Grow Globally: The New Altitude of Cross-Border M&A

An article by Mona Pearl

Executive Summary


• Three out of five cross-border M&A deals do not live up to expectations, mainly due to culture clash, poor due diligence, and contrasting management styles.
• With the growing trend of cross-border transactions, post M&A failure can be eliminated with systematic M&A due-diligence.
• While most firms focus on fundamental “hard” challenges such as infrastructure, EBIDTA, ROI, and more, 80% of the risks associated with international M&A derive from “soft” challenges such as cultural integration.
• The skills required to negotiate successfully in one’s own country do not necessarily translate to success abroad. The key is to identify which skills cross over, which skills require retooling, and which skills are simply missing from the toolbox.
• Knowledge and understanding of the business operations and finance of the target company, no matter how in-depth, will not compensate for lack of cultural understanding in the negotiating process.
• Successful negotiations only occur when both sides understand and trust each other and are willing and able to engage in a process of meaningful information exchange. Therefore, getting the right advisory team to help with focal points and issues in different regions of the world is crucial.
• From the very first stages of negotiation, and certainly before a letter of intent has been entered into, the parties in a cross-border transaction must think carefully about their legal assumptions and question whether they apply before coming to the negotiating table.
• Following basic guidelines will help prevent late-stage cultural problems from derailing an otherwise sound international M&A transaction.

Introduction

Companies choose to undertake a merger or acquisition (M&A) for a variety of strategic reasons: to access new markets and expand their global footprint, obtain new technology, new brands, complementary products, access to experienced management, or to remove a competitor or potential competitor. Over the past decade, M&A activity has increased substantially as this route is a natural progression for businesses that are gaining experience and confidence abroad. The global crisis did further fuel the M&A frenzy as sellers are generally more distressed and, therefore, more inclined to consider this route. Also, there is less competition from buyers in the seller’s home country, and, most importantly, prices have fallen to attractive levels.

However, the picture isn’t as rosy as we may wish to see. Rise up, stretch, and rub the green dollar signs from your eyes. Three out of five deals do not live up to expectations, mainly due to culture clash, poor due diligence, misalignment of strategic goals with the market reality, and contrasting management styles, but also to a myriad of other pitfalls.

This article serves as a focal point for businesses planning to enter into the world of M&A, as well as a troubleshooting guide for the ones already working in that space who are having difficulties. Success is considered to mean a post-M&A integration of both companies where they continue to do well by capitalizing on growth while pursuing as well as adapting the goals they planned to pursue at the outset. Successful companies integrate M&A with a strategy that starts with due diligence and continues through negotiations to a post-integration phase that has been investigated and planned ahead. So, how should companies avoid the hasty pre-deal planning that turns so many of today’s M&A transactions into disasters?

Strategic Alignment

For some, the world is flat; others say it is a bumpy and curved world. Whatever the terrain, there is one major change that companies are having an extremely hard time planning for: designing a new kind of global strategy which focuses on the ability to change in almost a moment’s notice, and still maintain the action plan as an integrated unit. Sounds like a contradiction? Maybe, but it is the new reality as events in the world force companies to redefine the meaning of strategic planning, and therefore, the way companies should see the global playground.

For many companies, cross-border M&A is a new altitude they need to manage. Like high-altitude climbing differs from many other pursuits because of the constant threat of danger and potential death, so do many successful leaders in national markets feel about global markets; the potential risk, the daunting idea of failure, and the unknowns. The difference is that elite high-altitude climbers mentally prepare for the climb while maintaining an effective focus on the mountain. They keep their eyes open, looking up, reaching the new altitude. They know they need to acquire new skills to reach the top.

Due Diligence

Start With the End Game in Mind
Pursuing expansion and growth in the global market requires a whole new realm of due diligence and risk assessment, or should we relate to it as opportunity assessment? That’s proving to be a significant obstacle for most businesses. Acquiring or merging with a foreign company is much more than a business deal based primarily on the numbers. In fact, the numbers are generally known well in advance and rarely become deal-breakers later in the game. Rather, the critical issues in the due diligence phase (though it does include some aspects of valuation) are strategic and cultural in nature. Success in this area requires dealing effectively with differences in corporate culture, maintaining the loyalty of the employees, stakeholders, and customers of a foreign company, and gaining an understanding of that company’s human and business values.

