EBS Mergers &

Acquisitions
10 June 2005

1. Introduction
Mergers and acquisitions represent a major
source of organizational change.

Organizations that can identify the need for change,

design the changes required and implement these
changes more effectively and efficiently than others
are more likely to survive and prosper.
Those that cannot adapt to change are likely to
perish.

Deregulation, globalization and information

technology are removing barriers to
international trade.

Strategic Focus Wheel

Strategic
Planning

Strategic Risk
Management

Project
Mgmt of
Change

Strategic planning selecting the

most appropriate option.
Making strategies work
connecting the plan to critical
day-to-day activities.
Making
Strategies Project management of change
Work
ensures completeness and control
over the realization of the chosen
strategy.
Strategic risk management
identification, monitoring and
management, both as a control
and as an input to planning.

Definitions
A merger or acquisition in a company sense is
the combination of two or more companies into
one new company.

In a merger, there is usually a process of negotiation

involved between the companies prior to the
combination taking place.
In an acquisition, there is not necessarily a
negotiation. The acquired company may or may not
continue to exist as a separate entity, depending on
the intentions of the buyer.
Acquisitions can be friendly or hostile.

Rationales
Rationales consist of the higher-level reasoning that
represent conditions for a merger decision.
Strategic: Achieves a set of
strategic objectives (including
defense)
Speculative: acquired
company is a commodity
Management failure: by the
time strategic variance is
detected, it is sometimes too
late to correct it by itself

Financial necessity: lost

shareholder confidence
Political: what is encouraged
and what is prohibited

Drivers
Drivers are mid-level specific (often operational)
influences that justify the merger.

Requirement for specialist skills or resources

National and international stock markets
Globalization: geographic separation is becoming
less of an obstacle to managing as a single entity
National and international consolidation
Diversification: although this typically benefits
management at the expense of shareholders

Drivers
Continued

Industry and sector pressures

Capacity reduction
Vertical integration
Increased management effectiveness and efficiency
Acquisition of new market or customer base
Buying into growth sector or market

Vertical Integration
Vertical integration is the merger with suppliers
(backward) or retailers (forward).

Combined processes
Reduced risk and/ or enhanced risk management
Configuration (i.e., data flow) management
Quality management
Reduced negotiation, although perhaps at the
expense of decreased leverage
Proprietary and intellectual property protection
Individualization: controlling aspects of an
operation to protect quality and image

Horizontal Integration, Conglomeration

Horizontal integration occurs where two
companies engaged in essentially the same
product or service merge to improve their
combined value.
Conglomeration mergers occur where the
merging companies continue to operate in
different sectors and industries (no integration).

Merger Lifecycle Phases

Inception (initiation)
Feasibility: finances and logistics are considered,
followed (sometimes) by a commitment to proceed
Pre-merger negotiations: on structure and format of
combined organization
Contract formulation
The Deal: sets out the rights and obligations of the
parties
Implementation: in-house (usually) teams establish new
staffing, systems and processes
Commissioning: acclimatizing to the new regime

The Players
The early stages tend to be dominated by the strategic
planners (or equivalent), who are responsible for
initiating the merger and for making a strategic
evaluation of the decision.
External consultants are primarily involved in setting up
the contract and related aspects.
The post-deal work is largely dominated by the
implementation team.

Early involvement tends to benefit in making realistic

assessments of time, effort and synergy, although this cost is
thrown away if the deal is not finalized.

Measuring Success
There is a tendency for the shares of a target
company to inflate. In terms of short-term gain
by the acquirer, most mergers and acquisitions
fail.
Long-term performance can depend on a wide
range of variables. Usually the form of payment
(cash, shares or both) and the effectiveness of
the implementation are key determinants.

Scenarios for Failure

Inability to agree terms

Overestimation of the target value
Target too large relative to acquirer
Failure to realize identified potential synergies
External change
Inability to implement change
Shortcomings in implementation and integration
Failure to achieve technological fit
Conflicting cultures
A weak central core in the target

Merger Waves
Five major waves since late 19th century:

Railroad Wave (1895 1905): completion of the

transcontinental railway allowed companies to go national
Automobile Wave (1918 1930): Consumers are vendors are
better able to meet.
Conglomeration Wave (1955- 1970): Legislative impediments
to horizontal and vertical growth resulted in unrelated
diversification.
Mega-Merger Wave (1980 1990): Deregulation and
relaxation of merger-control legislation.
Globalization Wave (1994 - ): Characterized by low interest
rates, long supplies and capacity, mature industry, growth of
computers and communications technology.

2. Strategic Focus
should be on the competencies that are central to
the achievement of the Companys strategic objectives.

If the current and desired positions are known, it is generally

possible to plot a course between these positions, along
which the Company must progress. (Sometimes they drift
from this course.)
Competencies will change as the Company grows and
evolves, or as its competitors, customers and markets change.
Where there is a deficiency, the organization has two choices:
internal development of the necessary characteristics or
obtaining these externally.

Why merge or acquire?

Companies merge with or acquire other companies in
order to improve their own competitive advantage.

Merger rationale may be: (1) economies of scale, (2)

combining indirectly related assets, or (3) unrelated
diversification.
Ideally, the acquired assets should complement those of the
acquiring company.

A merger or acquisition may be relevant to:

Corporate strategy: the selection of the businesses in which

the Company should be active.
Business strategy: how to compete in the selected area

Misconceptions
Mergers are standard practice.

There is often a lack of experience, especially in

implementation and integration. This is often true even in
companies who have merged, as they tend to focus on
individuals rather than formalizing the knowledge acquired in
the transaction.

Acquisitions are easy.

It is often easier to acquire a company than to merge with it,

since it avoids some of the technological and cultural
integration issues.
The effort can be resisted by regulators (especially when the
deal is large), shareholders, competitors and the staff/
management of the target.

Misconceptions, 2
Targets tend to oppose.

The very pursuit tends to drive up the targets share price,

making a sale attractive to shareholders.
The deal may allow growth.
The deal might allow the target to fend off a hostile takeover
(in favor of a white knight).

Targets, once acquired, are easily absorbed.

Merger can be opposed.

Talent can take flight.
Redundancies are not so easily eliminated.
It may never happen.

Mergers are more easily integrated than acquisitions.

This depends on the degree of integration desired.

Misconceptions, 3
It is easy to assess financial value.

Some companies are, in essence, portfolios of intangible,

risky assets and liabilities.

Divested companies will be bought by other

companies.

If the operation was divested because it was a poor

performer, its prospects may be different that if the
divestiture merely improved the strategic focus for the parent
(not a core asset).
The divested company could go it alone.
The company may be acquired with the intention of resale,
and thus stay intact.

Strategic Assumptions
If the targets core activities are related to those of the
acquirer, the strengthened core increases likelihood of
success. But,

Potential synergies are frequently over-estimated.

Similarity may be superficial (are there real redundancies and
portfolio effects?)

If the core activities are not related to those of the

acquirer, the merger or acquisition distributes market
risk. But,

Shareholders can do this more effectively on their own.

This tends to benefit management more than shareholders.

Strategic Assumptions, 2
A company using funds generated by mature activities
to acquire companies operating under growth
conditions increases the prospect of long-term
revenues. But,

Only if those companies generate sufficient return.

Otherwise, the best thing to do with the cash may be to
dividend it to shareholders.

Financial Considerations
Acquisitions require cash or access to financial
capital.

Prudent strategists are always careful about the

critical financial ratios.
Capital or other barriers may make acquisition
infeasible, and merger the only viable alternative.

Strategic Alliance
An alternative the strategic alliance often
amounts to a trial marriage.

Long-term relationship
Significant interdependency
Joint control across a range of areas
Continued contributions by the parents

However,

The participants retain their separate identities

The resources shared may or may not include core
competencies.

