How integrating a Digital acquisition target is different from a Traditional Post Merger Integration model?

Introduction

• Digital has become a buzz word now and continue to disrupt every industry as almost every industry is changing its business model to align to digital strategy.This has resulted in industry convergence where a company with strong Digital technology assets can disrupt any industry as entry barriers no longer continue to exist now.
• This has led to legacy companies using M&A as a growth strategy by acquiring digital companies to access their capabilities and resources in order to protect themselves from further disruption.
• The legacy companies operating in every industry have come to realize that their business have become cash cows that is generating steady cash flows from their long standing customers relationship but the demand for their services either is stagnant or continue to decline with entry of digital.Companies like Amazon and Facebook have literally disrupted every industry with their innovative business models and their usage of latest technology like Artificial intelligence which has enabled them to increase market share at low cost.

How different is a Digital M&A from a traditional M&A?

• Traditionally M&A were done to increase scale and improve cost efficiency.The combined entity post acquisition will have a significant market share and has huge scope to reduce cost by eliminating redundant processes, people and technology.Hence the post merger integration was relatively an easier aactivity as the acquired entity would be completely absorbed by the acquirer followed by huge layoffs and vendor consolidation to achieve cost savings.In some cases, excess plants or offices used to be shut down as these were no longer required.The balance sheet of both the companies would be consolidated and revenues combined.There would be customer synergies with a scope to cross sell and up sell.The most important rationale would be to eliminate competition by gaining additional market share which would result in few players in the industry.Over a period of time, these players would combine together to form a cartel and increase prices.
• In case of a Digital M&A, the acquisition in most of the cases does not happen within the same industry. These acquisitions are complementary.Most of these acquisitions are transformational and are not scale acquisitions.Hence cost synergies is no longer relevant to the strategic rationale. The acquisitions is also between companies of different size.Most of the cases, the target companies revenues does not exceed 10% of acquirer firm revenues.Hence cost savings does not have a material impact on the profitablity of the combined entity.

The strategic rationale involving a digital target is primarily focused on two things:

• Access to technology/capability - The acquirer in order to insulate itself from digital disruption wants access to digital capability in order to strengthen its existing service offerings or to come up with a new service offering to capture lost market share.
• Access to Digital Skillsets - There is a severe shortage of supply in talent available for digital services.The legacy companies do not have resources with this skillset and also find it difficult to hire such talents directly from the market.Hence one way of acquiring these talent is through acquisition.

Size of Digital targets in acquisitions

Of late, there have been two approaches followed:

• Acquisition of targets with revenues less than $50M - The legacy companies acquire small targets to get a feel of the latest technology used by the target and also fill a gap in their portfolio of service offerings that the target company can address.Most of these targets are startups with entrepreneurial culture and usually have focused service offerings.These companies are extremely innovative and use latest technology and practices to address customer pain points.The acquirer also can get a sense of how a digital target works and what its operating model looks like.Most of these are generally bolt on acquisitions where the target is integrated to a functional or business unit of the acquirer.
• Acquisition of Targets with greater than $150M - These are targets that have a reasonable customer base and their service offerings are generally accepted to be world class.These targets have a loyal customer base as well as a developer community who are fans of their products and offerings.In this case, the acquirer is also a digital savvy company and the strategic rationale for such acquisition is primarily to increase the customer wallet share and expand the overall customer base.The strategic rationale of these acquisitions are usually focused on scale and synergies are primarily arrived at how the service offerings of combined entity can increase the market share in a particular geography or in product/service.

Integration strategy for a Digital Acquisition

• There cannot be a one size fit all approach for integrating a digital target. The integration strategy should change depending on the deal and the strategic rationale behind the acquisition.
• The integration strategy has to follow the strategic rationale to capture value immediately.

