Saving Public (and Private) Companies


Leading Causes of Death of Publicly Traded Companies
Companies are still a major economic engine in commerce. Imagine what the landscape would look like if we had only free-lancers of single proprietors looking to do business with each other — the ultimate fragmentation.

Thus what happens when a company dies makes a difference to society. But how do we know the data is accurate when we measure lifespans? Studies on the general quantitative and statistical character of firms have produced mixed results regarding their lifespans and mortality,” say the authors of a recent study that looked at the lifespans of more than 25,000 publicly traded North American companies, from 1950 to 2009.

Madeleine I. G. Daepp, Marcus J. Hamilton, Geoffrey B. West, Luís M. A. Bettencourt found that the typical half-life of a publicly traded company in any sector is about ten years. In the study, they analyze data as to the factors that contribute to this finding. By far the most frequent reason for a firm's death is a merge or acquisition. From the article (see full article for references):

There is a great diversity of perspectives on a theory of the firm, focusing on different aspects of their costs, organization and evolution. In modern economic theory, the existence and boundaries of firms are understood in counterpoint to the dynamics of self-organization in markets.

Economists such as Coase and Williamson proposed that firms exist in order to minimize (positive) market transaction costs involved in the production of goods and services. In situations when, for example, there is particular specificity of goods and services exchanged between two economic agents, such transactions may be best organized internally to an organization rather than negotiated in the open market. As such, firms may split, merge or liquidate in response to economic agents evolving new and better ways of dealing with the various costs and revenues of production and exchange.

However, calculations on a spreadsheet tend to forget a very important variable, one that makes the economies of scale argument not as smooth or simple as it looks like by the numbers — and that is people. People add complexity.

Therefore, at least on the average, the merger of existing companies should be approximately neutral in terms of the balance between costs and benefits. However, this relatively simple picture becomes more complex in the light of behavioural studies of the impact of decision-making and management practices on the growth and viability of actual firms.

Because both customers/clients and employees/managers/leaders are people, success is predicated upon several variables, including how to factor in for the context and environment where relationships and connections take place in each organization. After developing a solid understanding of these soft metrics of how the business operates, more emotional and implicit knowledge than operational data, addressing them with a well-thought-out communication and conversation plan is a good end point.

But it is not a starting one. We need to have better answers to what happens when a brand dies. Decision-making should benefit from visibility into dynamics other than how we merge IT systems, because even those systems were designed to fit a specific process and way of doing business, not just a business model.

Were United and Continental truly “united,” as the new name indicates? From the Article

three years in, the merger is still causing problems. Late last month, for example, America's Department of Transportation fined United $350,000 for taking too long to process its customers' refund requests. (The airline also got in trouble for reporting some of its overbooking, baggage, and pet-related statistics incorrectly, but was not fined for those violations.)

Here's the remarkable thing about this latest fine, which was connected to delays of some 9,000 refund requests: United blamed it on the merger. According to the Los Angeles Times, United told the regulators that when the two legacy airlines' reservation systems were merged it resulted (in the words of a DOT report) "in some unforeseeable anomalies that caused a temporary inability to process refunds in a timely manner."

Computer problems are the front end of a back end issue, one that is not just about systems. We also need to have better questions before a brand or company dies.

In Comprehensive Guide to Mergers & Acquisitions, A: Managing the Critical Success Factors Across Every Stage of the M&A Process Yaakov Weber, Shlomo Tarba, and Christina Oberg say:

Many research studies conducted over the decades clearly show that the rate of failures is at least 50 percent. In surveys conducted in recent years, the percentage of companies that failed to achieve the goals of the merger reached 83 percent.

Following these findings, it can be expected that senior managers and boards of directors would avoid merger and acquisition activities as much as possible and would search for other strategies to achieve market share and profitability goals.

However, reality indicates the opposite. The trend of mergers and acquisitions has been constantly increasing over the past 20 years. Moreover, the number of mergers and acquisitions and the sums of money invested in them have shattered the all-time record almost every year.

Global M&A deal volume rose from 27,460 transactions in 2010 to 30,366 in 2011, an 11 percent increase according to WilmerHale report from 2012 on M&A activity.

Similarly, global M&A deal value increased 53 percent to $3.11 trillion in 2011, up from $2.03 trillion in 2010. Average global deal size grew to $102.6 million in 2011, up from $73.8 million in 2010.

In the United States, the volume of M&A activity was fairly steady, increasing 7 percent, from 9,238 transactions in 2010 to 9,923 in 2011. U.S. deal value jumped 79 percent, from $887.3 billion in 2010 to $1.59 trillion in 2011, due to a spate of large transactions.

In Europe, both deal volume and deal value continued to increase from their 2010 levels. Deal volume increased 15 percent, from 11,736 transactions in 2010 to 13,501 in 2011. Boosted by a number of large transactions, total European deal value increased 91 percent, from $780.5 billion to $1.49 trillion.

The Asia-Pacific region also experienced growth in deal volume and value. The number of Asia-Pacific deals increased 12 percent, from 7,970 transactions in 2010 to 8,905 in 2011, whereas aggregate deal value increased 26 percent, from $652.5 billion to $822.2 billion. According to Bloomberg’s M&A report from 2012, China’s appetite for buying opportunities continued to increase, with $158 billion worth of deals announced in 2011, a moderate 9 percent increase from $145 billion in 2010.

The book was published in 2013. The authors however reference a survey report of financial market professionals made by Bloomberg. It says that the M&A activity will continue to grow with Asia-Pacific companies expected to be the most aggressive buyers, and firms in the European region expected to be the most attractive targets. They go on to say:

Yet, even if the number of mergers and acquisitions declines in the next few years, it is clear that this strategy will continue to remain important to many organizations. In addition, the increase of international activities and processes of globalization will encourage international mergers and acquisitions. Will the high rate of failures continue to characterize the M&A activities? It is hard to say. There are reasons to believe that certain dimensions of M&A remain difficult due to the complexity of M&A.