While most firms focus on fundamental “hard” challenges such as infrastructure, EBIDTA, ROI, and more, 80% of the risks associated with international M&A derive from “soft” challenges such as cultural integration. Understanding a corporate culture along with the culture of a country or region play a crucial role in determining the long-term success of an M&A deal.

As we face a higher volume, a greater degree of complexity, more competition, and change that transcends borders, industries, and disciplines, companies will need a new kind of expertise to thrive in the new reality. How will you fill the gap? More people, different people, or a different way to operate?

Today, most companies are operating in a manual-like, old-fashioned way: follow the crowd, neglecting to align company capability with target market. The degree and complexity has never been greater, and it is going to grow, so how about simplifying your approach and adapting it to the new altitude? What does it really take?

• Understand your market and the altitude of your customer, decision makers, and other crucial factors.
• Know how to attach the importance of global strategic planning to some of the converging factors that are going on.
• Deal with disruptions in the business level: how do you plan to utilize them and pull them through?
• Are you going to engage in “trendjacking”? Either create your own trend and deliver on it or trendjack an existing one?

Do you know enough?

Due diligence on a global scale requires a company to go beyond traditional M&A work and consider variables that may be unfamiliar to most companies and business people. It means obtaining relevant, detailed information and advice concerning the political, national, corporate, and human culture of the target company, as well as the ability to interpret the relevance of this information to their business operations. This means using a holistic approach that can be painful at times. The information, sometimes imperceptible for some, for others are very clear; but it requires careful interpretation if it is to be transformed into a road map.

This is an area where doing things the way you are used to just may not work. There is a need to operate and think different than in-country. Ignoring or misunderstanding these issues can leave a company’s M&A initiative dead in the water.

Start Looking in the Right Places

Contracts, labor and employment law, profits, EBIDTA, and potential ROI may be obvious matters, but these considerations represent just the tip of the iceberg—the visible tip. Underneath the water and hidden from view is where real danger lurks. For example, there are a myriad of less well known social norms, including methods of communication, chains of command, power relations, ethics, and pace of life, to name just a few. In many countries it’s important to understand seniority and to whom questions must be addressed. With so much at stake, it’s worth the investment of resources to prepare, train, and develop those who will be conducting the due diligence abroad as well as making sure that they will ask the right questions and look for the answers in the right places.

Better still, engage an expert to help anticipate probable issues so that preparations are completed properly and surprises are eliminated.

Cultural Due Diligence

While all M&A require bridging the differences between corporate cultures, this exercise becomes even more daunting when you add in the effects of national cultural differences, distance, and language barriers.

In many cross-border M&A deals, the effort involved in cultural integration proves more difficult and just takes longer than expected. Part of the problem stems from the strictures of “political correctness,” which discourage any overt references to national differences out of a fear of creating offense. Other problems arise from a lack of understanding of the basic rules that govern how business is conducted in different cultures. For example, when working with Japanese colleagues, anyone who fails to understand the importance of maintaining the appearance of harmony and agreement (even when neither actually exists) risks creating serious discomfort among coworkers or causing offense at meetings with behavior that would otherwise be viewed as perfectly acceptable.

Factor In

Too often, the real difficulties and challenges of M&A surface months after deals are signed. Then the tough questions—that should have been addressed in the front-end due diligence process—start flowing. For example:

• How will this newly acquired enterprise be integrated into the existing company?
• Will it operate independently or as a division?
• How will the integration be made as smooth and seamless as possible?
• How will the acquiring company deal with duplicate departments, systems, and vendors?
• How will the new business be operated the day after that deal was sealed?
• Will this organizational structure produce loyalty?
• Will the employees and managers stay?
• What will the local reaction be to any proposed changes?
• What is the new competitive landscape?
• Determine how the target company operates in a broader, human-capital sense.
• How will its customers and employees view a foreign company moving on to their turf?
• What is the work ethic of the employees?
• How is productivity viewed, measured, and maintained?
• What is the management style in the country, region, and of the company?
• Which are the company’s main competitors?
• How stable is the political environment?
• Last but not least: are there any FCPA issues that may arise as a result of the above points of reference?

