Acquisitions should be successful, but few are, in fact.
Acquisitions should be successful, but few are, in fact. The reason for this nonperformance is always the same: disregard of the well-known and well-tested rules for successful acquisitions.
The six rules of successful acquisitions are:
The successful acquisition must be based on business strategy, not financial strategy.
The two entities must share a common core of unity, such as markets and marketing, or technology, or core competencies.
The acquirer must respect the business, products, and customers of the acquired company, as well as its values.
The acquirer must be prepared to provide top management to the acquired business within a fairly short period, a year at most.
The successful acquisition must rapidly create visible opportunities for advancement for both the people in the acquiring business and people in the acquired business.
The allocation of capital and people determine whether the organization will do well or poorly.
The allocation of capital and performing people converts into action all that management knows about its business—they determine whether the organization will do well or poorly. An organization should allocate human resources as purposefully and as thoughtfully as it allocates capital. To understand a capital investment, a company has to look at four measures: return on investment, payback period, cash flow, and discounted present value. Each of these four measures tells the executive something different about a prospective capital investment. Each looks at the investment through a different lens. Decision makers should not evaluate capital investments in isolation, but as part of a cluster of projects. They should then select the cluster that shows the best ratio between opportunity and risk. The results of capital spending should be assessed against expectations in the postaudit procedure. Information gathered from the procedure can then be used to help make decisions about future investments.
The decisions to hire, to fire, and to promote are among the most important decisions of the executive. They are more difficult than the capital allocation decision. An organization needs to have a systematic process for making people decisions that is just as rigorous as the one it has for making decisions about capital. Executives need to evaluate people against expectations.
Benchmarking assumes that being at least as good as the leader is a prerequisite to being competitive.
EVA (economic value added analysis) is a good start to assess the competitiveness of an enterprise in the global marketplace, but to it we must add benchmarking. Benchmarking is a tool that helps a firm tell whether or not it is globally competitive. Benchmarking assumes, correctly, that what one company does another company can always d as well. “Best performers” are often found in identical services or functions inside an organization, in competitor organizations, but also in organizations outside the industry. Together, EVA and benchmarking provide the diagnostic tools needed to measure total-factor productivity and to manage it. They are examples of the new tools executives should understand to measure and manage what goes on inside the enterprise. Combined, they are the best measures we have so far available.
Until a business returns a profit that is greater than its cost of capital, it does not create wealth, it destroys it.
Measuring total-factor productivity is one of the major challenges confronting the executive in the age of knowledge work. For manual work, measuring quantity is usually sufficient. In knowledge work, we have to manage both quantity and quality, and we do not know yet how to do that. We must try to assess total-factor productivity using the common denominator of revenues and expenses. By measuring the value added over all costs, including the cost of capital, EVA (economic value added analysis) measures, in effect, the productivity of all factors of production [or the true economic costs produced by all resources used].
Never mind that a business pays taxes as if it had earned a profit. It does not cover its full costs until reported profits exceed its cost of capital. Until a business returns profit that is greater than its cost of capital, it operates at a loss. And this is why EVA is growing in popularity. It does not, by itself, tell us why a certain product or a certain service does not add value or what to do about it. It does show which products, services, operations, or activities have unusually high productivity and add unusually high value. Then we should ask ourselves, “What can we learn from these successes?”
Switching to economic-chain costing requires uniform accounting systems along the entire chain.
The real cost is the cost of an entire process, in which even the biggest company is just one link. Companies are therefore beginning to shift costing from including only what goes on inside their own organization to costing the entire economic process, the economic chain. There are obstacles in implementing economic-chain costing. For many businesses it will be painful to switch to economic-chain costing. Doing so requires uniform or at least compatible accounting systems of all businesses along the entire chain. Yet each one does its accounting in its own way, and each is convinced that its system is the only possible one. Moreover, economic-chain costing requires information sharing across companies; yet even within the same company, people tend to resist information sharing. Whatever the obstacles, economic-chain costing is going to be done. Otherwise, even the most efficient company will suffer from an increasing cost disadvantage.
Activity-based costing is a totally different way of thinking.
Traditional costing techniques are now rapidly being replaced by activity-based cost accounting. Traditional costing builds cost from the bottom up—labor, material, and overhead. It concentrates primarily on manufacturing-related costs, the so-called inventoriable costs. Activity-based costing starts from the end and asks, “Which activities and related costs are used in carrying out the complete value chain of activities associated with the cost object?” Activity-based costing includes the cost of quality and service.
By designing quality into products and services during the design stage, design costs may increase, but warranty and service costs are likely to decrease, thus overcoming any cost increase experienced at the front-end of the chain. And unlike traditional costing, it includes all costs of producing a product or service.
The problem is not with technology. It is with mentality.
Traditionally, Western companies have started with costs, put a desired profit margin on top, and arrived at a price. This is cost-led pricing. In price-led costing, the price the customer is willing to pay determines allowable costs, beginning with design costs and ending with service costs. Marketing provides information on the price the customer is willing to pay for the value the product or service provides.
A cross-functional team starts its analysis of costs by taking this price as a given. The team then subtracts the profit required to compensate the enterprise for capital investment and risk, and arrives at an allowable cost for a product or service. Then it proceeds to make the tradeoffs between the utility provided by a product and allowable costs. Under price-led costing, the entire economic framework focuses upon creating value for the customer and meeting cost targets while earning the necessary rate of return on investment.
We cannot achieve results until we have information on cost and value.
Basic structural information is focused upon the value that is created for customers and the resources used to do so. The concepts and tools of accounting are now in the throes of its most fundamental change. The new accounting tools are not just different views of recording transactions but represent different concepts of what business is and what results are. So even the executive far removed from any work in accounting, such as a research manager in a development laboratory, needs to understand the basic theory and concepts represented by these changes in accounting. These new concepts and tools include: activity-based costing, price-led costing, economic-chain costing, economic value added, and benchmarking.
Activity-based costing reports all the costs of a product or service until the customer actually buys the product, and provides the foundation for integrating cost and value into one analysis.