Alliance: The Resource View

The Companys core competencies are usually
based on its unique resources:

Finance unique structure may have cost

implications
Technology and other intellectual property
People unique skills
Production capacity, access to supplies
Management organization and systems
Brand customer acceptance

Alliance: The Risk View

The Organization

More cheaply and quickly implemented than a

merger.
Contract could contemplate dissolution at the end of
some period.

The Partner

Alliance resources might be appropriated.

The Outcome

Objectives may not be achieved.

Alliance: Strategic Fit

As with mergers, good strategic fit should allow
companies to use their respective strengths and
overcome weaknesses.

These benefits do not just occur they have to be

engineered.

Key fits are in:

R&D joint willingness to accept and implement the

findings of research
Implementation each taking a long-term view
Establishment mature companies have a basic choice
between defending traditional markets or being the aggressor
in new ones.
Risk mergers are expensive and disruptive.

Unrelated Diversification
Focused companies concentrate on one sector or
industry. Diversified companies have assets across
different sectors and industries (conglomeration).
Obvious targets are companies with undervalued assets
or in financial difficulty.

Sometimes a capital injection is all that is required to generate

sustainable growth.

Conglomerates are difficult to manage, as they often

lack the diversity of skills or the flexibility in systems to
detect issues.

Divestiture and De-merger

When an acquisition does not fulfill the purpose
for which it was acquired, it might be divested
or de-merged.

Sell it (intact)
Spin it off
Liquidate

The Ideal Merger?

Six characteristics appear to drive a good merger:

Thorough investigation of the target prior to commitment

Core business activities of target should be compatible with
or even complement those of the acquirer
Friendly (rather than hostile)
No large-scale increase in debt
Acquirer and target should be accustomed to change
Both should have a commitment to research, development
and innovation

Greatest probability of success

Offer increased shareholder
value
Increase shareholder
confidence
Are implemented quickly and
effectively.
Are strategically focused
Improve product quality
Improve customer service
and reliability

Improve employee
motivation and commitment
Improve competitiveness in
industry or sector
Improve competitiveness in
the economy as a whole
Take advantage of favorable
external changes, like
deregulation

Regulators
Regulatory scrutiny is particularly likely when the
merging companies might affect the price of goods and
services in a market.
There is some effort being made to coordinate these
reviews, especially between the EU and the US, there
are still issues of:

Scope EU threshold is higher

Coordination EU must consider member states
Definition of the market
Differing philosophies on concentration EU is more
focused on resulting concentration than on pre-merger
market shares

Strategic Focus
is the concentration of attention around the
core competencies of an organization.

Companies can make acquisitions that complement

and strengthen that competency.
The potential acquirer should consider the degree of
relatedness offered by the potential target.

Strategic Focus, 2
Stage 1: Identify an achievable and strategicallycorrect focus area (four Cs) akin to SWOT

Conduct an analysis of the existing organization

Consider existing and likely future environment
Carry out a diagnostic evaluation of problem areas
Clarify core competencies and purpose of the
organization

Stage 2: Strategic Planning

Establishment of long-term objectives and the

strategies required to achieve them

Strategic Focus, 3
Stage 3: Strategic Change

The organization must embark on a strategic change

campaign (SCC).
This is accomplished with elements 2 and 3 of the Strategic
Focus Wheel: making strategies work (connecting the
strategic plans to the day-to-day activities essential for
implementation) and project management.
This should be regarded as a cascade function, i.e., broken
down into smaller components so that:
Specific control is available at each level
The operatives that execute the change, who are not likely interested
in the big picture, can understand the need for change and how it will
be carried out.

A Project
has five characteristics:

Specific start and finish times

Concerned with operations not core to the business
Cost limits or objectives
Relatively short compared to the lifecycle of the
company
Are relatively complex

There will be measures (milestones, time, cost)

for measuring progress.
Outsourcing or divestitures may also be projects.

Aligning Focus with Performance

The entire process from supply to delivery is often
called the value chain (closely related to the supply
chain).

Mergers and acquisitions can rectify deficiencies in the

existing chain or produce new elements required for a revised
chain.
In terms of performance measures mapped to strategic
objectives, would the proposed merger or acquisition:
Speed up or make achievement easier?
Cause improvements and by how much?
Cause deterioration and by how much?

The Value Chain

Strategic planning is inherently concerned with
the value chain of the organization.

The value chain itself has a structure and fit with the
organization, and vice versa.

A key to successful merger or acquisition is the

degree of strategic fit that can be achieved.

The degree of difference bears on the effort and cost

to get achieve an adequate outcome.
Mergers tend to be more amicable, as the terms are
negotiated and have the support of shareholders (=
one less obstacle).

Dynamic Value Chain

The Organization
Procurement

Inbound
Logistics

HR

Operations

Infrastructure

Technology

Outbound
Logistics

Marketing
and Sales

Service

Supplier relationship
Management

Customer Relationship
Management

Suppliers

Customers

The Supply
Chain

Customer / Supplier Relationships

These began to change as producers were able to use
the internet to source from a wide range of potential
suppliers and were able to plan supplies on a strategic
basis.

This allowed companies to outsource, reduce supply costs

and reduce the time required to bring products to market.
Companies were driven to a more collaborative approach
with customers, integrating across organizational boundaries
with each other: automatic stock replenishment or vendormanaged inventory.
These relationships assist production efficiency by more
accurately forecasting demand.

Balanced Scorecard
Kaplan and Norton focus on four aspects of
performance:

Financial perspectives: profitability, future growth

and the degree of risk involved
Customer perspectives: differentiation, customer
satisfaction
Internal business processes perspectives: each
process has strategic priorities
Learning and growth perspectives: developing and
maintaining a culture of change and innovation

Characteristics Mapping
The acquirer or both merging entities must
evaluate the degree of fit in the proposed
conjunction.

This determines the degree of restructuring required,

how likely it is to achieve this, and
the likely timescales and costs.

The key is whether the necessary degree of

strategic fit can be achieved within time, cost
and performance parameters (and the trade-offs
among them).

Characteristics Mapping, 2
The method breaks down the acquirer and target into a
number of key functions, then considers a number of
fit drivers along the opposite axis.
Acquirer
Characteristic

Procurement
Marketing
Sales
Logistics
Service

Target

Degree of
Difference

Desired State

Degree of
Change
Required

Likelihood of
achieving

Extent to
which change
is essential

Change and Strategic Drift

Internal and external changes may impact upon
the strategy implementation process.

Objectives may not be correct in terms of what the

Company actually requires to achieve their defined
strategic outcomes.
Objectives could become obsolete.
Assessments of the current or desired positions
could be incorrect.
There may be divergences in implementation.

Change and Strategic Drift, 2

The longer the integration takes to complete, the
greater the likelihood of an unexpected impact
on the integration process.

In reality, things start to change as soon as the

strategy or course has been calculated.

Old Plan, New Plan

Most strategic planning uses a three-step
process:

Identify the desired ends

Develop ways to achieve these ends
Assemble and commit the necessary means

Under conditions of turbulence (rapid and

unexpected change), it may be more appropriate
for the organization to use a reverse logic
approach (means, ways, ends).

Mid-course Corrections
may not be possible if there has been some
significant intervening event. Otherwise:

Strategic realignment (new strategy)

Objective definition
Corrective / tactical response
Corrective impetus
There is necessarily a time element in altering course toward new
strategic objectives

Resource consumption
Throw-away costs

Consumer attitude

Drift Monitoring
Internal
Phased strategic review
Analysis of Critical Success
Factors (CSF)
Analysis of Key Performance
Indicators (KPI)
Analysis of Critical Business
Activities and Measures (CBAM)
Linking basic operational and
functional unit to strategy
Supporting issues (e.g., systems
alignment, incentives)

External
Customer demand
Competitor behavior
Commodity prices (incl.
interest and F/X)
Innovation and new
technologies
Statutory regulation
Key Environmental
Indicators (KEI)
broader economic focus

Scenario Planning
is a method of considering strategic objectives in the
context of possible changes in the internal
environment:

Best case scenario

Worst case scenario
Mid-case scenario (most likely)

This requires that you identify the drivers behind each

condition and how changes in each affect the overall
condition.

