Lessons from over half a million deals with Professor Killian McCarthy

Speaker A: Welcome to the Mergers and Acquisitions podcast. If you are a regular listener, you will know that we're all about learning from deals to do other deals better. Last episode we learned from one specific deal, the Unilever McCormick deal. But what if you could learn from thousands of deals or even half a million at the same time? That's what we'll try today, with an academic approach brought by my guest, Cillian McCarthy. Kilian is a strategy specialist, author and advisor with a focus on how firms create and scale value. He is a ah professor of Strategy with appointments at the Radboud University in Nijmegen in the Netherlands, where I am interviewing him today, but also with the Kiev School of Economics in Ukraine and the Royal College of Surgeons in Ireland. Kirjan's work explores how firms grow and reposition themselves in response to changing systems, from regulatory shifts to geopolitical upheaval. As I said, I was keen to have Kilian on the podcast because he has analyzed the strategy and performance effects of more than half a million acquisitions, 100,000 alliances, 50,000 corporate venturing deals, and 5,000 divestitures. He's authored four books and his research has been featured in leading academic journals such as Research Policy and Harvard Business Review. Welcome to the podcast, Kirian.

Speaker B: Thank you very much. It's my pleasure to be here.

Speaker A: I'd love to start our conversation by trying to understand where your fascinations for studying MA deals comes from. Have you got a sense of how it started?

Speaker B: Very much so. So as an economist by training, I was sitting in a master's class and I heard the statistic that 75% of mergers and acquisitions fail. And I thought, no, this can't be the case. You know, there's so much smart people behind it, so much money is spent on it. We have so much data available to us, how can it possibly be the case? 75 and fail. So I started reading on it, and the more I read on it, the more puzzled I became. And the more puzzled I became, the more I wanted to know the answers.

Speaker A: And when you say 75% fail, what is your definition of failure?

Speaker B: Yeah, so that's a very difficult question, of course, with mergers and acquisitions. Uh, in my case, it's when the deal creates no value or negative value, and what we see is quite a large amount create negative value. If you speak to advisors. Well, the answer is often we wanted to do a deal, we did a deal, the deal was a success. But in my case, it's really especially if it's stock listed companies, for example, did the company perform better after the deal than it did before? Did it create more value or not? Did it live up to expectations?

Speaker A: And now what I understand is with all these, uh, numbers of deals that you've analyzed, you, uh, must have a big data model. Could I call it like that? So before we start discussing the results, uh, from that model, can you explain a little bit of what's in it and how it works?

Speaker B: Yes, sure. So, as I said, I'm an economist by training, so I like to use big, uh, data sets. And that's very much the starting point here. So what we do is instead of looking at individual deals talked about by individual CEOs or individual advisors, promising synergies, promising value being created, what we do is we just collect the raw data. We ask and we say, okay, uh, comparing this firm to that firm, comparing how it performed after the deal with how it performed before the deal, and running that exercise across thousands or even more, hundreds of thousands of deals at a time, you get a sense as to what's the truth in the data. The advisors, the consultants, the CEOs, they might say, if you always go left, it always creates value. But what we can do in the data is we can see, well, what happens to the firms that go left, the firms that go right, and the firms that just keep on course, which is actually the truth. And in that way, you get rid of a lot of, I suppose, the bias, the sentiments, the almost the superstitions from within the industry on what you should do and what you actually see is what happens when you do X

Speaker A: and not Y. I'm becoming even more interested now. If you recall the second episode of this podcast series, and we had Jeff Rudnicki of McKinsey, and he had the same analysis, deals, on average, uh, destroy value. And it was a real driver to create this podcast. If only we can reduce the value destruction a little bit, uh, we'd be helping the world. So your findings are proving again that this mission is a very relevant one.

Speaker B: Absolutely. So it's one of the, I suppose the talking points quite often is, who are you helping with the kind of research that I do? Are you helping shareholders to get richer? Yes, of course, there's an element of that. But at the end of the day, when you look at some of these big companies, these big acquisitions, these big failure rates, you're talking about jobs, you're talking about taxes, uh, you're talking about innovation, you're talking about national innovation systems. Quite often, I think there's a bigger social dimension to it than simply a question of shareholders getting richer. Yes, uh, mergers and acquisitions are useful financial tools, but when they go wrong, the consequences have real world impacts, I think. So I think we have a duty to understand them for that reason.

