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TRADITIONAL DUE DILIGENCE IS NOT ENOUGH

By Patricia Dodgen

Mergers, acquisitions, hostile take-overs, even joint ventures and collaborative projects - these topics fill column after column in our daily newspapers and are a standing business news item on the network evening news.  How many really succeed, and succeed in the originally planned timeframe? How many actually generate performance equal to original expectations?  Sadly, very few.  And almost every one of these endeavors involves some level of unpleasant surprise, some major hiccough, or worse on the road to completion.  Why?  How can legions of accountants, consultants and other high-level experts be wrong? The answer is fairly straight-forward; however, the explanation is somewhat complex.  I’ll use a simple analogy to try to convey the answer.  The detailed explanation I’ll cover in the next article.

Have you ever planned an elaborate vacation?  A dream trip to a destination in another country or on another continent?  Possibly you’ve dreamed of a European destination like Rome or Paris.  Beautiful cities - romantic, historical destinations rich with new experiences - dining, art, music, architecture, culture.  Maybe you imagine yourself in a more exotic location - palm trees, island music, emerald water.  How do you prepare for your vacation of a lifetime, one you’ve long anticipated?  Well, most of us read travel articles in magazines, or raid the travel shelves at our local bookstore or on-line bookseller.  We might use a travel agent to help us put together the right combination of activities and accommodations. The more exotic and distant the location, the more energy we’ll probably invest in preparing for the trip.  We will comparison-shop hotels for the perfect combination of amenities, location and price.  We’ll check out the pages of the major food magazines for restaurant reviews.  We might even invest energy in a foreign language course, or tapes, or a phrase book so we can communicate with the local population once we arrive.  We’ll make painstaking plans and arrangements, all designed to result in the experience of a lifetime.  How likely is all that effort to result in a real dream vacation?

Well, obviously, a bad hotel, mediocre food and botched travel logistics can make for a miserable trip.  But just getting to your destination, staying at the ideal hotel and having a few expertly-prepared meals doesn’t necessarily add up to that once-in-a-lifetime experience.  Even when every arrangement you’ve made comes off exactly as planned, you may not end up with the heavenly experience you’ve dreamed about.  You may return from your trip vaguely unsatisfied and disappointed in the gap between your expectations and reality.  Worse yet, you may decide to never undertake an expensive vacation again.  This same phenomenon applies to mergers, acquisitions, joint ventures, and collaborative projects (MAJV&CP’s). 

Typically in a MAJV&CP significant effort is invested in preliminary research and fact finding.  The larger the relative value of the MAJV&CP, the more formal and lengthy the research process will be.  Usually mergers and acquisitions follow a lengthy and detailed due diligence process.  Due diligence tends to involve specific steps designed to provide management, the board of directors and shareholders with a level of comfort or reassurance that undue financial and operational risk has been assessed and avoided. Most due diligence processes involve the analysis of major categories of activity, including operations, marketing, distribution, customers, products and suppliers.  The primary factors evaluated include comparatives and details of the different types of assets, the customers, employee agreements and benefits, long-term contracts, environmental issues, any foreign operations or activities, legal factors, product and supplier issues, and potential tax issues.  However, the factors being analyzed are most often basic measures of operational and financial health.  Going back to our dream vacation analogy, they are the hotel and airline arrangements - our seat assignments, time of departure and arrival and itinerary of activities.  While they serve to confirm our comings and goings and the nature of the activities we’re planning, they may or may not guarantee the experience will meet our expectations or needs.

What’s missing?  What is the magic component in our vacation preparation process that serves to measure the real level of our expectations and describe our real needs and compare them to what is realistically likely to happen in our dream destination?  In our vacation scenario, that element is a below-the-surface examination, not only of what kind of experience is likely to occur, but of our internal needs and expectations.  What do we want in a dining experience?  A gourmet meal?  An opportunity to eat and converse with the local population?  An opportunity to observe how the various ingredients of the meal are prepared and the history of the dish?  You may have a very satisfying plate of food, and still walk away from the experience not having gotten what was really important to you. The difference is not in the logistics, but in the objective clarification of what is desired versus what will be provided. 