These may be weighted according to relative importance.

The approach is indicative rather than definitive.

3. Why Mergers Fail

The majority of mergers fail to meet their original value
creation objectives.

Longer-term projected benefits often dissipate because of

poor implementation and especially as a result of poor
integration.
Sometimes the underlying rationale is degraded during
implementation, frequently as a result of cultural integration
issues.

A typical measurement is shareholder value.

The cost of integration leads to steady or reduced shareholder

values in the short term.
It is a long time before the financial benefits of the merger
are fully apparent, by which time other activities also
influence the value (merger effect cannot be isolated).

Merger Failure Drivers

are entities or activities that create and develop
the likelihood of merger failure occurring.

Shareholder rejection
Negotiation failure
Regulator block
Strategic failure
Cultural failure
Financial failure
Integrative failure

Information technology
failure
Leadership failure
Risk management failure
Globalization issue

Shareholder Rejection
In a merger, the majority of shareholders in both
companies must favor the arrangement.
In an acquisition, a majority of target
shareholders must tender their shares to the
acquirer.

A sufficient minority comprising a percentage large

enough to prevent the acquirer from calling the
remainder might effectively block the deal if the
acquirer is uninterested in being (merely) a majority
shareholder.

Negotiation Failure
The two companies may be unable to agree on
merger terms and conditions that are mutually
acceptable.
During the course of negotiation, an event
including market reactions to the proposal can
significantly affect the value for one or the
other.
The targets Board or shareholders may be
hostile to the bid, thus raising the effective cost
of acquisition.

Regulator Block
A regulatory intervention is believed by some to
act as a control albeit often a stupid and
ineffective one to prevent a combined
company from exercising significant influence
over products or pricing.

Strategic Failure
Mergers often fail because they do not
demonstrate sufficient strategic alignment.

Diversification is the enemy of management focus

and control.
Mergers have a much better chance of being
successful if the companies produce related products
and if the acquired company skills and other assets
complement those of the acquirer.
The very fact of merger often dampens innovation,
and may weaken the motivation and commitment of
key individuals in the acquired company.

Strategic Failure, 2

Original strategic objectives may be:

1.
2.
3.
4.

inaccurate
unachievable
contradictory
obsolete or superseded by external events.

The objectives may be acceptable, but the

implementation planning process may be:
1.
2.
3.
4.
5.

incomplete
wrongly structured
based on inaccurate or unreliable assumptions
based on assumed resources that are not forthcoming
insufficiently flexible to allow for change.

Strategic Failure, 3

Even if strategic objectives are acceptable and

the implementation plans workable and
accurate, problems arise because:
1. priorities change
2. some areas cannot be implemented
3. resources are withdrawn
4. imposed changes render sections of the

implementation impracticable
5. cost limits are reached before implementation is
achieved
6. major unforeseen cultural issues arise

Cultural Failure
The cultural aspects of mergers and acquisitions are
very often underestimated when the implementation
process is being both planned and executed.
These might be characterized by:

High staff turnover

Loss of key personnel
Increasing employee conflict and stress
Decreasing employee motivation, energy and commitment

Effective communication and strong human resources

control both reduce the uncertainty for employees. The
difficulty is that HR is just as vulnerable to job
uncertainty and raiding as any other function, at
precisely the time when the need for it is greatest.

Integrative Failure
A common problem is the erosion of senior
management interest as the integration process
takes place.

Status declines once the deal is signed.

Redundancies, disruption and reorganization start to
affect people directly.

Many are not planned in sufficient detail.

Integration is often left to in-house, non-specialist

and often inexperienced teams.

4. Valuation
This module is concerned with defining the financial,
rather than strategic, advantage of merging.
Financial markets require managers to make investment
decisions that provide an expected return at least equal
to that obtainable from comparable investments.

A merger or acquisition is a complicated form of capital

budgeting.
The net advantage of merging (NAM) is the net additional
value created or destroyed from the combination.

Net Advantage of Merging

NAM = VAB (VB + PB) E VA, where

VA and VB are the values of firm A and firm B respectively

PB is the premium obtained by the targets shareholders (a
cost to the bidder)
E is the expenses and costs of associated with the acquisition

On average, sellers do considerably better than buyers

when it comes to getting value from the transaction.

The premium for control is typically in the order of 30% of

the pre-announcement share price.

Determining Cost
The cost is the amount by which the cash price
exceeds the present value of the target:

Cost = Cash price PV(B)

The text describes the second term as the target
firms present value as a stand-alone entity. The
market price is a poor guide to this value, as the
former will incorporate a premium.

There is a positive net present value (NPV)

when the gains exceed the cost.

Acquiring with Company Stock

The attribution of costs is more difficult when the
acquirer offers shares or a combination.

A portion of the uplift is reflected in the shares of firm A

used to acquire firm B.
The per-share cost is equal to the value of the combination
divided by the (new) number of outstanding shares.
Likewise, the cost could be derived by subtracting the standalone price of firm B from the portion of the combination
then held by firm B shareholders: Cost = PV(AB) PV(B).
The greater the proportion of the acquiring firms equity
being offered, the greater the cost.

Rights and Wrongs in Valuation

The correct approach is to estimate the change in value
of the firms after the acquisition is made.

This reduces the valuation task to identifying where future

cash flows will change, where costs can be cut and revenues
enhanced.
It also avoids the difficulties of estimating the value of the
combined and comprising entities, or the typical bias in
valuing potential benefits.

Earnings per share (EPS) growth is sometimes used as

a justification for an acquisition.

This can, however, mask a deterioration in the quality of the

earnings (risk and future prospects).

Valuation Methods
Three approaches:

Comparables: finding firms whose value is known

and using key criteria to produce a price indication
or a range. One may also value comparable
transactions.
Fundamental: estimating future cash flows and then
applying the discounted cash flow method.
Real options: for contingent outcomes (growth
opportunities).

Benefit and Valuation

Type

Description

Certainty Valuation

Tactical synergy

Reduced operating
expense
Revenue enhancement
from existing products

High

DCF

Strategic
Opportunity

Differentiation
Specialization
Economies of scope and
scale

Medium

Risk Adjusted
Discount
Real options

Transformation

Paradigm shift

Low

Real options

Discounted Cash Flow

The basic model allows for inter-temporal
adjustment between outgoings (costs) and
income (benefits) by discounting them at their
opportunity cost.
Four key factors:

Future cash flow profile

Cost of capital (should reflect the risk inherent in the
business)
Time horizon
Terminal value

Computing Free Cash Flow

Element
Gross Sales
Less: Cost of Sales
Operating Profit
Less: Other cash expenditures
Cash from continuing operations
+/- changes in working capital
+/- changes in capital expenditure
Less: Taxation
Free cash flow

$
A
(B)
C
(D)
E
W
X

(T)
F

Purchase Price
Purchase of equity
+ Cost of debt assumed
+ Transaction costs
- Excess cash in target
Net cost of acquisition

Exit Price
The value beyond the forecast period can be
calculated using a pricing model, using a
multiple or valuing a perpetuity.

The text adds the debt to the multiple. Surely this

value should be subtracted.
The value of a no-growth perpetuity is the free cash
flow divided by the discount rate:
V0 = FCF / r
As most firms anticipate growth, this is
incorporated:
V0 = FCF / (r g)

Cost of Capital
is not an arbitrary number, but a hurdle rate
required to compensate providers of capital for
giving up alternative investments (opportunity
cost).
Most firms use a combination of equity and debt
for financing. The weighted-average cost of
capital (WACC) gives the discount rate for the
business.