Speaker A: And the scale of value destruction can be quite staggering. Uh, you use this example of Daimler buying Chrysler back in 1998, I think, and um, selling it again, uh, ten years later.

Speaker B: Yeah, absolutely. So there's a famous research from the 1980s in the US published in the Journal of Finance, and it looked at, I believe, about 4,000 deals off the top of my head and it found the average deal was losing 25 million. Yes, there are cases, Daimler Chrysler is a classic textbook case of Daimler buying a company again from the top of my head for 30 something billion, uh, losing a billion a year for 10 years and then paying a private equity company 600 million to take it off of their hands at the end of that period because it just simply couldn't integrate it. So there are those cases of these massive failures. But when you look across the sample of this 4000, for example, the negative effect is 25 million. It's very tempting to kind of point to these one off big examples. But the more, in a way scary finding is that this one off big example is actually quite normal.

Speaker A: So the next thing you would want to do is to start to understand why so many deals fail or fail to deliver the value. Because we already know, of course it's relatively easy to sign a deal. It is far more difficult to, uh, deliver the value that was promised. And uh, that's your point. Uh, the deals get done, but the value isn't delivered. So what are the key reasons behind that?

Speaker B: Yeah, so I suppose that was really the kind of the starting trigger back in my masters for me of trying to understand, well, if there's all of this brain power and money behind mergers and acquisitions, and we have 100 years of data on what deals work and why, then the real question is how do you do it better? Uh, how do you learn from it? And I suppose the answer is for me, quite simple, quite straightforward. Mergers and acquisitions are a very high risk way of doing business. They're sold on synergies. But when we look at the synergy forecasts and the synergy expectations, or the synergy, what is actually delivered, at the end of the day, there's really a massive disjoint. The statistics that I always quote is about 60% of the cost cutting synergies are realized on average. And by comparison it's about 7% uh, of the growth synergies are realized on average, which means that 92, 93% we're wrong on the synergy forecast that we're making. We're overly optimistic on how easy it is going to be to create value through an acquisition. Again 60% of the cost cutting, 7% of the growth. But when you look at the motives behind the acquisitions, 86% are aimed at growth. So 86% of mergers and acquisitions are aimed at this tiny chance that you're actually going to earn some sort of a real synergy from it. So the forecasts are wrong, the motive is wrong. We're doing the wrong deals the wrong way for the wrong reasons in my opinion.

Speaker A: And would that be because people don't have access to previous history of uh, how it worked or they don't have a capability to um, um, execute cost cutting uh, programs or they can't um, kind of forecast uh, the markets. And I'm trying to go a level deeper.

Speaker B: Yeah. So I think that the reality is they have access to all of the data. They have access to me, just as you have access to me. Uh, we're a public resource universities. Uh, this data is publicly available. The statistic on the failure rates is very commonly known. I think the problem is, well there's a lot of money to be made in mergers and acquisitions. There's an entire industry advising, consulting, facilitating that makes money through mergers and acquisitions. And there's a lot of managers uh, that believe that they're different and believe that they're going to be better. So there's research for example that shows that managers that are about to retire are much more likely to make risky acquisitions than managers that are not because they have much less to lose at that point. I think they think perhaps a little bit too highly of their own competencies and they a little bit overestimate themselves and underestimate the risk, to be honest.

Speaker A: Maybe a uh, supporting example of it is um, on the cost cutting is that of course if you have synergies you have ah, cost cutting. But that's for the acquirer. The business that's selling also needs to cut cost because uh, suddenly your headquarter staff is being paid uh, by a smaller company. So you need to cut the headquarters accordingly. And that doesn't figure in uh, any of the presentations? Typically.

