How to achieve value behind the deal during merger integration

Barry Brunsman, Scott Sanderson, Mark Van De Voorde
Deloitte & Touche Consulting Group
Chicago

Mergers and acquisitions (M&A) have long been a part of the oil and gas industry.

For the most part, however, mergers have been asset plays-acquisitions of properties or infrastructure to "round out" a portfolio.

In these cases, post-merger integration-the formation of the new company after a deal is closed-became an exercise of assimilating the acquired property or company. The integration effort-measured in time or resource requirements-was not significant.

Recent deals, however, are quite different from past asset plays. Megadeals such as Halliburton Co./Dresser Industries Inc., Nova Corp./TransCanada PipeLines Ltd., and the well-publicized downstream joint ventures in the U.S. and Europe (see related story, p. 30) involve much more than assimilating a new asset base. The success of these deals will depend on quickly rallying organizations with different strategies, management models, organization designs, operations models, and supporting infrastructure around the objectives of the deal.

Deloitte & Touche's experience suggests that the scale of recently announced mergers and acquisitions will require a well-planned and executed integration effort. This article describes what the merging companies in

the oil and gas industry face as well as the process through which these issues can be addressed and resolved.

M&A: creating a new enterprise

Mergers and acquisitions result in the creation of a new enterprise.

The fundamental challenge of M&A is to create an enterprise that generates more shareholder value than the predecessor companies generated independently. Deloitte & Touche uses a generic enterprise model to explain the issues merging companies must address and to help them understand the magnitude of the challenge they face (Fig. 1 [173,192 bytes]). This enterprise model includes the following levels:

• Vision and mission. This defines the current competitive environment, the companies' strengths and weaknesses in this environment, the vision for the future competitive marketplace, and the mission that describes how the company will "win" in the future marketplace. Relevant petroleum company issues include: What are the strengths and weaknesses of the merging companies? Do antitrust issues constrain the scope of the enterprise? What is the basis for the competitiveness of the future enterprise, given an industry facing weak oil and gas price expectations?
• Competitive strategy. This defines the enterprise's value proposition (the reasons customers will prefer the company's products and services), specific market positioning, and the business model (how the company will monetize its value proposition) that will allow a sustained competitive advantage. Relevant petroleum company issues include: How will we manage our brands? What markets will we compete in? How do we rationalize our products and services to create an integrated product and service offering? How should we prioritize our R&D investment given our new, expanded product and service offering? How can we use the size of our new organization to create a competitive advantage when our competitors are merging, too?
• Management model. This defines the governance and leadership requirements of the enterprise. Relevant issues include: How will the office of the chairman function? What leadership styles will be appropriate in the new organization? What organizational "levers" will allow executive management to achieve the objectives of the competitive strategy?
• Organization structure. This level defines the organizational responsibilities, performance requirements, and reporting relationships that allow the organization to achieve the objectives of its competitive strategy. Relevant petroleum company issues include: How do legal constraints and contractual obligations affect the reporting structure? What performance measures should be used to measure the success of each organizational unit (return on capital employed, return on net assets, et al.)? How can we eliminate organizational boundaries that limit the flow of information between technical specialties?
• Operations. This defines the management, operations, and support business processes required to achieve the company's strategic objectives. Relevant petroleum company issues include: What are best practices, and how do we achieve them? How can we eliminate operational redundancy? What division offices, vehicles, etc., can we eliminate? How can we implement integrated "mission critical" processes (e.g., new product/service development, business development, payroll processing, human resources management, shareholder services, risk management, etc.) by Day 1?
• Information technology (IT) infrastructure. This last level defines the hardware and software architecture requirements that enable the business processes needed to achieve the objectives of the competitive strategy. Relevant petroleum company issues include: Can similar IT projects (e.g., Year 2000 problem solutions) be combined to lower IT costs? How can IT projects and staffing be prioritized? Clearly the issues that merging petroleum sector companies face are many and significant. A holistic merger process that links corporate strategy to the post-merger integration effort is the means by which these issues can be resolved. The following describes the merger process, focusing on the details of post-merger integration.

Merger process

M&A is the fastest means by which an acquirer can significantly reposition its place in the competitive market. The decision to merge with or acquire a company, however, should not be made lightly.

Deloitte & Touche Consulting estimates that 60% of mergers fail largely because of integration approach. To understand the keys to M&A success, it is helpful to understand that all elements of the merger life cycle constitute pieces of a highly interrelated merger process.

