Harvard Business Review

Building Deals on Bedrock

Don't use deals to change your company's foundation. Use them to do what you do better.

Par David Harding and Sam Rovit

First published on septembre 01, 2004
min


This article originally appeared in Harvard Business Review (subscription may be required). Whether they like it or not, most CEOs recognize that their companies can’t succeed without making acquisitions. It has become virtually impossible, in fact, to create a world-class company through organic growth alone. Most industries grow at a relatively slow pace, but investors expect companies to grow quickly. Not everyone can steal market share, particularly in mature industries. Sooner or later, companies must turn to acquisitions to help fill the gap. Yet acquisitions can be a treacherous way to grow. In their bids for new opportunities, many companies lose sight of the fundamental rules for making money in their industries. Look at what happened to manufacturing giant Newell. When Newell’s top managers approached their counterparts at Rubbermaid in 1999 about the possibility of a merger, it looked like a deal from heaven. Newell had a 30-year track record of building shareholder value through successful acquisitions of companies like Levolor, Calphalon, and Sanford, maker of Sharpie pens. Rubbermaid had recently topped Fortune’s list of the most admired U.S. companies and was a true blue-chip firm. With its long record of innovation, it was very profitable and growing quickly. Because Newell and Rubbermaid both sold household products through essentially the same sales channels, the cost synergies from the combination loomed large. Newell expected to reap the benefits of Rubbermaid’s high-margin branded products—a range of low-tech plastic items, from laundry baskets to Little Tikes toys—while fixing a number of weak links in its supply chain. Partner David Harding explains why major deals make sense only when they reinforce a company's existing basis of competition or when they help a company make the shift, as the industry's competitive base changes. Rubbermaid’s executives were encouraging: As long as the deal could be done quickly, they said, they’d give Newell an exclusive right to acquire their company. Eager to seize the opportunity, Newell rushed to close the $5.8 billion megamerger—a deal ten times larger than any it had done before. But the deal from heaven turned out, to use BusinessWeek’s phrase, to be the “merger from hell.” Instead of lifting Newell to a new level of growth, the acquisition dragged the company down. In 2002, Newell wrote off $500 million in goodwill, leading its former CEO and chairman, Daniel Ferguson, to admit, “We paid too much.” By that time, Newell shareholders had lost 50% of the value of their investment; Rubbermaid shareholders had lost 35%. What went wrong? It’s tempting to brush off the failure as a lack of due diligence or an error in execution. Admittedly, when Newell looked beneath Rubbermaid’s well-polished exterior after the deal closed, it discovered a raft of problems, from extensive price discounting for wholesalers to poor customer service to weak management. And Newell’s management team, accustomed to integrating small “tuck in” deals, greatly underestimated the challenge of choreographing a merger of equals. Yet even without those problems, Newell would have run into difficulties. That’s because the deal was flawed from the start. Although Rubbermaid and Newell both sold household basics to the same pool of customers, the two companies had fundamentally different bases of competition. Levolor blinds and Calphalon pots notwithstanding, Newell competed primarily by efficiently churning out prosaic goods that could be sold at cut-rate prices. Rubbermaid was a classic brand company. Even though its products were low-tech, they sold at premium prices because they were distinctive and innovative. Rubbermaid could afford to pay less attention to operating efficiency. The two companies had different production processes and cost structures; they used different value propositions to appeal to customers. If Newell’s executives had remained focused on the company’s own basis of competition—being a low-cost producer—they would have seen from the outset that Rubbermaid was incompatible. How can acquirers avoid the Rubbermaid trap? We’ve been studying the question for years. In fact, we’ve analyzed 15 years’ worth of data (from 1986 through 2001) from more than 1,700 companies in the United States, Europe, and Japan; interviewed 250 CEOs in depth; and worked with dozens of big companies in planning and implementing mergers and acquisitions. Our research has confirmed our experience, leading us to conclude that major deals make sense in only two circumstances: when they buttress a company’s current basis of competition or when they enable a company to lead or keep up with its industry as it shifts to a different basis of competition. In other words, the primary purpose of mergers and acquisitions is not to grow big fast, although that may be the result, but for companies to do what they do better. Bain Book Mastering the Merger Learn more about the core decision strategies that help companies win in M&A. That means some companies should never do major deals. Firms that have a truly unique competitive edge—the Nikes, Southwests, Enterprise Rent-A-Cars, and Dells of the world—should avoid big deals altogether. For such companies, large-scale acquisitions are usually counterproductive, diluting their unique advantages and hampering future growth. It also follows that the odds are overwhelmingly against the success of a single headline-grabbing megadeal. If you already do what you do better than anyone else, a big merger or acquisition can only siphon money, resources, time, and management attention away from the core business. And even if you don’t, rarely will a single deal be the solution to all your company’s problems and bring no issues of its own. Perhaps this sounds self-evident. But few companies are so strategic in their approach to mergers and acquisitions. When we surveyed 250 senior executives who had done major deals, more than 40% said they had no investment thesis—meaning they had no theory of how the deal would boost profits and stock price. And half of those who did have an investment thesis discovered within three years of closing the deal that their approach was wrong. That means fewer than one in three executives went into deals with a sound reason that actually stood the test of time for buying a company. All too many of them made the same mistake Newell did with Rubbermaid: pursuing an acquisition that conflicted fundamentally with their company’s existing or desired basis of competition. In this article, we’ll examine how successful acquirers in both stable and changing industries use the basis of competition to guide their deal-making decisions. We’ll also explore how a company’s rigorous understanding of its basis of competition can change the way it approaches the deal-making process. But first, let’s take a closer look at what we mean by basis of competition. Read the full article in the Harvard Business Review. David Harding is an advisory partner in Bain & Company’s Boston office and the former leader of the Global Mergers & Acquisitions practice. He is a coauthor of Mastering the Merger: Four Critical Decisions That Make or Break the Deal (Harvard Business School Press, 2004). Sam Rovit (sam.rovit@bain.com) is a Bain director based in Chicago who leads its global mergers and acquisitions practice. They are the authors of the forthcoming book Mastering the Merger: Four Critical Decisions That Make or Break the Deal (Harvard Business School Press), from which this article was adapted.