Speaker B: No. And indeed what you quite often see and what's very much underestimated is the consequences to the target I think of the integration. So we always talk from the acquirer side. The Acquirer is losing money. And that makes sense because the acquirer is the one who initiated it. But in the process of the integration, quite often what happens is you kill the goose that lays the golden egg. So when we look at innovation studies, for example, we see in the biotech sector or the IT sector, if I acquire firm quite often I acquired you, I bought you because you do something better than I do, because you're interesting. But in the process of trying to create those synergies, I have to integrate you. And in the process I often disrupt you, damage you, destroy you. So when we look at innovation studies, for example, we find that process can be so disruptive that it can reduce the output, the innovation output of the acquiring company by about 20%, but it can reduce the innovation output of the target company by as much as 50%. That process of integration is very violent. You know, those synergies have to be realized. There's razor thin margins to be made in mergers and acquisitions. And that's really what you see when you look at the data. You know, it's a small gains, huge potential losses. So you need to cut those synergies to create those synergies. You need to cut to cut, you disrupt and you're disrupting something in a system that you don't understand. And the result is innovation loss, people loss, people exiting job losses and disappointment.

Speaker A: I, uh, can relate to this personally. Uh, in Shell, uh, the beginning of the energy transition, uh, we felt we needed to um, uh, buy into some of the businesses uh, that were um, starting up in that area. And some of these you saw exactly those uh, effects uh, going on. On the one hand you can say a business can scale up under a bigger umbrell finance behind it, but it can also feel that they're being put in a straitjacket and they can't uh, follow their own intuition anymore. And uh, they're lost in bureaucracy. And to manage those two dynamics, uh, is a real challenge. Let's take a quick break now having heard the bad news, we're going to listen to a message from our sponsor, Pilco.

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Speaker A: you're back in the M. And a podcast with our guest Kilian McCarthy, who is sharing his deal wisdom gathered from analyzing up to half a million deals. Now we've heard the problem, but, uh, you must have come across something that's going well. I hope you have. So what can you do to escape this fate of so many deals? And have you looked at commonalities in successful deals?

Speaker B: Yeah. So the other side of the 70% fail means 30% succeed. That's what, uh, a consultant friend of mine always tells us, how to be in the 30% that succeed, of course. And when we look at them, it's reiterating the story. Mergers and acquisitions are a very risky way of doing business. There's very low margins to be earned. The synergies are easier to achieve in terms of cost cutting than in terms of revenue, expansion or growth. So when you ask who works or which deals work, the answer is always the least sexy. That's basically, uh, my conclusion. The less sexy it is, the more likely it is to work. And what that means, of course, is stay at home. As soon as you cross the border, the chances of failure increase quite a lot. I'm sure you've seen this in your, uh, experience as well. Stay, uh, in your own industry as shell in its own area. It knows what a good business looks like. It knows how realistic those forecasts are. It knows which costs can be cut and how easily. So don't step outside of your industry and keep it simple, keep it focused on costs. If you keep it up, uh, focused on costs, As I said, 60% of those targets are going to be achieved. If you focus on the synergies, the growth, you focus on foreign markets, you focused on exploration, then you're in the chance that that works, uh, drops quite a lot. So I suppose that's my deal wisdom, in a way is, uh, the less sexy the deal is, the better. The problem for corporates, of course, is corporates can stagnate and do the same things over and over. So how do you balance the fact that what's good for the business may not necessarily be good for the acquisition?

Speaker A: I'm thinking of two things here. Um, the first one, uh, to start with is don't you see more in the tech sector at the moment? If you're big, you can swallow lots of small things and make a success out of maybe not all of them, uh, but if you only make a success out of two of them, you, uh, already do very well. So let's start with that one.

Speaker B: Yeah. So I suppose that's kind of a bit of a portfolio approach to acquisitions. You know, buy 10 and hope that one or two of them succeed. As a company, that might be a good strategy. But as an acquisition itself, which is kind of the angle that I often look at, it's not great, of course, because to make that acquisition work, you need to invest in us at the end of the day. And I suppose this is the big lesson for me from the whole 20 year journey that I've had is at the end of the day, this is a people process. I started off with data sets and economics, but it's really down to people. If I buy your company, no matter how good you are, and you as an entrepreneur leave, or the key people leave, I don't invest in you properly or in your shell. Example. I over structure you, I over manage you. I come from a hierarchical, uh, rigid company and you're an organic, growth, entrepreneurial ones. That culture is never going to work together. As a company, that portfolio approach might make sense. Spread your bets, invest in 10, hope that one works. But on an individual acquisition perspective, yeah, you need to invest time, you need to invest people, you need to invest resources, you need to give people space, security freed, freedom. That takes time, that takes money. And will that pay off? I'm not sure.