Another way of thinking about this disconnect is to consider that various cultures have different standards for “personal space”, or how closely or far apart individuals position themselves from one another.  If your dream destination is a culture where it is customary to stand or sit within a very few inches of the person with whom you are conversing, the topic may be fascinating.  But if you come from a culture that expects more personal distance, chances are you will be too personally uncomfortable to notice.  Your dream vacation may be marred by memories of these unanticipated, but very real and unsettling experiences. 

The business world analog to the personal space example is found in a recent situation where different corporate communications styles could have become an merger breaker without outside intervention.  One of the merging companies had fostered an environment that valued and focused on open communication and consensus-based decision making at the senior management level - the very physically close culture described in our analogy.  The other company had a more formal and traditional, hierarchical process.  Communication was closely controlled and monitored on more of a “need to know” basis.  When these two company environments were brought together, what ensued was a case of “too close/not close enough” misfit.  The managers from the more traditional company were appalled at the candid level of communication going on - in fact they perceived it as broadcasting insider information via e-mail to an audience entirely too extensive and inappropriate.  The consensus-based managers were puzzled at the level of alarm expressed by their more traditional counterparts.  Real and significant conflict was created, and ultimately, the basic elements of trust and collaboration necessary to create a unified team were destroyed. The result - a merger that was headed toward failure and missed expectations.

In another recent acquisition, the company that was acquired had traditionally operated within a model where their sales representatives were given considerable latitude to manage and set product pricing.  They were able to manipulate product margins to the best interest of both the end customer as well as the company itself.  After another firm acquired this company, the process and rules concerning pricing and margin management were changed to the acquiring company’s model - totally governed by upper level management where all changes or negotiations involved a lengthy and bureaucratic approval ladder.  Consequently, a number of key sales representatives felt their authority and professional standing had been diminished, and they felt they no longer had the ability to actively meet their customers’ needs and support a positive long-term relationship with them.  As a result, many of these key individuals left the company and took positions with several major competitors.  Additionally, not only did the employer lose these highly trained sales consultants, but over time the sales reps’ key customers moved with the reps to the competing firms.  Not only was the acquisition less than successful, the subsequent cost to the acquiring firm was dramatic.

In the due diligence process for MAJV&CP’s, these key factors and dozens of others issues just as problematic are often overlooked or minimized.  Management tends to put their resources and energy into the more traditional financial and operational measures that have been the staples of the due diligence process for decades.   Measures aimed at determining the cultural fit of the merging organizations are ignored or given superficial attention because they are perceived to be more difficult or even impossible to objectively identify and evaluate by comparison to the traditional measures.  Frequently these factors are viewed as less important than the more traditional measures.  However, these elements are often the root cause of the failure of a MAJV&CP.  

These critical factors include various behavioral and human dynamics, change measurement and evaluation criteria, and intuitive and systemic type observations.  In the broader context of the business world there is a tendency today to ignore these causative and complicating factors.  They appear on the surface to be qualitative and difficult to accurately measure.  However, with the appropriate approach and the application of proven empirical disciplines, a much more comprehensive and accurately predictive analysis can be developed and used to improve the chances of a successful MAJV&CP.   It is critical that an appropriate balance between traditional operational measures and these ignored cultural measures be reached in order to have the highest probability of success in any MAJV&CP.

In my next article, I’ll explain the overall assessment process and the empirical approach for developing “Critical Fit Criteria” that will significantly enhance the accuracy and effectiveness of the due diligence process and greatly improve the probability for a successful return on investment.  Meanwhile, may your summer vacation be everything you hoped and more.


Patricia Dodgen is a Fellow of The Business Forum Institute.  Patti holds a BS, Financial Management (Cum Laude), Clemson University, 1977 and has broad experience as a senior executive in financial, technical, and operational management for various industries. She has specialized consulting experience in the telecommunications, broadcasting, print media, and computer technology fields. Currently, Patti is working on a national project to redesign the fundraising activities of a major non-profit client.  Her approach to business strategy and development evolved during her years with Dun & Bradstreet as a senior business analyst and with Digital Equipment Corporation (DEC), as a senior financial manager. At Dun & Bradstreet, Patti had the opportunity to closely examine and analyze the financial and operational successes and failures of a vast assortment of businesses of varying size within many industries. As a key senior analyst, she investigated, analyzed and developed conclusive responses to business questions for firms such as RJ Reynolds, Belk Store Services, Nucor and Bernhardt Industries. Patti is a frequent speaker at national conferences on the topics of complex change management, strategic positioning and "managing by the numbers". 


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