CEOs and investment bankers love to talk about, and do, mergers. So do journalists. A big combination of two companies gets people all excited. There is always a lot of talk about how "synergy" will allow the two companies to be worth more combined than they were worth independently. Yet, there are no academic studies that prove this point. Quite to the contrary, academicians will tell you over and over that the synergies don’t appear, and the combined companies are worth less than they were worth independently. Usually quite quickly. So, if CEOs like to make these deals – why don’t they work? Why does Mercedez Benz buy Chrysler, only to see the value plummet and eventually sell the company off to a private equity firm?
Let’s take a look at AOL/Time Warner (see chart here). In the 1990s these two companies were leaders in their markets. AOL had pioneered internet access to the home, and was clearly #1. Time Warner had become the dominant player in cable television, also #1. Both were growing at double digit rates. To the CEOs, investment bankers, and most onlookers putting these two entities together brought together the best of both markets – creating a no-lose media company destined to be pre-eminent in the next decade. But the cost of the merger ended up far outweighing any benefits. The value of the combined company plummeted. Worth almost $100/share in 2000, today the equity trades for about $15/share (an 85% value decline.) Billions of dollars in investor equity was wiped out. And today as AOL tries to revive itself as an internet player it is derisively referred to as "AO Hell" or "Albatross OnLine" (read about AOLs newest move here.) Why didn’t the great media company that was predicted develop?
All businesses have Success Formulas. Whether profitable or not, whether growing or not, all businesses have Success Formulas. These Success Formulas are a nested, tighly integrated combination of the business’s very Identity, it’s Strategy for growth and the Tactics which support the Identity and the Strategy. All behaviors, internal sacred cows, hierarchy and organization, decision making systems, IT system, hiring procedures, asset utilization programs, metrics and costs are organized to support that Success Formula. The business isn’t an ideological being as often described by executives or journalists – it is a very tightly-knitted Success Formula operated day in and day out, every day, in pursuit of doing those things that made the business grow.
In a merger, the two business Success Formulas collide. As sensible as a combination may be, as powerfullly as they share customers, as efficiently as they may use the same infrastructure, as aligned as their strategies appear, they have two different Success Formulas. And when it comes time to merge – neither simply disappears. Suddenly, to achieve the great projected value, it is expected that some kind of new Success Formula will appear that achieves the lofty future goals. But how will that happen? These Success Formulas grew out of years of development during the businesses’ growth. This sudden combination is no substitute for the evolutionary development of a Success Formula. At the time of merger, regardless of the size or success of either business, they two suddently confront themselves as two gladiators in the colliseum. Which will reign?
And that is when things go wrong. The only way the desired value can be achieved is if a new entity is created that actually develops an entirely new, third Success Formula. But given the high stakes, who wants to take the time to develop this? Who believes they can afford to define a new Identity, to craft a new Strategy out of market success, and to build a whole new set of Tactics that support the new Strategy? Who will set up White Space to start bringing together pieces, testing the development of anything new and putting plans against the rigor of market acceptance? The CEO and investors want results – and now!!! So what happens? Inevitably, one of the Success Formulas gets picked as the winner (usually by the new CEO), and that one sets about to convert the other entity into the "designated winning" Success Formula. At this point, many of the value creators of the losing Success Formula disappear. People leave. Products are dropped. Customers, or whole markes, are dropped. Manufacturing and service systems are eliminated. Very rapidly, the exercise becomes a cost-cutting frenzy as two of everything is converted to one. And the "winner" becomes a subset of what the two starters brought to the merger.
At AOL, Time Warner bought AOL. The Time Warner guys remained in charge. Pretty quickly, they set about converting AOL into a Time Warner Success Formula. And in the fast-changing internet world, AOL quickly started losing value. Time Warner froze AOL into place as a dial-up service with specific extras. They flooded mailboxes with CDs begging people to sign up for a free 3 month service. But as bandwidth expanded, and Comcast along with the phone companies installed broadband to more and more homes and businesses, the value simply evaporated out of AOL. Time Warner remained Time Warner, but AOL soon became an out-of-date internet dinosaur.
Creating value via merger is a very tough thing. One company, ITW, does it very well (see chart here). But ITW doesn’t try to put its acquisitions onto common systems, or bring them into one operating unit. ITW is quite unique in allowing its acquisitions to create value out of their markets as they see fit. Most CEOs can’t stand this sort of independence, and they move quickly to convert the merged company into the Success Formula of the acquirer. And within months, much of the value originally sought is gone. Just like at Time Warner and AOL.