Speaker A: So the first dimension you mentioned, uh, is all very strategic. It's about which targets you choose. And if you're not too ambitious with that, then actually you have a higher chance of success. But can you, uh, also try and mitigate and maybe manage the more complex ones once you have more experience in, uh, doing deals or, uh, better deal makers or better advisors to kind, uh, of navigate the pitfalls there?

Speaker B: Yeah, it's a very difficult question. And, uh, it's difficult because the literature is very unclear actually. So we say very clearly since the 1980s, as long as we have data and computers to run it, stay in your own industry, don't go abroad. You increase the risk of failure by two, three times as soon as you do that. What we don't really find is a lot of experience, benefits. So we don't really find that CEOs for example, or boards become better at acquisitions. What we do find when we look at the data is CEOs and boards who got lucky once are more likely to make Future acquisitions, and CEOs and boards who failed once are less likely to make more acquisitions. What we don't really see is a, uh, Beneficial learning from it. We don't necessarily see evidence that you can learn as a company to acquire as an individual in a company. What we do see is of course firms that invest in acquisition teams can build up that capability, but then they need to build up that capability and they need to invest in that capability and they need to utilize that capability. If you're in Philips or in Shell and you've built up a big team, you need to make sure that you're deploying that regularly. So you just like any top sport, you use those muscles, you train those skills. If you don't, then you, you fall back into again. The evidence shows you fall back into the state. It's the status of being the ad hoc acquirer. And the ad hoc acquirer has, well, worse chances than a coin flip that resonates.

Speaker A: And indeed in Shell we could uh, scale it that way. Uh, don't forget that for example, if you look at acquisitions, you might be looking at 100 potential targets. Start uh, a real project around maybe uh, 20, and uh, have only five that meet your internal criteria. You start negotiations and maybe one is uh, successful in the end. So if you go through that cycle, it means that you're still uh, spending a lot of uh, man hours and exercising that muscle, as you say, uh, continu with divestments, maybe uh, those numbers are a little bit less. Uh, and the um, concept of the serial acquirer that we went through and uh, we had a nice example of uh, company dcc, um, the CEO was in, uh, in our podcast, uh, they've grown with uh, uh, many smaller deals, felt also as one where indeed that muscle uh, was uh, already trained. They only did bigger deals after they, they'd done many, many smaller ones. And it's still a uh, key criterion for them. It did generate growth.

Speaker B: Yeah. So I think using the muscle is definitely important. Learning uh, from the failure is also very important. And I feel like, I think in continental Europe, I feel like we're a little bit better at this than perhaps in the US Maybe I see as well when I look at China. That's also something we discussed uh, previously. You know, there's kind of more of a willingness to learn from failure. I think we're a little bit more cautious continental Europe with M and A in general. And I think we're a little bit more aware of the differences, aware of the difficulties. And when something goes wrong, I think we're also more willing to stand up and say, okay, this is something we need to now build into our muscle memory. For next time. And I think building up that kind of capability, learning from failure, but also learning from smaller, safer domestic deals before you have larger, unrelated foreign ones. I think that also makes a lot of sense.

Speaker A: Yeah. An example that resonates is, um, uh, that one of the deals where I failed was hundreds, uh, of millions of, uh, value not, uh, delivered. And at one stage I expressed that, uh, maybe my future in M and A, uh, was not so great. And the response was, what? We've just invested hundreds of millions in you. We're going to get, uh, it right. So if that mindset is behind, then, uh, you have actually a culture where you can learn. Okay, maybe some other common mistakes, uh, that you see. Can you walk, uh, us through them?