Cost of Equity (ke)

Using the Capital Asset Pricing Model (CAPM)
ke = rf + (rM rf) where
rf is the risk-free rate of interest
(rM rf) is the market risk premium
is the shares systematic risk, found by regressing return s
against a market-wide index

Estimating from dividend performance

ke = ((Pt + D) / P0) - 1 where
P0 and Pt are the initial and terminal prices of the equity
D is the dividends

For a share paying in perpetuity with growth rate g

ke = (D / P0) + g

Cost of Debt (kd)

We are computing the net cash flows after tax.
As interest payments are tax deductible, we
calculate the effect of the tax shield:
kd,AT = kd(1 T)

If the yield-to-maturity is 7.20 % and the tax rate

is 35 %, then
kd,AT = 7.20(1 0.35) = 4.68

Calculating the Cost of Capital

WACC = ke[E / (D + E)] + kd[D / (D + E)]
where

E is the market value of equity

D is the market value of the firms debt
D + E is the market value of the firm

Two factors to consider:

The pro forma capital structure may be significantly

different than the pre-acquisition one
The firm to be acquired may have significantly
different risk from that of the acquiring firm

Applying the WACC

The weighted-average cost of capital structure implies
that the firm will employ a constant capital structure in
the future.

WACC works if the new business being acquired has the

same risk as the old business and the acquisition is small
relative to the acquiring firm.

An alternative method is to calculate the firms discount

rate for the unleveraged, all-equity firm and to model
the financial side-effects separately.

This is known as the adjusted present value (APV) method.

Net APV = NPVall-equity + PVtax shield +NPVside-effects

Growth Opportunities
One of the motivations for acquisition is that it
expands the range of business possibilities for the
combined entity.

These remain latent until management makes a conscious

decision to exploit them in the light of a favorable economic
environment and business model.
These might be likened to options, since they give the firm
the right, but not the obligation, to pursue them.
They are not amenable to valuation with the DCF model,
which cannot contend with the possibility that the value can
change.

Real Options in Corporate Finance

Expansion: scale up or follow on in favorable
circumstances
Deferral: to establish timing or to learn
Contraction: temporarily idling operations or the
option to abandon
Flexibility: in inputs (e.g., fuel choice) or outputs

Valuing Real Options

When there is certainty, flexibility has no value.

The value of flexibility increases the more there is

future uncertainty (volatility).
A key assumption is that while the investment
decision depends on a parameter that is uncertain, it
becomes less uncertain over time.

Two basic approaches:

Binomial option-pricing model (assumes discrete

outcomes)
Black-Scholes-Merton option-pricing model

Binomial Valuation
Apply the volatility terms to determine the outcomes at
each node:

Up move: u = et
Down move: d = 1 / u

Determine the payoffs after the last iteration

Work backwards using the probabilities:

Drift: a = er(t)
= (a d) / (u d)

The value in the previous time frame is the discounted

value of the weighted outcome:

Vt-1 = [Vu,t * + Vd,t * (1 )] e-r(t)

Work back to t = 0

Black-Scholes-Merton
C = SN(d1) Ke-rt N(d2)

Where d1 = [ln(S/K) + rt + ((2/2)t)] / [ t0.5]

d2 = d1 - t0.5
N(d1) is the cumulative normal distribution equal to
the delta
cumulative normal distribution returns the
probability of the outcome of the input value or less,
given the mean and standard deviation

Pricing variables for options

Financial Option

Real Option

Variable

Current share price

PV(expected cash flows)

Strike or exercise price

Cost of investment

Time to expiry

Time until opportunity to

undertake project expires

(T t)

Risk-free rate of interest

Risk-free rate of interest

Share price volatility

Volatility of project cash

flows

Value leakage

Lost net cash flows from

deferring project

q or D

5. Bid Tactics
The objective is to persuade the target companys
shareholders and management that selling or merging is
the right decision.

Even in a friendly acquisition, targets management wishes to

ensure that they get the best possible terms.
Target hostility and regulatory impediments can easily derail
this process.

The bidder should establish a maximum price.

A sensible price leaves a positive net advantage of merging

(NAM) with the acquiring firm.
It is relatively easy to calculate the costs; there is much less
certainty around the value of (and the ability to realize) the
benefits.

Value of the Acquisition

will be a combination of the existing asset value
(tangible and intangible) together with the cash flows
derived from those assets.
The value enhancements have increasing risk
(decreasing certainty) as one moves from cost
reductions to synergies to new strategies.

Under pressure to succeed, managers have a tendency to

overvalue the potential benefits.

The process can become a bidding contest where the

objective becomes winning rather than value creation.

It is possible that the target is worth more to another bidder.

Market Reaction
to the announcement is a reliable predictor of the
subsequent performance of the takeover.
A market model would predict a general relationship
between a shares return (ri) and market return (rM),
where the latter is measured by an index:
ri, t = i + irM,t where

and coefficients are computed with historical data

The return is that observed at time t

The difference between the expected return and the

actual return is known as the abnormal return (AR),
and those added together over an event period as the
cumulative abnormal returns (CARs).

Merger Performance
Run-up

Targets tend to under-perform

Bidders tend to outperform

Event period

Targets tend to significantly outperform

Bidders tend to be neutral or slightly negative

Post-event

Targets tend to fall if not acquired

Bidders tend to under-perform
The winners curse is that the high bidder was the one that
was the most optimistic about the benefits of the
combination.

Bidding and Resisting as a Game

Although there are other stakeholders, the negotiation
is mainly between the acquirers managers and the
targets managers, as agents of their respective
shareholders.

The personal stake of the target managers inclines them to

resist, even if the deal is in the interests of the target
shareholders: an agent principal problem. The shareholders
may be able to realign these interests with a golden parachute.
The acquiring managers may likewise have a stake in
completing, regardless of whether the combination increases
value.

Game Theory
Merger or acquisition presents a variant of the
prisoners dilemma, where the benefits of
cooperation outweigh the alternative strategy
but only if the opposing side can be trusted to
cooperate.

The dominant strategy is to exploit.

The dominant solution equilibrium has a worse
outcome for both parties than the non-equilibrium
solution of cooperation.

Ownership clock (UK)

3%: must disclose interest in company
25%+: can block changes to the articles and
memorandum of association
30%: triggers requirement to make a bid for the
company
50.1%: control
75%+: can make changes to the articles and
memorandum of association
90%+: force remaining shareholders to sell
(mop-up provision)

Offense
If the targets management is receptive, the acquirer will
always choose a friendly approach.
If the targets management is hostile, then the acquirer
can:

Abandon
Force a negotiated settlement through a bear hug an offer
so attractive that its refusal could prompt a legal action
forcing directors to justify under the business judgment rule
Forego a settlement and: (1) make a tender offer, (2) buy up
shares in the market, or (3) commence a proxy fight.
A dawn raid is an attempt to buy a large position in the target
prior to a bid.

Defense
A radar alert might be watching for buying activity in company
shares.

If managers are seeking to add or extend critical capabilities to participate

in attractive growth areas, others may be looking to do the same.

The target management might prefer a different acquirer: a white

knight.
Run the firm efficiently rather than leaving this to the acquirer:

Use up excess cash in the firm, by acquiring assets or by declaring a

dividend.
Restructure the capital structure of the company if earnings are stable and
the company can support debt.
Divest undervalued assets or subsidiaries.