Some of the strategic rationale for a digital acquisition could be:

• Access to the IP/Technology of the target - If the acquisition is done to leverage the target IP and capability, then the integration strategy would be to absorb the target company with acquirer.The acquirer can transfer the IP and patents to its name and can either integrate it with its service offerings or build a framework at the top of the existing IP.In this case, there is no need to preserve the identity of the target company.The customers which were leveraging target IP needs to be informed of the integration strategy and communicated that there will be no impact to the services provided to them.The IP that would be built can be sold to the combined customer base.
• Access to Target skillsets/Customers - In these acquisitions, the target has a differentiated service offering and has a loyal customer base.In such cases, it is prudent to preserve the identity of the target.The target generally has a strong brand and reputation and acquirer should continue to run the business as a standalone entity to retain its customer base.The success of the target's strong position in market is due to their skilled employees.Hence integration should take into account the employee benefits and expectations in order to prevent any attrition post closing.

Integration Planning

• This is the most important phase of the integration.In many cases the post merger integration has resulted in loss of market share and employee churn.
• The biggest reason for the failure is that the acquirer in order to realize the synergy and revenues targets fail to preserve the identity of the target company.The reason why this acquisition itself was done was due to the service offerings and processes of the target company.If this process which had given success to the target company is messed up by the acquirer during the integration planning, then this will lead to attrition of key employees thus jeopardizing the entire value to be realized from the transaction.
• During the integration planning or in the 1st 100 days post closing, the integration team needs to understand how the target company operates.Then the target operating model has to evolve from the current operating model.This requires time and hence integration team needs to have a realistic time frame for executing the integration.Based on the strategic rationale, the integration approach may vary from having the target operate as a stand alone entity to complete absorption of target entity to acquirer business.
• It is better to have a modual functional based integration approach and priortise integration areas which would provide maximum value.For instance if the strategic rationale is to increase wallet share of existing customer, then a joint target needs to be taken for the customer by the sales team.If the combined team is looking to win new business, then the sales team of both entities need to work together on the bid with detailed pricing and service offerings for the bid. In case of up selling and cross-selling to the current customer base, the target/acquirer needs to refer the other team at right opportunity and time to pitch for additional work.Hence in this case, the sales integration is the most important function to be integrated first.The sales team of both entities needs to be given training on the service offering/ value proposition of combined entity that is needed to be sold.In addition, sales targets are assigned to each sales rep which includes the revenue targets of the acquirer, target and synergy targets.
• The integration execution requires proper and continuous communication strategy so that all stakeholders involved are informed on the integration strategy and approach taken to achieve synergies targets.Once the integration plans are finalized, then it needs to be monitored on a frequent basis to track the progress achieved.

Why Cultural Integration is most important when acquiring a digital target?

• In a digital acquisition, integrating the diverse cultures of target and acquirer is the single most important factor which can determine the success of the deal.The cultural fit between the acquirer and target needs to be assessed in detail during the due diligence phase.Any risks in the culture fit needs to be assessed and followed by the mitigation plan.During the due diligence, if there is a huge difference between the cultures of target and acquirer, then it is better to abort the deal at that stage.
• In case of smaller digital targets, the employees are used to entrepreneurial work culture and would find difficult to adjust to bureaucratic and formalized working style of acquirer.In some cases, it is recommended to follow a reverse integration approach where the acquirer business unit is integrated with target business to create a new business unit which would be run by the target.In this case the target identity and business model is preserved and acquirer team have a chance to collaborate with target on important customer engagements which would foster good relationships between the target and acquirer.

Conclusion

• For a digital acquisition, integration is the most activity that would determine if the deal is successful or not.Integration strategy needs to be aligned to the strategic rationale of the deal to capture value drivers immediately.
• Target Operating model of the combined entity should be decided after understanding how the target runs its business.Hence degree of integration between the target and acquirer should vary as per the deal rationale and the synergies to be realized.In most cases, the target is allowed to function standlaone in order to preserve the identity of the target with integration happening only for back office functions like HR,Finance and IT.
• The acquirer needs to be agile and flexible with his integration approach and adapt according to the circumstances.
• Communication forms an integral part to the success of the integration.All the stakeholders, specifically the target employees needs to be engaged to ensure that they are motivated and understand what is expected from them to achieve the end state objective.
• At the end, it is extremely important to share the progress of integration with the customers of both entities and how the integration would impact them.
• A part of the objective for the acquirer should be to support the target in scaling its business, so that the target can expand its business to other regions or diversify its service offerings.