The answers to these questions and many others come from gathering the right information through due-diligence in a cultural context, and having a strategic plan, i.e. how will the company operate in the new structure from day one?

Companies need to look internally at their strengths and weaknesses in relation to their action plan. That means evaluating corporate resources, manpower, internal knowledge, and their own culture (perception, loyalty, motivation) before determining whether expansion opportunities are viable and warrant penetration into new markets.

Negotiation

The Importance of Cultural Tune In
Beware: the skills required to negotiate successfully in your own country do not necessarily translate to success abroad. In fact, past strengths can be future weaknesses on the international stage. The key is to identify which skills cross over, which skills require retooling, and which skills are simply missing from the toolbox. Most importantly, business people should never assume that knowledge and understanding of the business operations and finance of the target company, no matter how in-depth, will compensate for lack of cultural understanding in the negotiating process. It won’t. Cultural awareness is no longer a nice skill to have; it’s essential for success overseas.

For example, negotiation, as it is understood in the United States, is the process by which interested parties resolve disputes, agree on courses of action, bargain for an individual or collective advantage, and attempt to fashion outcomes that serve mutual interests. Internationally, however, negotiating has much more to do with understanding people and their customs and developing relationships. Unfortunately, many US executives are unfamiliar with this dance and mistakenly launch directly into the technical phase of negotiations. Such short-circuiting of the negotiating process will lead to frustration, disappointment, squandered resources, and lost opportunities.

The Art of Negotiating Across Borders

After months of preparation to enter the global marketplace—including extensive market analysis, identification of a target market, numerous product modifications, and the development of an elaborate market entry strategy—it’s finally time to seal the deal! But not so fast. Sealing that deal successfully will require tremendous finesse in terms of international negotiation skills. The fact is that cross-cultural negotiations can make or break even the most carefully executed global expansion efforts. Not to mention, for example, that both Asian and European countries have, as a matter of survival, developed expertise in negotiating in an international marketplace and are light-years ahead of the United States in this proficiency.

Be Aware of Differing Legal Frameworks and Assumptions

In significant cross-border transactions, the parties will almost always be assisted by legal counsel who can help their clients with negotiations. These advisors can be invaluable, as they bring experience, as well as specific legal knowledge, to the negotiating table.

That said, it is important for a business person to understand his or her own relationship with the foreign legal framework and to constantly question the assumptions at work. Although we tend not to think about it, we carry our legal culture with us. In other words, while most sophisticated business people understand that laws and accounting rules may vary in foreign countries, they tend not to focus on the fact that the legal assumptions underlying transaction negotiations also vary. The result is that even when assisted by top legal counsel, business people may not be able to use them effectively because they do not question their underlying assumptions about the legal framework.

This can best be illustrated by example. In the United States, one of the basic assumptions that business people bring to the negotiating table is that “freedom of contract” prevails. In other words, by and large they assume that if the two parties willingly agree to certain terms and conditions, they can be enforced. It is therefore an unpleasant surprise for the US business person when he or she finds that certain agreements entered into are unenforceable—even if the other party wants the agreements enforced as well. In specific instances, legal counsel will advise on the applicable law, but by that point the business person may have lost negotiating power on the issue involved. Having gotten the foreign party to agree to a particular issue after long negotiations, they must now throw out their agreement and start from scratch!

In emerging markets, increasing wages and social benefit obligations may not be deal breakers, but it is critical that these and other human capital costs be included and played under several scenarios for a number of years if a buyer is to get a more realistic picture of a target company’s value and of future integration issues. The lack of transparency combined with the greater overlap between political, regulatory, and economic policies in emerging markets adds to the nature of unpredictability, and therefore requires more due diligence, data points, and sensitivity to cultural nuances.

The more a country falls into the category of emerging market, the more likely it is that political red tape will slow the pace of progress, as well as labor laws that may vary from one jurisdiction to another. Other issues may include the limit on the number of foreign nationals that can be brought in to assume key responsibilities, and there is of course the issue of local employee loyalty and how to maintain it. US firms face the Sarbanes–Oxley issue, since most companies in the emerging markets are not obliged to comply with that regulation.