Poison Pills as a Game

These defenses are intended to make a potential
takeover more difficult, but often do so by
entrenching incumbent management:

Large severance payments to target managers

New share issues in the event of an offer
Rules prohibiting the Board from considering any
offer deemed to be not in the best interests of
shareholders
Prohibitions on the Board entertaining competitors
offers or counter-offers

Advisors, Directors
Both sides of the transaction are likely to use
professional firms and specialists to advise and
assist their aims.
Business judgment rule (USA): directors must be
able to demonstrate to a court of law that they
have acted in the best interests of the
shareholder in a transaction.

The rule also requires directors to affirm that the

transaction is fair to shareholders and is the best
transaction available.

Role of Regulation
Regulation of takeovers takes two forms:

Competition (anti-trust) the public policy issue

Merger process corporations law and securities regulation

Competition policy reflects two opposing views of the

underlying economic process: that mergers are anticompetitive, and that merger activity is an expression of
the competitive process.

The usual US test is whether the result will lessen

competition substantially or is likely to create a monopoly.
The EU will prohibit a merger if it creates or strengthens a
dominant position.
The regulator may reject the transaction, approve it outright,
or approve it on conditions (e.g., divestment).

Industry Concentration
Regulators have been concerned with measuring the
effect of an industrys concentration on
competitiveness.
The Herfindahl and Hirshman index (HHI) is the sum
of the squares of the market shares.

This takes into account the size and distribution of firms in

the market.
It approaches zero when there is a large number of firms of
nearly equal size. The index increases as the number of firms
decreases and the disparity in size increases.
Where index < 1000 prior to merger, no investigation; if 1000
1800, investigate if merger increases index by > 100; if >
1800, investigate if merger increases index by 50.

6. Due Diligence
is the investigative step after the bidding stage and
preceding the conclusion of the contract.
Pre-bid analysis has been based on information in the
public domain. For due diligence, there is access to the
targets internal information.

The acquirer is attempting to confirm that assets and

liabilities have the values attributed to them by the financial
statements (regulatory due diligence).
The process should also evaluate the degree of business and
strategic fit between the acquirer and the target (strategic due
diligence).
New information may lead the buyer to renegotiate terms,
especially when they are large uncertainties about future
values or tax consequences.

Due Diligence Objectives

The objectives are: (1) to validate the business strategy
that led to the merger decision and (2) to highlight any
issues that might affect integration.

A focus on the target as a stand-alone entity ignores or

underplays the value gains expected from the combination.
The investigation should proceed in the context of the
mergers objectives, and identify any gaps between the
combinations competencies and resources and the
requirements of the strategy.
The greater the reliance on synergies and other
complementarities from the takeover, the greater the
importance of the integration.

Planning
Clarification of the scope, depth, requirements and aims
of the process will minimize the risk of subsequent
problems.

The investigative model should capitalize on the knowledge

and experience of all concerned parties within the acquirer.

It is easy to become side-tracked:

A checklist ensures a focus on key information and the

critical value factors, e.g., staff retention, technology
compatibility. Priority might be driven by the riskiness of the
elements being examined.

The due diligence team should have a composition

appropriate to the evaluations to be made.

Critical Value Factors

Based on the strategic rationale, the investigators
will be interested in validating:

Efficiency increases better asset management,

product improvements
Operating synergies economies of scale and scope
Environmental, market and technical synergies
integrating experience, technology and organizational
systems
Organizational factors corporate culture, incentive
systems

Corporate Disruption
Mergers and acquisitions usually lead to significant
changes in managerial structure and systems:

Key personnel are replaced

New reporting and control procedures come into force
Management decisions are no longer in the remit of the
acquired firm

Due diligence may provide an opportunity to examine

the operational issues that may arise and the extent to
which they will affect the integration plan.

Cultural Factors
The target will have a formal management structure
giving the task and reporting relationships that control,
coordinate and motivate employees.
There will also be an informal set of values and norms
a culture that determines how people and groups
within the firm interact with each other and with
stakeholders outside the organization, such as
customers and suppliers.

Understanding the cultural factors and how they relate to

those of the acquirer is critical to integrating the acquisition.

Cross-Border Factors
A failure to understand how to operate in a
particular country in terms of management and
business practice can seriously jeopardize the
success of an acquisition.

It is obvious that laws and regulations will be

different.
There are likely to be even greater disparities in
corporate cultures when national cultural
characteristics, language and history are all different.

The Value of New Information

Decision analysis can be applied to the problem to
determine the optimal strategy and the value an
acquirer would be willing to pay for the target,
including the value of new information, when there are
several alternatives and an uncertain or risky pattern to
future outcomes or events.
The value of incremental information divided by the
difference between previous information and perfect
information provides an indication of an increase in
efficiency (%).

Revising Probability
Bayes theorem is used whenever probabilities
are revised in light of some new information
(e.g., a sample).

It combines experience (prior probabilities) with

sample information (numbers) to derive posterior
probabilities.
P(A and B) = P(A) x P(B|A)
P(A and B) = P(B) x P(A|B)

The theorem could apply to payoffs as well as to

probabilities.

Bayesian Revision

Results are conventionally summarized in a

table, showing how the calculations are built
up.
The posterior probability is calculated by
dividing the term P(V) x P(T|V) in the fifth
column by P(T).
Test
outcome

Variable

Prior
probability
of variable

(T)

(V)

P(V)

Test
accuracy
P(T|V)
P(T|V)

Posterior
probability
P(V) x P(T|V)

P(V|T)

Materiality
is used to describe the significance of financial and
other information to its users.

As a rule of thumb, an item or an aggregate of items is

material if it is probable that its omission or misstatement
would influence or change a decision. Otherwise, it need not
be investigated.

Consideration should be given to:

The size of the item

The nature of the item irregularities or illegal acts would be
material even if the amounts were small
The impact of the item on the economic value of the firm
e.g., contingent liabilities arising from pending litigation
Cumulative effects total effect of individual amounts on the
overall value of the target

Sampling
It is impossible to examine everything in a due diligence
process.

The size of a random sample from a finite population

determines the confidence level that the sample is
representative of the population.
If we are more interested in some parts of the population
than others, we make a random sample in various strata to
create a stratified sample.
We can also randomly select clusters of data and then
complete a census (all constituent parts) to form a sample.
In systematic sampling, we select each kth item, where k > 0.
This approach is common to reliability testing.

Non-random sampling
There may be reasons to select a sample that is
not representative of the population.

In judgment sampling, an analyst may select items

based on an understanding of the populations
characteristics, perhaps to determine whether a fuller
examination is required.
Convenience sampling may examine some cases due
to the ease of obtaining a sample.
Both are subject to sampling bias.

Due Diligence Risk

The risk from the due diligence process can be given as
DDR = IR x CR x ARR x SR, where

Due diligence risk (DDR) is the probability that the examined

items contain a significant error or misstatement.
Inherent risk (IR) is the risk that derives from the
characteristics of the firm and its business environment prior
to the establishment of internal controls.
Control risk (CR) is the risk that controls will not prevent or
detect material errors.
Detection risk (DR) is comprised of analytical review risk
(ARR) that the process will not detect material errors and
sample risk (SR) that the conclusion based on the sample
would be different if the entire population were tested.

Sampling Criteria
A confidence level is the mathematical
probability that the sample will not differ from
the population by more than a stated amount.
Precision is the element of certainty that the
error rate in the sample applies proportionately
to the population.

If the error rate of a sample was determined to be 5

percent and the precision was given as plus or minus
2 percent, this means that the potential error rate for
the population could be as high as 7 percent or as
low as 3 percent.

