Cultural Due Diligence:
A specialist communication service for M&A transactions
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With one in three mergers failing for cultural reasons, professional communicators have an opportunity to counteract the trend by offering a proactive diagnostic service.
It is everywhere to be seen but cannot be described. It belongs to all of us but is owned by none of us. It is impossible to value and yet we all regard it as precious. It is, by general consent amongst communication specialists, the reason why approximately a third of mergers fail.
It is culture.
Does your company tolerate lunchtime drinking? Does it have a dress-down Friday? Does it expect you to take work home over the weekend? These are all examples of corporate expectations, which generate powerful behavioural patterns. There may be nothing in your contract to stipulate conformity to such codes, but they help define your day-to-day experience of the organisation for which you work. More important, they help define the experience of the organisation which you in turn convey to customers.
Now, your boss might not object to your having a lunchtime drink. Your boss might even encourage you to take out a customer for a drink at lunchtime in order to explore a new business opportunity. But your company might be acquired by an organisation which does not encourage lunchtime drinking. Which puts you, your boss and your customer in a difficult position. Are you to continue taking out the customer and risk the wrath of your boss, who is wise to the values of the new regime? Is your boss to sanction your behaviour and lay his head on the block for your sake? Or is your customer to be told that, following the acquisition which now makes your company a market leader on three continents, you cannot even take him out for a quick beer on a Friday lunchtime?
It is over such questions that mergers and acquisitions fail.
The loss of value
The statistics are spectacular. The top ten M&A deals in the world from January 1 to June 19 2000 totalled a value of $529,024.1 million . If a third of these are to fail for cultural reasons, then $174,577.95 million is waiting to be wiped off that figure. Moreover, recent research suggests that 47 percent of executives in companies which are acquired will leave within a year of the acquisition, with the figure rising to 75 percent after three years. The experience can be a bitter one. As one employee recalls: ‘I worked for a small company that got merged into a larger company. All that happened was that the larger company’s people took all the key positions, got rid of the smaller company’s management, and kept the rest of us’ .
Companies make acquisitions in search of access to markets, brands, technologies, products and people. If the key people in the company acquired - with all their knowledge, expertise, influence and connections - are lost in the transaction, it is scarcely surprising that the transaction fails to achieve its projected value. Indeed, productivity in companies acquired is estimated to drop by as much as 50 percent as talent bleeds away and the survivors channel their energies into securing their position under the new management.
Viewed in this light, it is astonishing that Cultural Due Diligence is not a standard part of the M&A process alongside financial and legal Due Diligence. Certainly the case for its inclusion is compelling. As Adrian Taylor, CEO of Osborne Westphalen Alliance, observes, ‘Due Diligence is fundamental to any acquisition process. The higher the quality of Due Diligence conducted, the lower is the purchaser’s exposure to the risks associated with the deal. This is particularly the case in businesses whose core offering is the professional expertise of their employees. As managers increasingly seek to exploit the intellectual capital of companies acquired, objective assessment of not only personnel structure but also cultural values will become increasingly important.’
The Due Diligence process
Due Diligence has been defined as ‘the independent investigation of a company, its management team and its prospects for success by an investor before funding is provided’ . A pithier but no less accurate definition describes it as ‘a well-established mating ritual … which allows [the parties] to explore the benefits of the marriage’ . Conducted primarily by lawyers and accountants, it focuses on the following key business areas:
- Financial structure and performance
- Product portfolio
- Customer base
- Marketing, sales and distribution structure
- Research and development
- Management and personnel
- Legal matters
It runs between the signing of Heads of Agreement and the closure of the deal, covering typically a ninety-day period during which the parties are still negotiating even as the lawyers and auditors are gathering their information. It can be a draining process. As Charles Crosthwaite, Partner at Bird & Bird, observes, “Due Diligence reports are usually compiled and delivered to extremely tight deadlines. Lawyers cannot, however, guarantee that their reports will be read or acted upon. Professionals should strive to collaborate with clients to create a more effective intelligence gathering and assessment process.”
Many of the components of Due Diligence – for instance, the warranties and disclosures which have to be supplied by the legal entity being acquired - are statutory and formulaic. Focus throughout is on evaluating the evidence which will allow the transaction to be concluded. The link between orchestrating the deal and realising the potential of the new organisation is not the responsibility of lawyers and accountants, who may well have no further role to play after the agreement has been signed. This is where Cultural Due Diligence, with its focus on the future life of the new organisation, has much to offer. As Richard Lee, Partner at Clarks Solicitors, observes, ‘Many companies are extremely unsophisticated in their approach to the cultural aspects of their Due Diligence. Family businesses, in particular, can be hard to integrate. It can add real value to take your client
through some of the possible post-acquisition consequences of the deal. It certainly saves the client from making expensive mistakes.’
Cultural Due Diligence
Cultural Due Diligence differs from standard Due Diligence procedures in that:
- It is not mandatory in law
- It may be variously conceived and implemented
- It may be conducted by a range of parties
Common to all versions of Cultural Due Diligence, however, is the object of obtaining an impartial view of the organisation being acquired in order to maximise the business benefits deriving from the deal.