Speaker B: I suppose the biggest things are, uh, as I said, the wrong deal for the wrong reason in the wrong way. So the wrong deal being the unrelated deal. Stepping out of your industry, stepping out of your comfort zone in your country, uh, stepping out of your technology. When we look at innovation, uh, related ones, for example, methods of payment, how you pay the deal, uh, how you retain the people, these are also very important. What do you do with the CEO of the company you've taken over? Do you let go the full team? That's quite often the case. But when you let go the full team, you let go all of that knowledge and experience. Do you let that full team remain in place? Then you run the risk of not having those synergies, um, being integrated. So having to balance that is of course very important. Prior experience is also a very important one. We see. So another paper that I did, we looked at 3,000 acquisitions that had been done with prior alliance partners, for example. And we found that by having an alliance with the firm beforehand, you could overcome a lot of the, we call them, uh, information asymmetries, basically. I don't know what you know, I don't know what you have, but if I have an alliance with you beforehand, I get to see little bits in the kitchen, how things are working. I get to have a little bit of a better understanding of what I'm actually buying and a better understanding of what things are actually worth. So having that kind of prior alliance, uh, is also something rather than just cold calling basically, uh, those potential targets, spending some time with them in a less risky environment is perhaps a good way to build up that knowledge about what you're buying, what it's worth, and what you can do with this.

Speaker A: And in the same prior conversation, uh, you mentioned that accumulation of advisors is, uh, potentially a huge risk.

Speaker B: Yeah, absolutely. So you mentioned Harvard Business Review at the start. That was my first article in Harvard's Business Review is we looked at 10,000 deals and we looked at uh, the performance of them and we basically asked well how many advisors do you need? Uh, because, well I don't need to tell you or the audience but you know, it's becoming more, there's more and more advisors, advisors at more and more steps along the process. But that creates more and more confusion along the process as well and it creates more and more interest along the process. So the question basically was should you have an in house team, should you have one big advisor or should you have a really broken up process supported by multiple. And what we found was very strong evidence actually is that the more advisors you had, the worse it became. We were kind of curious as to know why that was the case. So we spoke to uh, some CEOs and asked them did they recognize, recognize this? And they all said yes, absolutely. You know one CEO told us, he said, when you have multiple advisors from the, the big four, the big three, uh, in your room, he said they all want to be the top dog, they all want to be the biggest guy, they all want to be the, have the one with the right answer. And he told us, uh, you know, sometimes he had to just pull them out into the corridor and say, you know, I don't care if it's you or you, I'm here for the deal. So focus on giving me the advice that I need to know. So we see evidence that the more advisors on the deal, the more complexity that brings in because it becomes more again of a human process where egos get into the way and less of ah, a technical one.

Speaker A: So uh, Kirian, I think I could call you the ultimate score taker in the world of uh, M and A Den. Companies and shareholders should come to you on a regular basis to find out how they are doing on your scorecard or the companies they invest in, how they are doing. So I'm interested, does that really happen or what do you know about companies keeping their own score?

Speaker B: So on the one side of course, uh, I'm glad that not every company is coming to me for an evaluation. On the other side, I do think this is a resource that we have as a university. This is a knowledge that is available to us that we freely disseminate with the world. In a way I find it a pity that more of them don't come because we have so much data. I was at a conference recently and uh, a partner from one of the big four was proudly talking about his data set with 75, um, data points and, um, telling the audience that they prove that they create value. And I thought to myself, well, we've got 1.3 million in our data sets, so the scale is not comparable. The truth is, in the data, we have no objectives. The advisors, of course, are trying to sell deals. They get paid by doing deals. We have no objective in selling them. We have the data available to us, and the data is telling the truth. The company's keeping their own score. So, uh, there are definitely companies that are doing it in a way. I think that more can be done with it. So you hear some good examples of firms that really do a kind of a post deal analysis to say, okay, what did we forecast? How much of that did we achieve? Where did it go wrong? When you're losing those hundreds of millions, uh, as you're talking about. But quite often what we also hear is the goal of the deal was to do a deal in China. We did a deal in China. Deal success. And there's very little evaluation of, okay, success, but in what way?

Speaker A: So, Kirin, have you considered judging these acquisitions against another alternative than just not doing a deal? Because if you don't do deals, then maybe we don't make progress either. So, uh, not doing a deal could mean building a business from scratch or doing a geographical expansion or a new product line. And if you think about a failed acquisition, uh, that could even be, uh, less costly than the failure of, uh, going through an organic process, uh, which takes a lot more time because business is relentless and you have to grow, change, innovate to stay alive as a company. Doing nothing is usually not a great alternative.

