Culture, the Slow Killer

To set the scene for this blog, I watched a documentary called 'Mercedes Goes to Motown' which was about the 1998 merger between Daimler-Benz (Mercedes) and Chrysler. I thought this would be the perfect documentary to watch as I am currently looking through the assignment on Fiat where CEO Sergio Marchionne would like to merge with another company in the automobile industry, but more that I just bought a German made car too (not a Mercedes, I wish). This of course leads onto Fiat, as the merger dissolved in 2007, Fiat later took them over. I thought this would be really relevant and help me when looking to be more informed at whether a merger would increase shareholder value.

M&A activity as I have mentioned before is one of my favourite topics in business, it is exciting watching what happens. It was obvious that culture killed the merger in this case (I have touched on cultural importance in previous blogs). I have read many FT, Economist, Forbes and Harvard Business Review articles on culture being really important to merger success. I can name so many more mergers that have failed due to or experienced cultural problems; AOL - Time Warner, HP - Compaq, BMW - Rover, Kraft - Cadburys (do I need to go on?).

I believe that bad culture can be the silent, slow and costly killer in a business or merger, as if I was to measure culture, how would I do this? You could undertake employee satisfaction surveys, but who is going to tell the CEO they hate the company? (they think Sir Alan Sugar will come in and say 'You're Fired!'). This was the second problem of the merger, Daimler did not undertake proper due diligence which was a big mistake. I have mentioned this before, but I believe due diligence is the most important factor when thinking about M&A activity; financial checks, cultural checks (if possible) and market checks at a minimum I believe. Take myself for example, when choosing a university I went to both Northumbria and Newcastle open days. My mind said I wanted to go to Newcastle as it is considered by league tables as 'better', but in the end I chose Northumbria because once I got there it fit me better and the culture felt better. If I hadn't gone to the open days, I would have been at Newcastle for 4years. Back to business, this is what Daimler needed to do, they needed to assess whether they would be able to survive a partnership into the future and if the culture fitted them.

One part of the documentary that we had learned about in the module was M&A premiums that one company can pay for the others shares. One of the most important things for management is 'the price', if the price is too much, your shareholders will react badly. In the documentary, the CEO of Chrysler wanted 28% more than the shares were worth, which increases the overall price. What I was thinking when that figure came us was that if I was a Daimler-Benz shareholder, I would be really annoyed that the company was going into a 'merger of equals' but the Chrysler shareholders get 28% more than I do. Other M&As also have paid high premiums such as when Pfizer acquired Vicuron Pharma in 2005 and paid 78% premium on the shares.

Finally, it was obvious to see that styles of leadership and workmanship were different in the USA and Germany. Just from my own view without looking into it, I perceive German manufacturing to be efficient and good quality (which is why I bought a German made car) and US manufacturing to be not as good quality, which I do think these styles would have caused conflict for management. If management from another company/country are taking over when it is supposed to be a 'merger of two equals', employees are naturally going to resent the leadership and may become increasingly dissatisfied and demotivated. When employees are demotivated, productivity will decrease which will also lead to a failed merger.

Buying, but for the Big Boys

The topic of Mergers and Acquisitions (M&A) is probably one of my favourite subject areas in business. I think it is because it would be so exciting to spend millions of pounds on another company then have the challenge of trying to integrate them to create the synergies and culture you have promised the shareholders (that might be crazy to hear I want to face the challenges). I remember in my GCSE and A-Level studies learning about some notable M&As:

Creating wealth for shareholders through M&A activity must be really difficult, you can do all the due diligence in the world and look at all financial indicators, but areas such as culture and employee motivation (which you can not physically see) may be your downfall which would be really unfortunate. Research conducted as far back as the 80's such as by Jensen and Ruback (1983) show that the target firms gains more than the bidding firm. I would be angry if my management based on hubris, their own self-preservation and hunger to build an empire would enter into a merger and then I wasn't gaining as much as someone who probably was not bothered.


One thing I remember from my business teacher at school was, she always stressed about culture, culture, culture (dare I go on?) was the single most important factor that could lead to the failure of M&A activity. In a sense I believe that, because you can not physically see the culture, but the financials are the starting point. My last blog (Blog 5) focused on culture which you can take a look at if you get time.