This article originally appeared in Harvard Business Review (subscription may be required).

Whether they like it or not, most CEOs recognize that their companies can’t succeed without making acquisitions. It has become virtually impossible, in fact, to create a world-class company through organic growth alone. Most industries grow at a relatively slow pace, but investors expect companies to grow quickly. Not everyone can steal market share, particularly in mature industries. Sooner or later, companies must turn to acquisitions to help fill the gap.

Yet acquisitions can be a treacherous way to grow. In their bids for new opportunities, many companies lose sight of the fundamental rules for making money in their industries. Look at what happened to manufacturing giant Newell. When Newell’s top managers approached their counterparts at Rubbermaid in 1999 about the possibility of a merger, it looked like a deal from heaven. Newell had a 30-year track record of building shareholder value through successful acquisitions of companies like Levolor, Calphalon, and Sanford, maker of Sharpie pens. Rubbermaid had recently topped Fortune’s list of the most admired U.S. companies and was a true blue-chip firm. With its long record of innovation, it was very profitable and growing quickly.

Because Newell and Rubbermaid both sold household products through essentially the same sales channels, the cost synergies from the combination loomed large. Newell expected to reap the benefits of Rubbermaid’s high-margin branded products—a range of low-tech plastic items, from laundry baskets to Little Tikes toys—while fixing a number of weak links in its supply chain.

Partner David Harding explains why major deals make sense only when they reinforce a company's existing basis of competition or when they help a company make the shift, as the industry's competitive base changes.

Rubbermaid’s executives were encouraging: As long as the deal could be done quickly, they said, they’d give Newell an exclusive right to acquire their company. Eager to seize the opportunity, Newell rushed to close the $5.8 billion megamerger—a deal ten times larger than any it had done before.

But the deal from heaven turned out, to use BusinessWeek’s phrase, to be the “merger from hell.” Instead of lifting Newell to a new level of growth, the acquisition dragged the company down. In 2002, Newell wrote off $500 million in goodwill, leading its former CEO and chairman, Daniel Ferguson, to admit, “We paid too much.” By that time, Newell shareholders had lost 50% of the value of their investment; Rubbermaid shareholders had lost 35%.