Speaker B: I think that's a great question and a very difficult one to answer. In terms of the methods that we use, uh, what we typically do is when we're looking at the stock market performance of a company, company, for example, is I look at your company historically, I position it relative to the market. I forecast how you should perform. I, uh, look at how you actually performed relative to the market, and then I describe it as creating value or losing value. So in a way, we're kind of. I can't know what the alternative could have been. You know, had you spent that 100 million on R and D, maybe you had much more patents. I don't know. I can't know. But what I can know is relative to the market, market, relative to your indices, relative to your competitors. So going back to the Daimler example that we Talked about Daimler was above its indices, it was above its competitors. When we looked at, after the acquisition of Chrysler, it collapsed. It went to a, uh, percentage of its competitors. It then became, you know, quite clearly this big wedge between what it was and what it should be relative to the index. And then it's very hard to say that that was a good acquisition. You see, that you can forecast, you can guess. Had they done business as usual, they would have been where the competitors are. They didn't. They made the acquisition, they collapsed, and they potentially become a target. So it's a little bit of guesswork in a way, but you don't know what they could have done. But you can say that relative to the others, they're performing better or worse.

Speaker A: And I think my last question would then focus on the role of the, uh, people approving the deals. So I'm thinking about the boards of the companies who get these acquisition proposals on their desk. What would be your advice to those folks, um, who are the ones who, uh, sign off on the proposals by the business?

Speaker B: I think my first advice always is be skeptical. So as long as I'm teaching this, uh, topic or studying this topic. Topic, uh, you know, I'm saying just be skeptical. If you say that only 7% of those growth synergies are going to be achieved, be super skeptical. Ask yourself, is this really the best road to Rome? You know, is there an alternative to do this? Alliances, for example, joint ventures, for example. If you really need access to that technology, do you really need to buy the whole baby and the bathwater, you know, or can you just get that access to exactly that little piece that you need? So be skeptical would be one advice. Be cautious. Don't buy the bs. A little bit of these big stories about all of this growth. The evidence says, yes, there are successes, but people also win the lottery. It doesn't necessarily mean that's a good strategy. And I think going forward, the last paper that we, uh, published, we were looking at the role of AI on the whole process. What the conclusion was. We spoke to a number of different industry analysts. The conclusion was that AI will speed up the front half of the deal, the due diligence, all of the dirty work, the data work that will be compressed, meaning that deals will go faster through the process to the board, meaning that board experience and that board caution will be even more important going forward because more analysis will be done quicker, more screening, um, will be done, more reports will be written with the help of AI, meaning that wisdom from the board is even more critical going forward. So in a way, I feel a little bit sorry for the board. The workload is going to increase in the years to come. The story is still going to be there. There's a lot of money to be made behind M and A. There's going to be a lot of people pushing deals. And the board really needs to have the wisdom and the caution and the peace of mind to say, okay, does this really make sense? Is this really the right road? Or can we get to where we want to get with a somewhat cheaper, somewhat less risky tool?

Speaker A: Thank you, Kilian. I, uh, do think that, uh, this has been a bit of a sobering, uh, podcast. We see a few light bulbs, uh, going, uh, in the sense of what we can learn. It's not a story about, about not doing deals at all, but being aware of, uh, the huge risk involved and uh, both managing them and deciding, uh, when not to do them are your key, uh, mitigants, uh, if I understand correctly, maybe, uh, looking into your, uh, huge data set, uh, could be another mitigant. Well, I want to thank you for being with me here in the studio, uh, in your own university and being on the podcast. It's been a real pleasure.

Speaker B: Pleasure. Thank you very much. My pleasure. I enjoyed the conversation.

Speaker A: And that brings us to the end of today's episode. Please remember to provide feedback on the previous podcast, which for a change analyzed just one deal, the Unilever McCormick deal. And my question then was, would you like more of these or shall we better stick with the tried and tested format of the previous 20 episodes where we have one guest with a specific expertise. You can leave that feedback on my LinkedIn post where the podcasts are announced or via the contact form of our sponsor@pilco.com. thank you for listening.