What I find really exciting (well exciting in my head) in this topic is the defence tactics that target firms can put down to stop firms bidding on them (the names are strange too). These poison pills in my head feel like they would be a little petty war like we would play at school such as flicking elastic bands at each other. How fun these poison pills may be, they can cause significant damage if a bidder does not spot them. Say a target decides to make a 'scorched earth' policy; load the firm up with debt, sell key assets to disrupt efficiency; if the bidder still goes for them they will ruin their shareholders value. I have learnt many poison pills; Pac Man Defence (who even makes up these names?), Greenmail, White Knight.


It is quite pertinent that today's blog is on M&A activity when there are two big ones in the news; Deutsche Boerse - London Stock Exchange and Three - O2 . From learning the material in this module and reading publications such as the FT, BBC to try and get all sides of the argument, I have seen that there are good and bad points for myself as a consumer and a member of the EU economy.


Firstly, the good. The Deutsche Boerse and LSE 'merger of equals' I believe will help the economy by providing better opportunities for European Companies to gain capital as well as companies from the US and Asia as London, Germany and Spain merged could help compete. However, how will the UK's EU referendum affect the benefits of this merger? I am undecided, but will continue to look.


Secondly, the bad. Three (CK Hutchinson) are looking to merge with O2, basically making the UK market for Telecom shrink to Three, EE and Vodafone (creating an oligopoly situation). Three want to pay £10.5bn for the merger (that is an exciting amount as I said before). How will it affect myself and you the consumer? Well, I think it really could, shrinking the market may lead to increased prices for the same service. When I go to look for new contracts, I currently think that there a lack of differentiation, so this will surely decrease more? Surely if they are creating better cost synergies they will reduce the prices (well this is what should happen), but I really do not think they will.


I never understood how a company would pay for the acquisition either (transfer through the banks Iphone app? Set up monthly instalments? Pay in 10p's?). But let me get serious, so the company will either pay using cash or shares. If I was a shareholder, I think I would the company to pay through cash as I would have to same amount of control and my shares won't be diluted. But if I was the target firms shareholder, cash may mean I pay a hefty sum of tax if I own a lot. Tough choice right?


As there will always be hungry managers, there will always be M&A activity in the market. Whether these are successes or failures will depend on how much research the company has done and whether they can integrate cultures. As consumers we will always be put as risk through M&As that we could be forced to pay more for the same service through lack of choice, however, we can only hope such mechanisms such as the Takeover Panel and Competition and Market Authority (CMA) regulators will help protect us.


Inside Job - A Culture of Dysfunction

This weeks blog will focus on my learning from the documentary 'Inside Job' by Charles Ferguson. What I like to do when watching something like this is identify a key theme of the documentary and then that is what I will talk about. The theme from this show was Culture.

The documentary went into detail about the dysfunctional behaviours of Wall Street and the Investment Banks in the US which led to the financial crisis (yes, again you have to hear about the crisis, sorry). These Wall Street bankers were selling sub-prime collateralised debt obligations (CDOs) to other institutions for their bonuses. This led to the collapse of Lehman Brothers and the need for Morgan Stanley to need bailing out.

What was really clear to see were people making terrible decisions and going for risky projects so that they could get their next bonus. This can be seen even after the financial crisis. For example, in 2012 RBS made a loss of £5bn and Lloyds a loss of £570m, but they both paid their top management bonuses of £607m and £375m. I just think that is absolutely ridiculous, how can you pay people bonuses for the losses they were making. Bloomberg made a nice quote that said that bonuses pre-2008 were incentivised for 'greed and risk'.

The second thing that was apparent was familiarity. You may ask why familiarity was a route cause of dysfunctional behaviour, but I think it is apparent. Familiarity between the CEO and Board, Leader of Country and Advisers or Investment Bank and Rating Agency (S&P, M, F) will create behaviours that will lead to bad decisions being made. I am currently doing a dissertation on audit quality and new regulation and I have found in my results that familiarity is one thing that reduces audit quality and this was another cause of the 2008 crisis. I don't think you can do a good job if you are supposed to be independent but also 'good mates' with the person who owns the company.

