Would you ask your local plumber to prepare your income tax return? Would you want your teeth drilled by the local gas station attendant? Of course not. In both cases, it’s obvious the person wouldn’t know how to do the job. But what about choosing someone who works in an occupation that’s closer to the requirements. What about picking an accountant to draw up your will or a plumber to fix your car radiator. Sometimes it’s hard to tell just who knows how to do a job and who doesn’t.
Companies experience this same difficulty. Many companies, especially large ones, think they have skills in certain areas, when in fact they do not. They may have some expertise in a field, but in a competitive, hungry business world, these skills are not sufficient to allow them to compete against companies that know the business inside and out.
“Synergy” is a term used to describe a situation where two businesses, by working together, achieve greater results than if they were working apart (one plus one equals three, so to speak). More often than not, however, companies involve themselves in businesses where there is no synergy. In such a case, the attributes brought to the partnership by each business actually make it more difficult for each business to be successful. An example of such a circumstance, recently described in Fortune magazine, concerns an oil company’s purchase of a mining company in the late 1970s. The oil giant purchased an established base metal producer and, over the next few years, invested more than $1 billion to expand and modernize the newly acquired operations. Despite this investment, the mining operations lost $95 million by 1984.
After a few years of such losses, the mining business was sold. Almost immediately, things began to turn around at the reborn mining company. Morale picked up and, in only two years, coal and copper costs were reduced 15%-20%. Productivity has jumped to 172 tons per man year today from 99 tons in 1984.
The reason for the turnaround was no secret to the mining company’s management. The oil company simply didn’t know mining. The mine managers spent much of their time organizing presentations to explain their concepts to oil industry managers who were unfamiliar with them. More often than not, novel ideas were not tried because the oil company’s people did not have a sense of how effective these improvements would be. As well, since mining returns were inconsequential (relative to oil returns), the mining side of the business did not receive the attention it deserved. Today things are different: presentations are made with little formality, and communications and decision-making are faster and more effective.
It is sometimes very difficult to know whether a new product or business “fits” with an established business. Even two mining ventures run by the same management can run into trouble if they are different in some essential areas. Take the hypothetical case of an American coal producer that owns a large, dragline strip mine in the the western U.S., as well as a smaller, truck-shovel coal mine in the Canadian Rockies. The strip mine has a uniform, thick and flat coal seam with a stripping ratio that changes little from year to year. The Canadian operation, on the other hand, mines thin, steeply dipping seams, and the stripping ratio changes dramatically from month to month. In this situation, it wouldn’t be unusual for the two management groups to misunderstand each other’s motives and actions. Such a misunderstanding could result in lengthy times for budget approval, difficulty in appropriating capital from the parent company and a hesitancy to accept needed new technology.
If creating synergy is such a difficult task, why do so many companies have a large number of seemingly unrelated businesses under their corporate umbrellas. Often managers feel bigger is better, and the attraction of a large, asset-rich company is a powerful one. Diversification also renders the over-all company less liable to failure if a particular economic sector does poorly. On the other hand, if there is no synergy among the various business units, the company’s shareholders will suffer. If a shareholder wants to invest in a different business, he can do so by purchasing stock; he doesn’t need one company to take over the business for him.
As Thomas Peters and Robert Waterman, Jr. say in their book In Search of Excellence, excellent companies “have strategies of entering only those businesses that build on, draw strength from, and enlarge some central strength or competence.” The authors add that, “while such firms frequently develop new products and enter new businesses, they are loath to invest in areas that are unfamiliar to management.”
A recent study shows that, of 120 companies which have acquired other business concerns, more than half are sorry they did so. Any company that plans to acquire or merge with another business should address several key issues before doing so. These are:
* Define your objectives — A company should first clearly determine what it wants to accomplish by the acquisition. If objectives are not identified beforehand, an inappropriate company may be acquired and settlement terms may not reflect the real worth of the acquired company.
* Define your business — It is important that a company defines what business it wants to be in and the business of the potential acquisition. A good, hard look at the skills and products or services of the potential acquisition is needed to determine whether the new business can be effectively absorbed and understood.
* Check the management ability of the acquired company — The ability of the two management teams to work together should be examined. Failure to do so has been the source of many acquisition failures. If the two teams are unable to work together effectively, because they have different skills or attitudes, the full advantage of the merger or acquisition may not be realized.
* Check for synergy between your company and the acquired one –Earnings per share after the acquisition should be expected to increase. A good example of synergy occurs when one company with management and mining skill acquires a company with large, undeveloped ore reserves.
* Analyse carefully the company’s performance–The performance of a potential acquisition must be analysed. Examples of things to look at include asset quality, projected cash flow and financial condition. A company should also ensure that the acquisition is affordable and that it does not put the acquiring company in a difficult debt position.
The challenge of organization is great in a highly diversified company. The organizational structure and management systems must create a climate that supports the strengths which each business unit brings to the whole company. At the same time, those aspects of each business unit that detract from the company as a whole must be minimized. One way to do this is to create relatively autonomous divisions around each distinct business unit. Each division is headed by a divisional manager who has a large degree of autonomy in making business decisions. This method allows the corporate level to set the over-all “tone” for all its businesses but permits each of the divisions to respond quickly and effectively to specific market forces.
Even with the best organizational designs and with business units that offer synergy, the task of successfully managing a large, diversified business is difficult. One thing seems certain: keeping an organization simple makes a lot of sense in today’s world of rapid change and fierce competition in the marketplace.
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