Computing the Precision Level

Precision is expressed in terms of a number of standard
deviations from the mean value.

mean(x) +/- z/2 x (/ n)

where mean(x) is the sample mean, is the confidence level,
is the sample standard deviation, n is the sample size and z
is the number of standard deviations corresponding to the
confidence level.
If we are seeking a confidence level of 90%, then 0.90 = (1
), = 0.10 and /2 = 0.05. We therefore seek the number
of standard deviations corresponding to 0.05, which is 1.65.
If the sample mean was 2.5, n was 100 and was 5 percent,
then the precision is
= 2.5 +/- 1.65 x (5 / 100)
= 2.5 +/- 0.83

Reliability Factor
The reliability factor is simply the negative
natural logarithm of the risk percentage
associated with the confidence level.

If the confidence level is 0.90,

reliability factor = -ln(1 0.90) = 2.3

Once the reliability factor and the monetary

error (ME) have been established, the sampling
interval is ME/ reliability factor.
The population divided by the sampling interval
gives the required sample size.

7. Implementation
as a process involves taking planned objectives and
converting them into real outcomes.
It takes place under conditions of change, and even
with detailed and accurate planning, there is an element
of uncertainty:

Unforeseen events may occur.

Planned events may develop in a different way than was
envisaged during planning.
These change risks require a tactical response, either to
preserve the plan or to establish a new plan.

Change Management
In most change processes, people from Company A
plan and implement change that will affect only
Company A. In a merger, people in Company A and
Company B plan an outcome to be experienced by
Company C (the merged entity).
Effective monitoring of the change requires the
development of a baseline strategic project plan (SPP)
that sets out the practices and procedures (including
calibration, monitoring and control) that are to form
the implementation process.

This can later be compared to the current (i.e., evolved) SPP.

The Implementation Phase

follows on from a series of earlier actions and
is to some extent dependent on these earlier
actions:

Strategic Evaluation Phase: establishment of

objectives and a search for appropriate targets
Operational Evaluation and Negotiation Phase:
target appraisal, negotiation, due diligence, closure
Implementation Phase: planning, integration,
monitoring, correction, evaluation

Value Creation
Value can be created only if the imple-mentation
process achieves the planned synergies from the
merger or acquisition.

Value may originate in scale economies, and in the

combination or increased efficiency of: (1)
management skills, (2) functional resources, (3)
operational support resources, and (4) research and
development.
There is not typically additional financial value, but
there is a quick option for growth and expansion
into new markets.

Integration Level
Mergers and acquisitions can require varying
levels of integration:

Total integration into the acquirer: greatest

likelihood of organizational resistance
Autonomous: except for some financial control
Semi-symbiotic: a slow merger with each operating
for mutual benefit
Holding: retained with the specific intention of reselling

Organizational Cultures (Harrison)

Clearly, the culture of the acquirer and acquired may
present obstacles to the integration, depending also on
the degree of integration required.

Power culture: autocratic; individual rather than group

decisions; suppression of challenge
Role culture: bureaucratic and hierarchical; emphasis on rules
and standardization
Task culture: emphasizes teamwork and commitment;
autonomy and flexibility generate creative environment
Person culture: emphasis on the individual and personal
development

Identifying Synergy
Synergies in an M&A context should result in improved
competitive advantage from:

Restructuring of the value chain in a way that the customer

perceives greater value.
Significantly reducing the cost of producing and delivering
the product or service.

In true synergies, resource sharing affects costs.

Classic examples are economies of scale and experience (or

learning curve) effects, for which there may be associated
costs of management or process interruption.

In apparent synergies, it is difficult to estimate value or

associated costs.

Exploiting Synergy
The implementation objective is to:

Identify and exploit true and apparent synergies

Create and exploit intended new synergies
Discover and exploit synergies not previously
foreseen. This is an entrepreneurial quality and often
relies on intuition, evaluation and redesign.

Implementation
is where plans are converted into reality by the
application of real tools and techniques.
at the strategic level, relates to the achievement of
long-term organizational objectives.
at the operational level, relates to developing the
new processes required to generate whatever it is that
the company produces as a product.
at the project level, relates to the completion of
individual projects that support or enhance the
operational processes.

Common Problems
Implementations tend to me messy, since they require
the disintegration and reintegration of the companies
involved.
The project team is often inexperienced with merger
implementation, is working together for the first time,
and members often retain functional responsibilities.
There are power and authority conflicts as the new
order evolves.
Moving goalposts project objectives are redefined in
response to changes or discoveries in the internal and
external environments.

Strategic Project Plan

A detailed Strategic Project Plan (SPP) must be
completed prior to the conclusion of the merger
contract so that implementation can begin
immediately.

This will contain performance criteria including time

and cost.
This also requires a monitoring and controlling
system to ensure conformance to the plan.

Implementation Elements
Initial concept and strategy formulation: one or both
companies identify a requirement to merge.
Pre-implementation planning: the collection of all
information relevant for the planning process.
Informal approaches: often coincide with industry
rumor of merger discussions.
Preliminary evaluation: respective shareholders consider
their comfort with the arrangement, and a price or
exchange ratio is developed.
Commitment to proceed: an agreement might include a
provision for damages if the merger is abandoned, or
this may take the form of a declaration of a hostile
takeover.

Implementation Elements, 2
Shareholder brief
Design: of the new companys business strategy,
organizational structure, marketing, suppliers, etc. This
forms the basis of the SPP.
Merger contract negotiations
Shareholder vote
Final agreement: often very complex in order to be
complete.
Disintegration
Implementation management
Formation of the new company

Implementation Elements, 3
Disposal of the old companies: these usually cease to
exist.
Share redistribution
Competency and capability mapping
Integration: linking the organizational structures into a
coherent new unit.
Commissioning: even if there is no clear end point, the
company declares completion.
Post-merger evaluation and feedback: the vital (and
often neglected) step of capturing the learning from the
project experience.

CSFs / Hazards
Critical Success Factors
Enterprise-wide risk
management: change risks
are high
Enterprise-wide connectivity:
merger objectives to stay
aligned with organizational
objectives
Competency balance
Information management
System design and
programming

Hazards
Merger / organization
objective misalignment
Inadequate customer care
Disproportionate
organizational focus: loss of
external awareness
Key competency erosion:
flight of key staff
Organizational conflict
Implementation rate:
processes that are rushed are
more likely to go wrong

Implementation Risk Management

A major theme of the course in one sentence:

The probability and impact of change risk are
particularly high, as the merger or acquisition itself
is designed to bring about a change, and the
process also operates under conditions of change.

Risk Classification
Some risks can be classified in terms of likelihood and
consequence. The first-level equation for risk:
Risk = f (event, likelihood, impact)

Where likelihood cannot be calculated, risk may be

examined in terms of overall hazard. Thus, a secondlevel equation for risk:
Risk = f (event, hazard, safeguard)
The hazard-control equation measures how dangerous
something is in relation the controls needed to control it, or
at least to reduce its impact to an acceptable level (leaving a
residual risk).

Risk Mapping
A risk map plots various risks according to their
likelihood (x-axis) and impact (y-axis). The analysis then
divides the map into four quadrants:

High Impact / High Likelihood: These are critical to the

success of the implementation process and are strongly time
dependent, i.e., immediate.
High Impact / Low Likelihood: Contingency planning, as
part of the risk management process, is particularly
appropriate for this type of risk.
Low Impact / High Likelihood: If left unmanaged, the
cumulative effect can be as great as the previous category.
Low Impact / Low Likelihood: These are not of sufficient
stature to allocate specific resources.

Risk Mapping, 2
The map is dynamic, which means that the different
risks can migrate over time with changes in the
operation, its controls or the occurrence of other
events.
Successful management would shift risks down (lower
impact) and to the left (lower likelihood).

Control and monitoring procedures should be developed and

risk owners made responsible for each major risk area.
The selected risks would be those that are controllable and
internal.

Risk Management Process

This is a continuous application, with a typical framework
comprised of:

Risk context (environment)

Risk identification
Risk classification, analysis and evaluation
Risk appetite
Risk response
Risk management system monitoring and review

Responses

Risk reduction
Risk transfer
Risk avoidance
Seek further information
Risk retention

Disintegration and Reintegration

Disintegration is the process of breaking a project (such
as a merger) down into components.

