Cold Feet: Why Shareholders Should Fear The Hasty Corporate Marriage
I never understood why Sears bought Kmart. Sears was a giant retailer, the dominant tenant in shopping malls throughout the US. Kmart was the spawn of S. S. Kresge’s dime stores. They served different consumer groups—different strata. When they came together, they combined a lot of the same merchandise in their stores, and they both lost their identities. I don’t see either surviving much longer.
Instead of allowing two companies to die, some embarrassed management teams settle on divorce, selling off the scraps for a fraction of what they paid—and leaving angry stockholders to ruminate over how management could have spent the cash better (think dividends).
How can titans of industry capable of earning and retaining billions of dollars also lose billions seemingly overnight in a bad acquisition?
To help answer that question, I’m going to focus on companies that merge with the intention of truly melding into one. They may continue to operate under separate names; however, management thinks the companies’ synergy will make both stronger—a true marriage.
How Three Strata of Consumers Buy
In my first career, companies hired me to improve their market share and gross profit margins. My team and I would start by surveying a client’s good customers, asking: “What criteria do you use to select a supplier, and how do you rank those criteria?”
The answer was always the same: service, quality, and price, and in that order. For individual consumers, though, the order of that answer varies.
There are three general strata of consumers. The first is the “carriage trade,” comprised of affluent people who live in expensive neighborhoods and might shop at Neiman Marcus. In the ‘50s and ‘60s, these folks drove Cadillacs. When we re-collated out our survey results by stratum, this group ranked quality first, service second, and price third.
If your business serves the carriage trade, you focus on product improvement, serving the customer better, and maintaining your profit margin. That’s how you beat your competition.
The next consumer stratum encompasses the middle class. Think Buicks and Oldsmobiles. These consumers rated service first, quality second, and price third. They could be swayed by a good sale occasionally, but it had to be a heck of a good deal.
Consumers in the third stratum want only one thing: the lowest possible price. These consumers clip coupons and are willing to drive several extra miles to save money. This is why Walmart stores have much larger trading areas than their competition. Walmart does a great job in this stratum by advertising price as the primary reason to shop at its stores.
If you do business in the third stratum, you look for every possible opportunity to cut your costs so you can beat your competitor by offering lower prices while maintaining your margins.
As an investor, if the strata of two merging companies don’t line up, be cautious of any hype. If you don’t think it’s a good fit, move on to the next potential investment.
Culture Conflict Brews Animosity
Conflicting corporate cultures should also send up a huge red flag in investors’ minds. The unwritten rules within any company that dictate its internal and external behavior matter, and they don’t change easily.
Think of any married couple you know with conflicting beliefs and values. Those marriages always struggle; daily life becomes a constant negotiation, and that can go on for decades. The couple quibbles over how to spend money, how to discipline children, which other couples to socialize with, and just about everything else. Frugal Fred throws a fit each time Spending Sally comes home from the store. He thinks Sundays are for football, while she wants to spend the day antiquing. She’s dead set on sending their kids to private school, and he thinks it’s a waste. Ultimately, one partner has to adjust his or her core values, or these conflicts will foster resentment… and often end in divorce.
Similar conflicts take place in the corporate world. If the unwritten norms, beliefs, and values of the merging companies don’t synch, they’re heading down a rocky path, possibly to Splitsville.
Dominating a Stratum Develops a Culture
When a company dominates a stratum, a distinct culture emerges. Think of Apple, which dominates the high-end computer sector. It’s constantly looking for ways to improve and innovate its product lines so the company can raise prices and increase its margins. I just bought my first Apple computer, and I’ve found that its customer service is far and away the best.
Contrast the attitude of Apple’s employees with those at Walmart. Walmart’s corporate employees focus on negotiating better prices from vendors and cutting costs anywhere possible. Walmart passes those savings along to customers, and its in-store employees, in turn, offer minimal assistance.
Apple and Walmart are both profitable, but their corporate cultures are worlds apart and could never produce a happy marriage.
On the other hand, consider Beats, the manufacturer of headphones and speakers that Apple purchased for $3 billion. There’s controversy as to whether Apple overpaid, and only time will tell.
The two companies’ cultures seem to be a good fit, though. Beats products are expensive, and every technician I ask recommends them. Apple stores sell several brands of expensive, high-quality headphones, but Beats’ headphones will be in Apple stores soon, designed specifically for Apple products and Apple customers. Many of the other brands will probably disappear.
Miller’s Money Chief Analyst Andrey Dashkov adds that, “Synergies tend to materialize when the customer base and approach to the market are the same between the two parties. Kraft’s acquisition of General Foods is a good example.”
He agrees that the Apple/Beats deal looks good for many of those reasons.
When Management Doesn’t Fit the Mold
There are dozens of other invisible aspects of corporate culture. One past client of mine was a corporate travel agency. It priced its services by rebating part of the commissions the airlines paid travel agents. My client didn’t want to get caught up operating on razor-thin margins, so it looked for ways to bring extra value to its clients to justify its pricing.
One of the company’s potential clients was a very profitable member of the Dow 30 Index—let’s call it the Big Name Company. My client secured its business after making a presentation to the corporate vice president of sales by asking, “Are you aware that over 90% of your sales people are traveling between 9:30 a.m. and 3:30 p.m. Monday through Friday?”
The vice president was shocked. Face-to-face selling time in front of customers is gold. My client pointed out that Big Name Company was losing potential sales time to travel, and it was costing the company.
I asked my client why he’d done that analysis. Turns out, he had a friend who worked for the competition, and every time it hired a salesperson from Big Name Company, the company ran into difficulty. The new employee couldn’t adapt to its culture of working 50-60 hours a week.
The focal point of management is another key aspect of company culture. Some companies micromanage the smallest details from the corporate level. These companies haven’t developed managers who are risk takers and independent thinkers. If such a company merges with a decentralized company, the transition can be particularly difficult. In these situations, it’s not unusual for top managers to leave shortly after the merger because they just don’t fit the mold.
As an investor, I only consider betrothed companies as investment candidates when they have similar cultures and values and operate in the same market stratum. When you read about a potential merger or acquisition, look beyond the hype. If companies are a good fit, there are a lot of hidden synergies which can lead to pleasant earnings surprises. There are terrific opportunities out there for folks who crunch the numbers and evaluate strata and corporate culture.
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