally dangerous risks.
"Perhaps such deals should come with an official warning: 'Acquisitions can result in serious damage to your corporate health, up to and including death,'" Alan Lewis and Dan McKone, managing directors and partners at LEK Consulting, wrote in a recent article published by the Harvard Business Review.
According to their research, the problem lies not in the high volume of M&A deals, but that oftentimes executives don't pay enough attention to the evaluation process that serves as a foundation for these deals. As a result, they often "get deals wrong."
"For instance, despite the importance of accurately identifying and calculating company synergies, diligence work frequently results in an overly optimistic view of the revenue synergy opportunity," Mr. Lewis and Mr. McKone wrote. "Often the weakest assumptions involve estimates of how much additional revenue the companies can generate when combined. This, in turn, leads bidders to overpay."
Here are two questions to consider when assessing if M&A is the best strategic option.
1. Would M&A help consumers complete their "journey"? According to Mr. Lewis and Mr. McKone, the straightest path to accelerated growth with the lowest risk usually comes from creating new products and services that leverage a company's existing resources, customers and capabilities. When considering a merger or acquisition, it should be clear how an organization will be able to expand its offering to its core customers, and that the capabilities to deliver on this potential rest in the other company.
"These acquisition synergies worked because they leverage what we call a 'journey edge' — a place where current offerings can be expanded in subtle but logical ways along the fuzzy demarcation between existing product definition and customer receptivity," Mr. Lewis and Mr. McKone wrote.
2. How is the deal using our foundational assets to create value in a different context? The discipline behind what Mr. Lewis and Mr. McKone call "enterprise edges" can be defined by asking the question, "Who besides a competitor would pay access to my assets?" This line of thinking helps leaders identify new revenue streams by challenging them to think of where else assets that are intended to serve a company's core business could be utilized.
"To test this framework in the M&A context, we ask, 'In the absence of a deal, would the acquiree pay for access to my assets?' This relatively simple approach is actually a powerful tool to help confirm or deny the potential for synergies," the authors wrote.