I am going to be an auditor after university (so exciting I know), so I have to be independent, I am sure subconsciously my opinions would change if my best friend owned to company rather than someone I did not know, I would place more 'trust' in what he said or did than a stranger. But it was clear to see in the documentary that people were not independent and making an ex-Goldman Sachs CEO Secretary of the Treasury helped benefit Goldman Sachs by $14bn in the bailout (yeah so independent right?).

Culture

Culture is so important in any firm, and is usually more of a reason why it is successful or a failure than any other in my opinion. Take Morgan Stanley for example, they had around 50,000 employees but a culture which was only looking for achievement of their next bonus which made them act so dysfunctional they were having cocaine and going to strip clubs every night.

Culture is important if you are wanting to undertake a merger or acquisition too. If I was a CEO and we found out that all the employees were really unproductive or taking high risks, this could cost us a lot of money and make the acquisition fail. But I think that it is so hard to actually think of how to measure the culture in a company unless you are there.

As a student and not having a full-time job before, I got the opportunity to undertake a placement. I could have tried to apply to a Big 4 accounting firm, but instead chose to go for Grant Thornton (who are number 5). The reason I did this was because I got told their 'culture' was a lot better (thank god is was a really great culture). But if the company has a horrible culture then I would have not succeeded in what I wanted there, and that would be the same with an acquisition.

Failures can be seen through recent history where companies have acquired others and have failed or had problems due to culture clashes:

• AOL - Time Warner
• Daimler - Chrysler

I think that a business leader in the organisation needs to set the tone for organisational culture. I believe this will help increase shareholder value by not putting it at risk, which would also be the case for a successful merger/acquisition as successful culture integration is said to be the most important factor for M&A success.


I just want to touch lastly as what my optimal culture I believe would be for a firm. I think a firm where you are recognised for things you do well, even a simple 'thank you' I found helped motivate me. Secondly, I think openness when explaining what I have done wrong, I hate when someone says 'oh, [this guy] said he didn't like you doing this', why didn't he just tell me? What is your optimal culture?



Empty Vaults - The RBS Collapse

The Royal Bank of Scotland (RBS) which found notoriety in 2008 when it was apparently '2 hours away from running out of money' and losses of £24.1bn (I can't even comprehend this figure). It was clear from my own viewing that I could conclude RBS had serious problems which included to rate of acquisitions, due diligence of these acquisitions and Fred Goodwin's leadership. As you can see below, this is the result of RBS management decisions.

RBS Share Price (Yahoo! Finance)

Acquisitions
RBS I feel really fell down on their rate of acquisitions, I think they over expanded too quickly and this can't be good as they ultimately had 'a finger in too many pies'. They were involved in Insurance, Hospitals, Airports, second-hand cars and asset finance (I can't see where some fit into banking). I thought that these acquisitions were a waste of money and there was no need to diversify from their core business of banking. The acquisition of ABN-Amro was obviously their biggest downfall. They had no idea about the level of sub-prime mortgages ABN held and therefore I do feel I can reach a conclusion that this was why they failed.

Fred Goodwin said "we don't do acquisitions for fun", but I thought that them buying a second-hand car company, this did not seem like it was done to 'better the core business'. RBS was not the only company undertaking failing acquisitions; HSBC's acquisition of Household (2003) fell victim to the sub-prime collapse and AOL's acquisition of Time Warner took less than 2yrs to fail.

Due Diligence
Watching the part where Fred Goodwin said that there was no real scrutiny of ABN-Amro's books really made me annoyed. I would have thought someone with all that business knowledge wouldn't have gone with the 'we did Natwest well, so this will be fine' mentality. Even myself, a final year business student looks into everything I buy; if I purchase a TV, I will be looking into it for a week at least to see if it is worth it (and that only costs £300 not £49bn).

Due Diligence is key when acquiring a business. It makes sure you're not buying 'junk' and will reassure you that you are not paying over the odds. I am currently looking to buy a car for work, I wouldn't want to pay £10,000 for something that is actually worth £6,000 or a car that has been written-off in the past. This is why you undertake due diligence. Anglo American mining is another example, they have really underestimated the challenges they would face when going to Brazil in 2009 and other projects where now their share price has dipped below 1999 listing level and have been given 'junk' bond status by credit firms such as Moody's (FT, 2016) (would they have been more successful if undertaking more due diligence?).