What went wrong? It’s tempting to brush off the failure as a lack of due diligence or an error in execution. Admittedly, when Newell looked beneath Rubbermaid’s well-polished exterior after the deal closed, it discovered a raft of problems, from extensive price discounting for wholesalers to poor customer service to weak management. And Newell’s management team, accustomed to integrating small “tuck in” deals, greatly underestimated the challenge of choreographing a merger of equals.

Yet even without those problems, Newell would have run into difficulties. That’s because the deal was flawed from the start. Although Rubbermaid and Newell both sold household basics to the same pool of customers, the two companies had fundamentally different bases of competition. Levolor blinds and Calphalon pots notwithstanding, Newell competed primarily by efficiently churning out prosaic goods that could be sold at cut-rate prices. Rubbermaid was a classic brand company. Even though its products were low-tech, they sold at premium prices because they were distinctive and innovative. Rubbermaid could afford to pay less attention to operating efficiency. The two companies had different production processes and cost structures; they used different value propositions to appeal to customers. If Newell’s executives had remained focused on the company’s own basis of competition—being a low-cost producer—they would have seen from the outset that Rubbermaid was incompatible.

How can acquirers avoid the Rubbermaid trap? We’ve been studying the question for years. In fact, we’ve analyzed 15 years’ worth of data (from 1986 through 2001) from more than 1,700 companies in the United States, Europe, and Japan; interviewed 250 CEOs in depth; and worked with dozens of big companies in planning and implementing mergers and acquisitions. Our research has confirmed our experience, leading us to conclude that major deals make sense in only two circumstances: when they buttress a company’s current basis of competition or when they enable a company to lead or keep up with its industry as it shifts to a different basis of competition. In other words, the primary purpose of mergers and acquisitions is not to grow big fast, although that may be the result, but for companies to do what they do better.

Bain Book

Mastering the Merger

Learn more about the core decision strategies that help companies win in M&A.

That means some companies should never do major deals. Firms that have a truly unique competitive edge—the Nikes, Southwests, Enterprise Rent-A-Cars, and Dells of the world—should avoid big deals altogether. For such companies, large-scale acquisitions are usually counterproductive, diluting their unique advantages and hampering future growth.

It also follows that the odds are overwhelmingly against the success of a single headline-grabbing megadeal. If you already do what you do better than anyone else, a big merger or acquisition can only siphon money, resources, time, and management attention away from the core business. And even if you don’t, rarely will a single deal be the solution to all your company’s problems and bring no issues of its own.

Perhaps this sounds self-evident. But few companies are so strategic in their approach to mergers and acquisitions. When we surveyed 250 senior executives who had done major deals, more than 40% said they had no investment thesis—meaning they had no theory of how the deal would boost profits and stock price. And half of those who did have an investment thesis discovered within three years of closing the deal that their approach was wrong. That means fewer than one in three executives went into deals with a sound reason that actually stood the test of time for buying a company. All too many of them made the same mistake Newell did with Rubbermaid: pursuing an acquisition that conflicted fundamentally with their company’s existing or desired basis of competition.

In this article, we’ll examine how successful acquirers in both stable and changing industries use the basis of competition to guide their deal-making decisions. We’ll also explore how a company’s rigorous understanding of its basis of competition can change the way it approaches the deal-making process. But first, let’s take a closer look at what we mean by basis of competition.

Read the full article in the Harvard Business Review.

David Harding is an advisory partner in Bain & Company’s Boston office and the former leader of the Global Mergers & Acquisitions practice. He is a coauthor of Mastering the Merger: Four Critical Decisions That Make or Break the Deal (Harvard Business School Press, 2004). Sam Rovit (sam.rovit@bain.com) is a Bain director based in Chicago who leads its global mergers and acquisitions practice. They are the authors of the forthcoming book Mastering the Merger: Four Critical Decisions That Make or Break the Deal (Harvard Business School Press), from which this article was adapted.