Primary reason for failure

The primary reasons for failures is related to the fact that it is easy to buy but hard to perform an M&A. In general, many mergers and acquisitions are characterized by the lack of planning, limited synergies, differences in the management/organizational/international culture, negotiation mistakes, and difficulties in the implementation of the strategy following the choice of an incorrect integration approach on the part of the merging organizations after the agreement is signed.

The authors of the guide then go on to detail the factors for success and failure according to three main areas: 1./ economics and finance, 2./ strategic management, and 3./ organizational behavior. Among the possible explanations for why this happens, despite scarce evidence of economic success, the authors list:

  1. Managers make mistakes in the evaluation of the value.
  2. Managers search to maximize their profit, even at the expense of the stockholders.
  3. Managers act out of pressure from the board of directors and stockholders to show continuous growth.

Or maybe the potential is there, but there are other issues at play:

  1. Organizational problems that occur after the merger entail many costs that negate the potential profit or do not allow for the realization of the M&A.
  2. There is a methodological problem with the measurement of the success and profitability of mergers and acquisitions, and therefore the existing profitability is not evident.
  3. The M&A causes reactions among external stakeholders that offset possible positive consequence. Such reactions include how customers decide to change their ways of buying products, whereas a continuous cash flow from these customers was part of the valuation of the acquired party. It is possible that only certain types of mergers bring a profit to the stockholders, whereas others do not.

Strategic management researchers focus on the management of the organization. This merits some definition — managing is what set the company's trajectory, and management is what generates an organization's movement after leadership has established its direction.

By virtue of their functions and study of these functions, strategic management says future cash flow is harder to predict. Thus they reject the assumptions of economic/finance researchers that:

  • It is possible to precisely predict the future cash flow of the firm for a period of several years.
  • There is the potential for increased inner effectiveness that is greater than the performance of the acquired party’s managers.

They have their own criteria for evaluating success. They include:

the size of sales, the increase of the market share, the improvement of competitive abilities, and of course the change in profitability after the merger in relation to a period before the M&A.

These measures are influenced, according to strategic management researchers, by the fit between the organizations, and therefore the main factor of success/failure in the merger/acquisition is the degree of strategic fit between the two companies.

Implementation is where things fall apart, specifically due to lack of focus on the human factors. The nature of differences between two companies is important, but even more important to success in planning is understanding the degree of these differences in management and organizational culture. The gap between policies and rules, for example, requires an adjustment for people who will then need to develop new habits — individually, and collectively.

There is also the cognitive load of learning many new regulations and business practices all at once while processing the emotional aspects of how we as humans respond to the stress caused by change, especially that we do not initiate nor are prepared to confront.

Some of the human reactions when communication and collaboration are not addressed (or not well) include abandoning ship physically, disconnecting mentally, going through the moves, or actively hostile behaviors. How we do what we do is one of the aspects of work where we feel we have agency. When our ability to influence things is non existent, we often make plans to be where it is.

People leave and tacit knowledge and experience go with them. Say the authors:

In essence, a main reason for the acquisition is the innovativeness, professional knowledge, and talented personnel. If managers and key personnel leave the acquired company, then the acquiring company is left without the value that it paid for. 

[read the full chapter here]

Making sense of the data that reflects truer figures on the mortality of public (and private) companies is a good step. As Daepp, Hamilton, West, and Bettencourt say:

As of 2011, the total market capitalization of firms in the New York Stock Exchange was 14.24 trillion dollars, comparable to the entire gross domestic product of the USA.

[…]

the distribution of firm lifespan has been the subject of far fewer studies

[…]

A perspective more directly tied to the demography of companies is organizational ecology. In the framework of organizational ecology, organizations that vary in their structure and relationships are modelled as competing for finite resources within a complex ecology of economic interactions. In this approach, which emerged from economic sociology, companies are seen as units of selection in markets and their longevity is the result of their successes of learning and adaptation in these environments.

Similar to this approach, we employ mathematical models from theoretical ecology to examine the lifespans and mortality of companies.

Among the most widely replicated results relating to the mortality of firms is Stinchcombe's liability of newness. This is the expectation that young establishments experience higher mortality rates.

Market attrition or as the authors call it to follow on the analogy, market-based selection, is a factor. Companies that receive funding are somewhat protected from the liability of adolescence that acts as a buffer until money runs out. Then the companies that have not built a strong sales pipeline become vulnerable to market shifts.

The authors list two other liabilities, which may very well be small deviations — liability of senescence, meaning their mortality rate increases as the companies age because “they accumulate rules and stagnating relationships with consumers and input markets that render them less agile and that re-configuration is increasingly expensive,” and  liability of obsolescence:

environmental requirements change over time and that, although firms may improve in competence and efficiency with age by becoming more specialized, these specific adaptations also increase the companies’ risk to new kinds of external shocks that will inevitably beset them.

The paper tests alternative hypotheses of firm lifespan and mortality risk and confirms “the hypothesis of an approximately constant mortality rate, finding that the exponential distribution of firm lifespans holds across business sectors and causes of mortality.”

It then applies its survival analysis to derive at the half-life of about ten years, “regardless of age.” Mergers and acquisitions are listed as a leading cause of death; the reasons go beyond two companies becoming one. Based on the data, it's more like two companies become half.

Before we go ahead and change the game, it's a good idea to understand the game we're in. We can create better organizational habits.

 

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