The smaller the component, normally the greater the degree

of control available.
Even though the activities are considered separate entities,
there will be linkages between them based on logic (Activity
B cannot start until Activity A has finished), time (if A is
speeded up, B can start earlier) or cost (A and B use the same
resources, so if done concurrently, the cost will increase)

Reintegration is the process of assembling the new

company from the components of the existing
companies.

If done correctly, this can produce new combinations of

people and processes that develop new synergies.

Managerial Levers
Leadership

The greater the degree of the unknown element in

implementation teams and in the process itself, the greater
the demands placed on the leader, particularly in relation to
the speed and reliability of response to tactical demands.

Objective Definition and Goal Setting

Functional representatives on the implementation team must

be aware of the strategic vision of the organization, and how
their function contributes to the achievement of this vision.

Formal and Informal Communications

High quality information sharing and exchange integrates the

efforts of the project participants. Problems often stem from
poor quality information, inaccuracies, or from information
that is ineffectively collected and distributed.

Transformation Tools
Selecting appropriate leaders is important enough to
warrant time and effort in a rigorous assessment
process.

A political selection process may lack the rigor of a

competency framework-based assessment because it depends
on the judgment (often unsubstantiated or ill-informed) of
the organizations politicians.

Competency modeling: It is useful to have some idea of

the competencies required in the future organization, to
measure the competencies of the people in the existing
organization, and then to use this information to try
and obtain the best people fit (reorganized as necessary)
to meet the needs of the new merged organization.

Competency Function
is the individuals overall characteristic set derived
from the competency profile:

Knowledge: relevant and useful information

Understanding: ability to apply knowledge to a problem
Skill: the ability to do something well, usually acquired
through practice (experience)
Perceived Social Role: The image a person wishes to project
in a group interaction
Personal Traits: personality and psychology of the individual
Underlying Motives: e.g., self or group orientation

Applying the Model

The end result of the assessment process is a matrix
showing the relative strengths and weaknesses of each
individual in relation to the competencies identified as
being important to the organization for the job or post
being considered.
The same information can be accumulated to show the
strengths and weaknesses of a team.

Identified weaknesses, whether technical or behavioral,

become a priority remediation issue in the implementation.

Merger Integration Survey

A merger integration survey (MIS), developed with many
research methods, is used for identifying important
organizational issues relating to the merger.
Individual and group
Development of
satisfaction/ motivation/
organizational authority/
commitment
communication/ power
structures
Team cohesion
Remuneration and reward
Alignment of individual,
systems
team and organizational
objectives
Individual and group
perceptions of job security/
Individual and group stress
reporting systems/
Conflict propagation and
operational quality
resolution
Specific actions required

8. Project Management
is a multidisciplinary and interdisciplinary generic set
of techniques. It is concerned with multiple objectives
and the various trade-offs that exist in achieving them.

A project objective of meeting a time deadline, for example,

might be possible only with increased cost or decreased
performance (quality).

Planning and executing the acquisition or merger

process is a project-based exercise.

Therefore, project management tools and techniques can be

used in the pre-merger implementation (planning process)
and in the merger implementation process itself.

Features of a Project
One-off, unique works where
the characteristics are defined
by the individual case.
Client specific
Relatively complex
Usually have a number of
clear and distinct objectives
Probably make use of limited
knowledge transfer

Are probably not the main

concern of the organization
Staffed by a multidisciplinary
team
Short lifespan but full
lifecycle
Set up to work across
functional boundaries
Relatively high risk activities

Obstacles to Implementation
Insufficient planning
Plans are effective only if adhered to, and if divergences are corrected
quickly. A process change requires re-planning.
Irreconcilable and unforeseen incompatibilities
These can arise from fundamental changes in demand or competition.
Post-acquisition change risk
in strategy, in operational processes or at the project level. These can
be planned or imposed; and originate inside or outside the organization.
Organizational resistance
results from a basic misalignment of the senior management view of
the change and the view of those working in the operations. It is driven
by the level of dissatisfaction with the status quo, the desirability of the
end state, and the practicality and risk associated with the end state.

The Concept
Project management offers a set of tools and
techniques for planning and implementing the merger.

However, if the acquired or merged company cannot offer

the products or systems that were sought as the basis of the
merger, the no amount of implementation planning and
control can give an effective outcome.

Generically, the most cited success criteria are time,

cost and performance.

There is a functional relationship among these, and they

clearly have to be planned and managed as related elements.
These usually tie to the strategic and operational objectives of
the organization.

Time Cost Performance Continuum

Quality

Cost

Time

Project Functions
Planning covers the activities to be accomplished and
the sequence in which they are to be executed.

The amount of planning is greatest at the beginning of the

project and diminishes as details become fixed.
Likewise, an error is fairly easy to rectify at the early stages
but much more difficult at a later stage.
The usual method of defining authority linkages is through a
task responsibility matrix (TRM), which lists the key activities
on one axis and the individuals or groups involved on the
other. The intersections define the nature of the individual or
group responsibilities and the corresponding date.

Project Functions, 2
Project managers are interested in authority
from two perspectives:

Accumulating sufficient authority to get the job done

Determining how much of their authority to delegate
to others involved in delivering the project.

In organizing the work, it is useful if the project

manager has an understanding both of the
politics of the organization and how this is
expressed in the present organization structures
and team management approaches.

Project Functions, 3
Controlling (from a people perspective) is essentially a four-stage
process:

Setting (achievable) targets

Measurement quantitative or qualitative
Evaluation of variance
Correction reducing or eliminating deviations. A second-level variance
analysis would determine whether the correction is effective.

Directing includes the classification and prioritization of work to

ensure that resources are committed in relation to the
importance of each individual operation.

This is particularly complex in a project team setting, as individuals are

assigned simultaneously to both functional and project teams.

Project Functions, 4
There are nine primary stages in any good team-building process:
1. Establishing individual and
team commitment.
2. Generating a sustainable
team spirit.
3. Obtaining all necessary
resources.
4. Establishing clear individual
goals and success/ failure
criteria.
5. Procuring the support of
senior management.

6. Demonstrating effective
leadership.
7. Developing effective
communications systems.
8. Applying appropriate reward
and retribution systems.
9. Identifying and managing
conflict, whether of
argument or incompatible
working practices.

Project Functions, 5
Classic leadership traits include the following:
1. Decision-making ability
2. Problem-solving ability
3. Ability to integrate new
team members
4. Interpersonal skills
5. Ability to identify and
manage conflict
6. Communication skills
7. Factor-balancing skills

8. Interface management
skill

A project manager is in
the unusual position of
reporting upwards to the
senior managers,
horizontally to the
functional managers, and
downwards to the
individual project team
members.

Project Planning and Control

Project planning and control comprises seven

major steps:
1.
2.

3.

Evaluate the project through the statement of work

(SOW) overall content and limits of the project
Generate a work breakdown structure (WBS)
time, cost and quality planning and control is done
at the lowest levels, then rolled up to higher levels
Execute project logic evaluation (PLE) which
identifies dependencies and determines the
sequence of activities, and is often driven by the
availability of resources

Project Planning and Control, 2

4.
5.

6.
7.

Separate time, cost and quality planning.

Use network analysis (Critical Path Method or
Program Evaluation and Review Technique) to
generate a draft master schedule (DMS)
identifying duration, start and finish times for
project activities
Use trade-off analysis to re-plan.
Produce project master schedule (PMS).

Project Cost Control

A Project Cost Control System (PCCS) is a two-cycle,
five-element cost planning and control mechanism.