M&A is a holistic process of which merger integration is the final step (Fig. 2 [88,054 bytes]). Deloitte & Touche Consulting describes the merger process as comprising four key steps, described as follows:

• Strategy development. An M&A strategy defines the objectives of M&A activity. Typical M&A goals include: 1) increase market share; 2) strengthen skills and core competencies; 3) develop a broader business portfolio and diversify, et al. M&A strategy development goes well beyond these high-level objectives, however. An effective M&A strategy is grounded in a fact-based corporate strategy and is developed in sufficient detail as to provide a basis for subsequent decision-making. The M&A strategy also seeks to answer preliminary integration questions. Ultimately, it is translated into specific target-screening criteria that the acquirer can use to identify preferred targets.
• Target screening. Target screening is the iterative process of identifying and evaluating potential acquirees. This step takes the developed strategy and examines each potential target for its ability to create value within the context of the strategy. An essential element of this value creation is the ability to quickly and effectively integrate the target into the acquirer.
• Transaction mechanics. Transaction mechanics includes all those activities involved in valuing, structuring, and executing the deal. A core element of this step is the identification, quantification, and validation of the synergies the deal creates. The results of this step include a thorough understanding of the strategic, operational, and financial expectations of the deal; the transaction details; and a transition plan to achieve the objectives of the transaction.
• Integration. Integration includes all those activities to achieve value creation. Although it sounds obvious, M&A success depends on effectively managing all of these steps. In reality, managing these steps is not trivial. It is often the case that these steps cross organizational boundaries. The organization responsible for corporate strategy may not be responsible for defining M&A strategy. The organization responsible for the M&A strategy may not be responsible for its execution. Organizational boundaries create frictions that threaten the ability to achieve the benefits of the deal. Also, mergers can lose their executive appeal after the deal is closed. As the merger falls off the CEO's agenda-typically during the integration phase-the likelihood of achieving the objectives of the transaction are greatly diminished. Deloitte & Touche's experience suggests that successful M&A activity requires focused and thorough pre-transaction strategy development, strong pre-transaction analytical effort, and comprehensive management of the integration effort. It is the last of these that is most frequently underestimated or unappreciated.

Merger integration framework

The scale of the integration effort frequently surprises those who are unfamiliar with its complexity and pervasiveness.

For example, the Halliburton-Dresser merger will create a combined company with 100,000 employees, global operations, and a fundamentally different approach to the marketplace. The effort to combine human resources, accounting, and information technology infrastructures alone is staggering, and these activities, although critical, do little to achieve the objectives of the transaction.

Still more effort will be required to craft the detailed organization structure, business plans, and operations model to achieve Halliburton's growth objectives.

In order to simplify planning and managing of an integration effort, Deloitte Consulting breaks merger integration into four logical phases: framework development, situation analysis, design, and implementation (Fig. 3 [108,555 bytes]).

Framework development

Framework development involves all those steps to establish the linkage between the objectives of the transaction and the mechanics of the integration.

Stated differently, the main objective of this phase is to answer the question: What do we want to accomplish in the integration, and how do we want to do it?

First and foremost, framework development involves defining the ground rules of the integration effort. Ground rules include: integration objectives, scope and timing, organizational design criteria, and Day 1 requirements. It is critical that these ground rules be consistent with the financial and operational assumptions that provided the basis for deal valuation.

Framework development also involves establishing the mechanics of the integration process. Merger integration can involve hundreds of people from the predecessor organizations and span continents. A well-defined organization structure-typically independent of either predecessor organization-is required to manage the integration effort. An integration organization usually includes:

• A "transition management team" (including the CEOs of the predecessor organizations) that establishes the ground rules and provides strategic direction to the integration effort.
• An "integration executive," who is responsible for the integration.
• A number of process teams chartered to analyze current business practices and define new practices that achieve the objectives of the transaction.
• Support teams chartered to analyze and define policies and procedures that span process teams as well as provide the infrastructure (e.g., external communications) that supports the integration effort.

Fig. 4 [125,179 bytes] depicts a typical integration organization structure.

A number of important considerations should be given during this phase:

• First, this phase will result in goals and objectives that are inconsistent with those of the transaction unless specific action is taken to ensure the alignment of transaction and integration goals.
• Second, merger integration is an unparalleled opportunity to shape an organization, so the highest-quality resources should be dedicated to this task. Although it is difficult to pull high-caliber staff out of the field for any period of time, it is critical to involve top performers in the integration effort on a full-time basis.
• Third, employees will scrutinize the decisions made during this phase. It is critical to communicate quickly, openly, and honestly when decisions are made.

Situation analysis

The objective of situation analysis is to answer the following questions: What do we look like? What do our customers require? How are we performing? It is surprisingly easy to overlook the significance of this step.

The performance of the two predecessor organizations can seem irrelevant to the performance of the future combined organization. This step is important, however, because it ensures that the new organization is built on the best of the two predecessors.

A number of analyses are relevant during this phase of the integration. Market and supplier analyses establish opportunities to better serve customers' needs and capture purchasing economies of scale. Business process analysis identifies best practices that can be exploited across the new organization, thereby increasing operational efficiency. Capital budget analysis can identify investments that no longer make sense in the context of the merger. Policy analysis provides the basis for the new organization's human resource, finance, and accounting policies and identifies the gap between the predecessors' policies that must be resolved during the next phase of the integration. Finally, systems analysis identifies redundant IT infrastructure and technical constraints that limit information flow across the new organization.