All of this means that from the very first stages of negotiation, and certainly before a letter of intent has been entered into, the parties in a cross-border transaction must think carefully about their legal assumptions and question whether they apply before coming to the negotiating table. Legal counsel can certainly assist in this endeavor, but it is up to the business person to raise the issues in a timely manner. Such successful negotiations only occur when both sides understand and trust each other and are willing and able to engage in a process of meaningful information exchange. Although it may sound simple, it isn’t.

Post-Merger Integration: Can It Be Done?

Most international deals fall through in the later, integrative stages of a merger or acquisition. Initial price negotiations, while certainly important, are rarely, if ever, the primary reason for failure. More often than not, it is the cultural evaluation of a target company that creates problems. Will its employees remain loyal? What motivates them? How about the customers? How will these issues affect operations and the business’s chances of future success?
A well planned post-M&A integration enables:

• companies to achieve business objectives;
• the business to grow more rapidly.
Failure at this stage causes:
• lost customers;
• lost employees;
• lost focus on the core business;
• damaged image in the marketplace;
• reluctance to undertake future M&A deals.

Years ago Michael Porter argued that most cross-border ventures were bound to fail mainly due to cultural issues. To emphasize the cultural effect, Prof. Geert Hofstede says that culture is more often a source of conflict than of synergy. Cultural differences are a nuisance at best and often a disaster. Integrating after an acquisition is hard, and is the reason that failure is common. This is especially true since it involves emotional and personal factors that are embedded in one’s cultural background and beliefs. The facts of the matter are that:

• Two years after an acquisition, the vast majority of acquisitions fail to meet pre-acquisition objectives.
• Three years after an acquisition, a mere 12% of companies grow more quickly than they did before.

Unsurprisingly, it has become a widely accepted belief that the rate of success in the post-merger phase remains poor because of the difficulties of culturally integrating the two companies involved. Constrained by the limited time in which it has to obtain results and by lack of planning, the acquiring company seeks to imprint its own culture on the acquired company. It seems as if the challenging issues come as a surprise, rather than being addressed during the due diligence stage.

Avoid Cultural Pitfalls and Seal the Deal

Here are additional basic guidelines to help prevent late-stage cultural problems from derailing an otherwise sound cross-border initiative:

• Practice cultural due diligence. Determine how the target company operates in a broader, human-capital sense. How will customers and employees view a foreign company moving on to their turf?
• Align internal and external teams in order to preserve continuity and create a healthy foundation for collaboration.
• Make a strong commitment. Peter Drucker once said that “Unless commitment is made, there are only promises and hopes…but no plans.” Management must be on-board 100%—on both sides! Developing an international market requires enormous energy, knowledge, managerial buy-in, and an understanding of business practices in other countries. Few, if any, companies have the resources to go it alone. They’ll need a global lens and the assistance of people experienced in global business transactions.
• Be humble. The brash, pushy approach of the rugged American business person doesn’t cut it in the global arena. Successful international business leaders possess a quiet, respectful humility combined with a passion for learning, understanding, and even practicing how people in other cultures live, work, and like to be rewarded. Customers in different countries have unique ways of relating to products and services. Their lifestyles vary greatly, along with their values, priorities, and buying habits. Savvy international business people blend in and adapt to the cultural norms of whatever market they’re serving. In this respect, cross-cultural or intercultural adaptability as a corporate principle is an absolute requirement for business survival and long-term profitability.
• Educate your people on cross-cultural communication. Research shows that communication between culturally different organizations is often plagued by prejudice and stereotyping on the part of the acquiring company’s managers. Poor or insensitive communication between managers and the target company’s employees can absolutely derail an international venture’s chances of success. On the other hand, with proper cross-cultural training, these problems can be minimized or prevented altogether.
• Get help. Seek guidance from an experienced, hands-on international business expert—someone who thoroughly understands how to do business internationally and in that specific region. Such a professional should be keenly sensitive to the national and corporate cultures of both the client and target countries. For example, what does it mean when foreign business executives go quiet at a key meeting? Are they in agreement? Disagreement? Feeling insulted? Or just trying to hide their laughter? How does the country’s ethical system differ from your own country’s? Is corruption rampant? Will you be competing with businesses owned by relatives of the country’s president? (Good luck—you’ll need it!)