The planning cycle includes all aspects of setting up accurate

cost plans. This is also the first phase.
In the cost control cycle, actual costs are compared to
planned costs so that overall expenditure is contained within
acceptable limits. The phases are work initiation, cost
collection, comparison and reporting.
Project variance analysis reporting (PVAR) the reporting
phase initiates a feedback loop in which cost problems are
identified, and corrections are planned and implemented. The
corrections are then themselves the subject of the cost
control cycle.

Earned Value Analysis (EVA)

is a significant control tool, as it links cost and
schedule performance. It uses three main variables:

Actual cost of works performed (ACWP)

Budgeted cost of works performed (BCWP): sometimes
called the actual earned value, is the cost that should have
been required to get the project to its current level of
development.
Budgeted cost of works scheduled (BCWS): sometimes called
the planned earned value, is the budgeted cost required to get
the project to any specified level of completion.

Derivative calculations:

Cost variance (CV) = BCWP ACWP

Schedule variance (SV) = BCWP - BCWS

Project Management as a Tool for Managing the

Overall Acquisition or Merger Process

The starting point for any acquisition or merger

implementation is the development of the
strategic project plan (SPP).

This baseline SPP can be compared to any thencurrent version, incorporating changes made along
the way.
Combinations of foreseen and unforeseen changes
will mean that the original series of estimated times
will become obsolete very quickly, and a series of
corrective or realignment calculations will be needed
in order to bring the program back into line.

9. Implementation Plan
Between inception and the signing of the deal, the
project is broken down into components and then
organized into a comprehensive project plan.
After the deal is signed, the project plan is used to
develop successful outcomes through monitoring and
control.
Acquisitions and mergers put people under a unique set
of pressures.

This can lead to unusual behavior, particularly in relation to

communication systems, power and authority structures,
administration and consent (or resistance).

Plan Detail
There is usually a functional relationship between the
detail of planning carried out and the success of the
project.
In practice, the level of detail demanded is that which
satisfies the level of control demanded by the
management team.

A plan that is too detailed is difficult to use or amend, and

tends not to be used.
Rectification costs will always be greater than the cost of
detailed planning.
Rather than make contingency plans for every possibility, it is
easier and cheaper to accept that there are unknowns in the
equation and to include some provision to cover them.

The Plan
The objective of planning is to develop and agree upon
a set of directions that tells the project team:

What is to be done
When it is to be done
How much it is going to cost
What resources are to be used

The plan itself is the link between the vision stages and
the execution stages.

It allows the vision to be mapped and converted into an

operational format showing the various stages to be achieved
in order to convert the vision into reality.

Strategic Project Plan (SPP)

Comprised of sections on:

Project aims and objectives

Supplies terms of reference for the implementation,
including scope and project boundaries
Describes how the project objectives tie with the strategic
objectives of the corporation

Team and human issues

Contracts and procurement
Schedules and cost plans
Resources
Risk management

Specific Integration Design

The integration process should be specifically
designed for the merger or acquisition.

It is dangerous to adopt a standardized approach.

There are three primary components that affect

the design of the integration process:

The size of the partner or target

The culture of the partner or target
The organizational structure of the partner or target

Integration Stages
Initialization

Merger project team summarizes its understanding

of the aims and objectives of the merger.
Terms of reference for the integration are
established.

Synthesis analysis

Attempts to discover the features in one company or

the other that will make the new whole better than
its predecessors.
Identifies areas that are not complementary (e.g.,
duplication)

Integration Stages, 2
Transition

Depends on the outcome of synthesis analysis

Selects the processes and resources that will be most
effective
Identifies gaps or weaknesses in the end result

Execution and implementation

Where a change is required, existing organizational

structures and authority structures are dissolved and
the new structures are put in place.

Merger Team and Human Issues

The merger project team has overall responsibility.
There are often merger integration teams:

MIT1, a senior management team, is monitoring the project

and project team, and ensuring the alignment of the merger
with the original strategic objectives.
MIT2, an operations/ functional manager team, is
responsible for the integration at the systems and cultural
level.
Specialist integration teams (SITs) may be created with
responsibility for integrating specific and scope-defined areas
of the merged organizations.

The merger transition team has responsibility for the

interface with existing and new customers.

Merger Project Team

Project teams are unusual in that:

They are multidisciplinary and highly heterogeneous,

in order to deal with the range of information
They are relatively short lifespan and lifecycle
dependent
They are secondary to the main organizational
functional teams

This group requires the support of senior

management to ensure that appropriately skilled
and qualified resources are made available.

Merger Integration Team

MIT1 should:

Drive major decisions

Establish the success criteria
Analyze the partner or targets degree of strategic fit,
their organizational/ cultural similarity and the
extent to which they contribute to the strategic
focus.

10. Executing the Plan

Plans go off track due to:

Changes imposed on the implementation as it is executed

Errors or omissions in the original plan
Inaccurate estimating as the original plan was being
developed
Changes that are introduced optionally

The activities that are most likely to go wrong are those

that are:

Most difficult to plan

Most difficult to analyze correctly during estimating
Over- or under-resourced
Dependent on other activities
Most subject to internal or external change

Correction
The trick is to be able to detect the divergence at
an early stage and then take action to ensure that
the divergence is corrected as quickly and
effectively as possible.
Sometimes divergences are the first indication
that the plan cannot be implemented in the
current form and a new plan must be drawn up.

Monitoring and Control

A monitoring and control system comprises:

A starting point
A desired end point
A progression curve
A current value
Analysis of current against projected values
Corrective action
Monitoring
Re-evaluation of performance versus objectives

Precedents
The integration process is generally preceded by
four key strategic decisions:

The name of the merged company

The identity of the CEO
The location of the headquarters
Which functions and/ or processes are to be merged

Successful Integration
uses an organization-wide approach.

The overall integration characteristics should take

precedence over the integration developments of the
individual units.

creates, when appropriate, permanent merger

integration teams.

The whole process does not have to start from a

zero experience base each time.

uses committed and experienced staff.

accepts flexibility and tactical response.

Successful Integration

includes MIT members in merger negotiations.

maximizes the integration rate.
makes frequent and accurate communication.
retains key employees.
exploits the opportunity to place new and effective
systems.
optimizes strategic fit.

Project objectives must be aligned with the (revised) strategic

objectives.

Successful Integration
achieves quick wins.
makes use of authority.

The best way to demonstrate to employees the

importance of the process is to have one or more
senior executives involved.

exploits the compatibility with existing

systems.
adopts the higher standard.

Achieving Synergies
often requires overcoming resistance in
existing:

Processes and procedures

Organizational structure
Personnel
Culture
Contracts

The key element is communication.

Strategic Issues
The strategy could have been incorrectly
planned.
The original objectives may have been
incorrectly assessed.
The original objectives may now have changed.
Unforeseen events may impact on the
implementation of the strategy.
New strategies may have evolved.

People Issues
Confusion

Inverse proportionality to communications

Training will often overcome

Maintaining performance and commitment

Quality management system compatible with work

breakdown structure (WBS)

Balancing opposing mindsets and convincing people

Conqueror mindset of acquirer

Grieving mindset of acquired
Success with a joint project does much to reduce barriers and
provide good feelings among team members.
Frequent milestones and gateways demonstrate that progress
is being made.

Contractual Issues
These issues end to revolve around the due diligence
process.
The incorporation process usually involves accepting all
of the stated liabilities of the acquired, which includes
warranties.
Where events create a right of termination:

Usually notice is required in writing

The other party has an opportunity to remedy the breach
Some form of notice period is observed.
Both parties are liable for debts to each other at the time of
termination.

Technical Issues
Common technical issues are time delays, cost
overruns and missed performance targets.

These result from changes after the

implementation has been agreed.
Typical internal changes
Typical external changes

Project scope
Project objectives
Resource availability
Extended due diligence

Competitor behavior
Customer demand