Leadership
One thing that was apparent when watching the documentary to me was Fred Goodwin's management style. Morning meetings were called 'morning beatings' and managers were intimidated to say if they believed something was wrong. I don't think you can run an organisation like that. Listening to others is the most important thing, especially when dealing with a public interest sector.

When I was in my placement working in the audit department, listening to what I was doing wrong and what I could do better was important to help me do a quality job and make sure every part of the audit was correct. This helped shareholders/stakeholders base decisions on true and fair information. If not, I could have been misreporting values and making wrong decisions which may have lost people money. This is exactly what Fred Goodwin did with RBS and definitely I believe another reason for their demise.

A Final Note
I think what really hit me the most when watching the documentary was that ordinary people (which I probably know a few) who have saved for years and were unfortunate enough to invest in RBS (where they thought their money would be safe) lost around 90% when RBS collapsed. These are the people who I really feel for.

References
Financial Times. (2016). Anglo American’s credit rating downgraded to junk, retrieved from http://www.ft.com/cms/s/0/1f989c28-d409-11e5-829b-8564e7528e54.html#axzz40cHUmspG 
BBC. (2011). RBS - Inside the Bank that Ran out of Money (documentary).

Aspects of Diversification - A Case of Ebac-Norfrost

Aspects of Diversification - A Case of Ebac-Norfrost

Acquiring a new business can lead to so many problems, such as what Ebac found when they bought Norfrost for £1million. A bankrupt chest freezer business once given the go-ahead to make Coke-Cola freezers for the Olympics in need of a re-brand and a new lease of life. Well, this is what Ebac saw anyways. 

However, one of the main problems when acquiring a new business is the fact that the acquirers (already being successful), think that they know it all. Successful in dehumidifiers and water coolers isn't the same as being successful in a fridge/freezer market worth £600m. Indesit (Italy) and Beko (Turkey) have market dominance and can compete on price with anything British made. So how do you become successful in a new market?

In the case of acquiring a new business, what needs to be done first is called Due Diligence! Without this (basically checking to make sure everything seems okay), millions of pounds (or dollars to appeal to an international crowd) can be wasted in buying a business, only to find out the machines you bought do not work or the business had huge debts you didn't know existed. This will cost you money through productivity lost and in general monetary terms. I implore you to take a look at the lack of due diligence that was undertaken when RBS acquired ABN Amro and how much ultimately it cost them.  

Secondly, research, research, research (do I need to emphasise my point?). There is no point going into a new market on the basis of 'I am already successful and know everything' or 'We will go with whatever the company we acquired have done'. You need to make sure you have the most up-to-date data possible. This involves primary research (or I guess you could look at Mintel reports as a start) by going to your customers and asking what do they want? What are their drivers to buy the product? These opinions will either make you a success or a failure. Many in business know, if you do not know your customer, you are destined to fail like so many before you. This has been so apparent in other industries, such as where Nokia did not react to what their customers wanted and rapidly declined when Apple and Samsung released their smartphones. 

Leading on from your research, the company needs to make use of their marketing abilities to get the brand out and known to consumers. Create that USP (unique selling point) that is not generic like 'affordable' or 'quality'; make it something to do with your long heritage or simply 'Made in Britain' (which is becoming fashionable again nowadays). In the case of Ebac, they were held back by the fact that they didn't know the uses of social media as a marketing tool or even what their USP was. Once they embraced it, they flourished. This brings me onto my next point with marketing. Whatever the product, marketing can be done successfully. Ebac wanted to go into chest-freezers. Interesting right? It's not an enlightened fact that chest-freezers are not the most widely searched term daily, therefore traffic would be low. However, knowing their key customers through research, they could identify the people who bought the product and then cater marketing towards them; in this case it was recipes which millions of people search for daily.

However, the key to everything (whether acquiring a business, undertaking market research or marketing itself) is planning. You must plan to succeed. As the old saying goes, Fail to Plan, Plan to Fail (oh how I hate cliche's).