There is a still more subtle analysis during this phase. The process teams and support teams mentioned earlier frequently conduct the analyses just discussed. Keep in mind that these teams are staffed with employees from each predecessor organization, and that these employees have likely never worked together before. As such, the process and support teams are a microcosm of the newly formed organization. The rest of the organization will likely experience the conflicts they experience. Observing them, therefore, allows senior management to discern effective leadership styles, decision-making processes, and conflict-resolution processes. This information will be critical to the design of the new company's organization structure and staffing of leadership positions.

There are several key considerations for this phase:

• First, this phase is about comparing performance of one company to the next and discerning the "best of both worlds" that will define the new company. It is important, therefore, to compare on an "apples to apples" basis. This comparison should also be on a business process basis. This approach normalizes performance on the needs of customers, suppliers, and employees.
• Second, the number of people involved in the integration process grows dramatically during this phase. The communication infrastructure (newsletters, e-mail networks, et al.) becomes critical.
• Third, the process and support teams are the new company in its embryonic form. The tone of the integration at this stage will manifest itself in the character of the new organization. Integration management should reinforce those cultural traits that it would like to see in the new organization and act quickly to eliminate those that it does not.

Design

The objective of the design phase is to answer the question: What do we want to look like? It results in the detailed designs for the new company's market and supplier strategies; organization structure; business processes; as well as human resources, information technology, and accounting infrastructure. The end-product of the design phase is a plan for the implementation of these designs.

The design phase is extremely challenging, although it may not seem so at first glance. If executed properly, the earlier integration phases result in clear design objectives and a fact base that identified customer requirements and best practices. It may seem that the results of this phase would be self-evident in the light of the results of the earlier phases. At the conceptual level, it can be. Speaking pragmatically, however, the design phase involves making hard decisions about staffing and locations, conducting rigorous risk assessments, and undertaking contingency planning, as well as detailing the implementation requirements of the resulting designs.

Two additional factors further complicate the design phase:

• First, designs are being created by discrete process and support teams. In many cases, designs need to cross team boundaries. Managing the integration of these designs is also extremely challenging.
• Second, designs are constrained by the rate of change that the organization can endure, the IT infrastructure can allow, and the objectives of the integration. Design is an iterative process that requires collaboration across process and support teams.

Iterative business design is analogous to iterative engineering design. A trial solution is created, evaluated, and updated until convergence on a final solution is achieved. In this case, the solution may be a business process or strategy alternative that achieves integration objectives and is based on the facts uncovered during scenario analysis.

This trial solution is evaluated for implementability: Does it conflict with other alternatives? Is it consistent with the organization design? Does its implementation require piloting or other risk-mitigation approaches, and is its implementation timeline consistent with the overall integration timeline? The answers to each of these questions will shape the new design.

There are several key considerations for this phase:

• First, it is during this phase that conflict is most likely among integration participants. The conflict is the result of pressures associated with the difficult decisions that participants are being asked to make. It can be healthy-if carefully managed by integration leadership.
• Second, the most real threat during this phase is the development of a design that isn't integrated across the enterprise. Integration isn't a task; it's a philosophy. Every member of the integration team needs to assume responsibility for design integration.
• Third, rumors will be created long before decisions are made. Communication is especially critical during this phase.

Implementation

The final phase of this merger integration framework is the implementation of the results of the design phase.

The objective of this phase is to implement the new company's strategy, organization structure, and work processes to achieve the benefits of the merger-in other words, to affirmatively answer the question: Have we succeeded?

Implementation is the relatively straightforward execution of the implementation plans developed during the design phase. These plans, however, can be quite complex. They will involve prioritization, piloting, and execution of contingency plans as the details of implementation unfold.

The implementation phase increases participation in the merger integration process until the distinction between the integration effort and the day-to-day operations of the new company become irrelevant. While the design phase may involve hundreds of people, implementation will ultimately involve everyone in the new company. At some point during implementation, the integration infrastructure is dissolved, and it becomes the job of line management to complete integration tasks.

There are several key considerations for this phase:

• First, it is likely that the two companies do not have sufficient resources to pursue implementation on all fronts simultaneously. Prioritization of implementation initiatives should focus on the Day 1 and mission-critical requirements of the new company.
• Second, implementation requires that line managers be brought on board, as they will be responsible for completing implementation initiatives. Many of these managers will not have been involved in the design phase. A "getting-on-board" process that helps them understand the objectives and rationale for the implementation initiatives will be required so that they can accept ownership of them.

Summary

Today's oil and gas industry mergers and acquisitions or joint venture deals are increasingly complex.

Not surprisingly, the integration effort required to create the enterprise that results from these deals is also increasing in complexity.

Unfortunately, history suggests that, while significant effort will be given to the development of the merger strategy that results in these deals and the transaction mechanics that support them, relatively little effort will be given to planning and managing of the integration effort that ultimately achieves the benefits of the transaction.

Today's M&A activity presents an unprecedented opportunity to reposition the oil and gas industry for the future.

This opportunity will be lost if merger integration issues aren't given due consideration.

Acknowledgement

The authors wish to thank Ryan Daniels and Craig Iseli for their material and editorial contributions to this article.

Bibliography

Mergers and Acquisitions White Paper: Deloitte & Touche Consulting Group, Mar. 31, 1998.

The Authors