Many aspects of the Cultural Due Diligence process are aimed at obtaining an objective view of the management and employees of an organisation. Key areas of focus include organisational structure, historical and projected headcount, personnel turnover patterns, profiles of senior management and compensation arrangements. One of the most divisive issues in many a merger is the inequality of compensation plans deriving from the two original organisations; resolving these can be a lengthy and costly process.
If focused solely on classic HR matters, however, Cultural Due Diligence risks failing to identify many issues which are likely to impact operational effectiveness during the post-merger phase. Put simply, business is generally based around some form of collective decision-making, and the means whereby decisions are reached can vary enormously from one company to another. It is the task of Cultural Due Diligence to investigate the values, perceptions, procedures and motivators whereby decisions are reached and collective effectiveness ensured. Core areas include:
- Organisational culture
- Industry culture
- National/regional culture
- Leadership style
- Corporate values
- Brand values
- Knowledge behaviour
This is where the professional communicator has much to offer.
The following is an outline of some of the most crucial questions to ask:
- What are the official values of the organisation to be acquired?
- What are its unofficial values?
- Does any disjunction exist between the two?
- Are they in concord with the values of the organisation making the acquisition?
- How are they articulated and how are they communicated?
- How do employees perceive their own company?
- How do they perceive the other company?
- How do they perceive the respective brands?
- How is the company perceived in the marketplace?
- Is there a shortfall between aspirations and actual perceptions?
- On what basis are decisions made (top-down, consensus-based, rapid, slow)?
- Is the organisation relationship-focused or deal-focused?
- Is the organisation product- or process-driven?
- How is innovation nurtured?
- How are new procedures adopted and old ones abandoned?
- How are managers motivated and rewarded?
- How are employees motivated and rewarded?
- How is business performance reported and evaluated?
- How is individual initiative recognised?
- How is group initiative recognised and fostered?
Brevity precludes expanding the above lists to their full potential, but another list of questions should also certainly be included:
- What is regarded as absolutely unacceptable behaviour?
- What subjects are regarded as taboo?
- Who are the corporate heroes and villains, and where are they now?
- Who is likely to embrace change, and who to obstruct it?
- Which was the company’s finest hour, and which its darkest?
Tools and methodologies
Questions of the above nature may be posed in various ways, some of them highly formalised and some ad hoc. Key issues will be the moratoria which preclude certain activities during the negotiation phase and the sensitivities which will exist both before and after conclusion of the deal. Face-to-face interviews, focus groups, desk research, telephone interviews and surveys (on paper and in digital form) all have their place. Tools such as the Merging Cultures Evaluation Index provide a means of tracking employees’ experience of change during mergers, which in turn offers management clear indicators as to the effectiveness of their own communication efforts whilst the integration continues.
Vital to the success of the whole, however, is the selection and judicious combination of a number of tools. Equally important is the painstaking capture of information and the presentation of that information in easily digestible form. The desire to produce high-quality empirical evidence should not, however, cloud the intuition, and the Cultural Due Diligence report should also provide space for spontaneous insights and individual hunches.
The procedures of Cultural Due Diligence cannot be ‘owned’ in the way that those of financial and legal Due Diligence are the statutory preserve of accountants and lawyers. There is, however, a strong case for external specialists to conduct this work in close liaison with internal teams, as is the case with conventional Due Diligence. This ensures rigour of methodology, impartiality, and also adherence to agreed objectives and deadlines.
The evaluation of the target organisation does not, of course, occur in isolation. It is conducted in order to ensure compatibility between the purchaser and the operation being acquired. This is vital in view of the fact that mergers frequently founder not over the visionary thinking of the senior managers who negotiate them but over the technical detail which is the bread and butter of employees tasked with making them work. Incompatibility of systems and processes on the one hand and of values and aspirations on the other is what wipes value off transactions.
Cultural Due Diligence should thus ideally be conducted on both parties to the transaction, as the following diagram illustrates:
Company A targets Company B. Company A appoints a Cultural Due Diligence auditor along with other Due Diligence specialists.
Whilst standard Due Diligence is in process, a Cultural Due Diligence audit is conducted on Company A.
On conclusion of the deal, and when access to Company B becomes available, the same Cultural Due Diligence audit is conducted on Company B.
Many variations on this basic procedure exit, but the advantage of this approach is that is ensures comparability of data, allowing the owners of the new organisation to identify potential points of mismatch between the two organisations and to deal with them proactively as soon as the integration commences. This leads to enhanced operational effectiveness in the post-merger phase, reduced loss of key personnel, and lower restructuring charges.
‘Know who you are dealing with’ is the mantra of all Due Diligence specialists. In Cultural Due Diligence, the range of possible indicators is wider, and focus is on obtaining information which will help realise the planned value of the deal in the months and years after completion. The first step to knowing whom you are dealing with is, however, to know yourself; and Cultural Due Diligence can considerably enhance the quality of corporate self-knowledge during periods of restructuring and expansion.
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