Although there are no guarantees in any business venture, the right international business expert can make a dramatic difference to one’s ultimate success.

Conclusion: Walk the Walk, Talk the Talk

So you identified the target to acquire, and your corporate development person and CPA made sure the numbers work. Then your attorneys made sure you comply with the legal guidelines, and your tech people figured a way to integrate the systems. Most chances are that the major hurtles are still to come. Cultural disconnects are among the leading causes of failed M&A, which then leads to major losses and can be one fundamental that can make or break the deal. How does a company determine what’s important/material? A company needs to understand the business strategy and how to run it in the target country; how the strategy is implemented and how its key stakeholders are related to the strategy—customers and markets, products, vendors, employees (operational, technical/engineering, etc).

Don’t neglect to ask the right questions, do research, gather data, and analyze information carefully in order to establish a specific strategy and a comprehensive plan for international expansion and integration. Neglecting these is why more than half of global M&A ventures end in failure, squandering valuable resources.

Companies need to be prepared, ready, and willing to get in the game wherever opportunity presents itself around the world. Once you are there, get in tune with the culture. Be ready to learn, be willing to observe, and be accepting of new ways of conducting business. Inevitably, this new dynamic will put certain companies up against companies from other nations with far more international experience. But that’s no reason to hold back. As you gain experience and master the ability to analyze, assess, evaluate, understand, and negotiate with other cultures, you too will become a fierce competitor in the world marketplace.

Penetrating, developing, and operating in international markets require an entrepreneurial philosophy and drive—the same kind of philosophy and drive behind every successful startup business. Companies must develop highly flexible business models that enable them to respond to new opportunities and threats. A new process for planning and continuous assessment, to include new tools and an elevated approach, will be necessary for success in the global arena.

When trying to reach a higher altitude, you need different equipment with you to better navigate, view, and move forward. Also, not everybody can operate at a different altitude. From the lowest place in the world to some with the highest elevation, people react in different ways: hypoxia, fainting, blood pressure, and so on. It also takes time to acclimate, and again, people need different timeframes. So, when we apply this logic to the business world, companies need to prepare for this new altitude: make sure the company has the necessary resources to make it; practice and train while being nimble and flexible.

More Info


Books:
Buono, Anthony F., and James L. Bowditch. The Human Side of Mergers and Acquisitions. Managing Collisions Between People, Cultures and Organizations. London: Jossey-Bass, 1989.
Hofstede, Geert. Culture’s Consequences: International Differences in Work-Related Values. Beverly Hills, CA: Sage, 1980.
Marks, Kenneth H., Robert T. Slee, Christian W. Blees, and Michael R. Nall. Middle Market M&A: Handbook for Investment Banking and Business Consulting. Hoboken, NJ: Wiley, 2012.
Pearl, Mona. Grow Globally: Opportunities for Your Middle Market Company Around the World. Hoboken, NJ: Wiley, 2011.
Rosenblooum, Arthur H. Due Diligence for Global Deal Making: The Definitive Guide to Cross-Border Mergers and Acquisitions, Joint Ventures, Financings, and Strategic Alliances. Princeton, NJ: Bloomberg Press, 2002.

Articles:
Brannen, Mary Yoko, and Mark F. Peterson. “Merging without alienating: interventions promoting cross-cultural organizational integration and their limitations.” Journal of International Business Studies 40:3 (April 2009): 468–489. Online at: dx.doi.org/10.1057/jibs.2008.80
Capron, Laurence, and Nathalie Pistre. “When do acquirers earn abnormal returns?” Strategic Management Journal 23:9 (September 2008): 781–795. Online at: dx.doi.org/10.1002/smj.262
Porter, Michael E. “From competitive advantage to corporate strategy.” Harvard Business Review 65:3 (May 1987): 43–59. Online at: tinyurl.com/434jzzl

Websites:
Association for Corporate Growth (ACG): www.acg.org
Geert Hofstede Cultural Dimensions: www.geert-hofstede.com
ISI Emerging Markets DealWatch: www.securities.com/dw

Written by Ellie MacKenzie

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