Corporate Cultural Due Diligence in Mergers and Acquisitions

Introduction: The Rise of Cultural Due Diligence

In the past few years, the number of mergers and acquisitions has dramatically increased, raising the importance of performing corporate cultural due diligence. Financial, operational, and technical due diligence have become routine undertakings before companies consummate a merger or acquisition. A review of the literature indicates that cultural incompatibility causes the most problems in the necessary transitions of many mergers and acquisitions. Through cultural due diligence, the human side of these transactions can be given the same scrutiny that has traditionally been applied to the more quantitative assets of companies (IRI Solutions, 2004). The purpose of due diligence is to improve the chance that the merger or acquisition will be successful, achieved through intensive searching for facts, thorough analysis, and constant reevaluation.

The term "merger" describes the highest form of strategic partnership, in which two or more legally independent organizations combine into one organization, both legally and economically (Recklies, 2003). The post-merger integration process is a difficult and complex task that comes with long lists of activities that must be fulfilled within a short time. In this phase there are many opportunities to exploit and many decisions to make. The post-merger integration phase covers the operational part of the merger project and often determines whether the merger becomes a success or a failure (Recklies, 2003). Most companies see compatibility — in terms of customer base, regional coverage, and product portfolio — as more important than a shared vision in mergers (see Chart 1 for more details).

The most well-known factors of due diligence include questions and analyses of financial and legal aspects; however, these questions address only two-thirds of the issue. The remaining and most significant third is cultural due diligence. Cultural due diligence is usually not performed, despite the fact that research shows it accounts for more than 50% of the failure of mergers and acquisitions (IRI Solutions, 2004). According to the research, "culture clash" — a term that now appears with almost daily frequency in the business press — is increasingly cited as the reason a merger or acquisition was called off at the eleventh hour, fell far short of its intended results, or resulted in serious and continuing operational problems (IRI Solutions, 2004). Typically, when a merger or acquisition fails, shareholders are most likely to hold the corporate board and officers liable for their failure to examine organizational culture as rigorously as the legal and financial aspects (see Chart 2 for more details).

As a result, cultural due diligence has emerged as a relatively new undertaking, with little or no historical precedent. It is a process designed to assess the operational reality of organizations involved in a merger or acquisition. It efficiently identifies and evaluates the cultural characteristics of both organizations across twelve domains of organizational culture and highlights where significant culture clash will impact organizational effectiveness (IRI Solutions, 2004). This enables the organizations to complete their merger or acquisition more effectively and efficiently, and enhances the loyalty and commitment to the new organization on the part of all employees. With one in three mergers failing for cultural reasons, professional communicators have an opportunity to counteract the trend by offering a proactive diagnostic service (Steffen, 2000).

For example, cultural questions include whether the company tolerates lunchtime drinking, whether it has a dress-down Friday, and whether employees are expected to take work home over the weekend. A review of the literature reveals that these are all examples of corporate expectations that generate powerful behavioral patterns.

Such behavioral patterns help define the company's day-to-day experience and are in turn conveyed to customers. A company that does not object to its employees having a lunchtime drink — and even encourages employees to take a customer out for a drink to explore a new business opportunity — may be acquired by an organization that does not permit lunchtime drinking. This places the supervisor, employee, and customer in a difficult position: should the employee continue taking out the customer and risk the displeasure of the new management? Should the supervisor simply enforce the rules of the previous regime? Or should the customer be informed that, following the acquisition that made the company a market leader on three continents, a Friday drink is no longer acceptable? Cultural due diligence performed before the merger or acquisition answers these questions and helps determine whether the merger is a good fit for both companies.

The Cost of Ignoring Culture in M&A

Non-performance of cultural due diligence results in an extreme loss of value. The top ten merger and acquisition deals in the world from January 1 to June 19, 2000, totaled a value of $529,024.1 million (Steffen, 2000). With one-third of these projected to fail for cultural reasons, the value lost amounts to approximately $174,577.95 million. Moreover, recent research suggests that 47% of executives in acquired companies will leave within a year of the acquisition, with that figure rising to 75% after three years (Steffen, 2000).

Companies make acquisitions in search of access to markets, brands, technologies, products, and people (Steffen, 2000). When the key people in the acquired company — with all their knowledge, expertise, influence, and connections — are lost in the transaction, it is scarcely surprising that the transaction fails to achieve its projected value (Steffen, 2000). Research indicates that productivity in acquired companies is estimated to drop by as much as 50% as talent leaves and the remaining employees channel their energies into securing their position under the new management (Steffen, 2000).

Due diligence has been defined as the independent investigation of a company, its management team, and its prospects for success by an investor before funding is provided (Steffen, 2000). Due diligence is a demanding process, typically covering a ninety-day period during which the parties are still negotiating even as lawyers and auditors are gathering information. Many components, such as the warranties and disclosures that must be supplied by the legal entity being acquired, are statutory. The focus throughout is on evaluating the evidence that will allow the transaction to be concluded (Steffen, 2000). The link between orchestrating the deal and realizing the potential of the new organization is not the responsibility of lawyers and accountants, who may have no further role to play after the agreement is signed (Steffen, 2000). It is at this point that cultural due diligence, with its focus on the future life of the new organization, becomes of utmost importance.

Cultural due diligence differs from standard due diligence procedures in that it is not mandatory by law, it may be variously conceived and implemented, and it may be conducted by a range of parties. Many aspects of the cultural due diligence process are aimed at obtaining an objective view of the management and employees of an organization (Steffen, 2000). It is the task of cultural due diligence to investigate the values, perceptions, procedures, and motivators through which decisions are reached and collective effectiveness is ensured (Steffen, 2000). This is achieved through face-to-face interviews, focus groups, desk research, telephone interviews, and surveys.

Tools such as the Merging Cultures Evaluation Index provide a means of tracking employees' experience of change during mergers, offering management clear indicators of the effectiveness of their communication efforts while integration continues (Steffen, 2000). The cultural due diligence report should also provide space for spontaneous insights and individual observations (Steffen, 2000).

What Cultural Due Diligence Involves

Cultural due diligence enables the comparability of data, allowing the owners of the new organization to identify potential points of mismatch between the two organizations and to address them proactively as soon as integration commences (Steffen, 2000). This leads to enhanced operational effectiveness in the post-merger phase, reduced loss of key personnel, and lower restructuring charges. A review of the literature reveals that many mergers or acquisitions fail because they do not meet expectations and objectives. Some of these failures occur because expectations were set too high; others meet some initial objectives but fail to achieve the same performance in terms of growth and shareholder returns as their competitors (Recklies, 2003).

The following chart compares the components of regular due diligence with those of cultural due diligence:

Chart 1 — Regular Due Diligence vs. Cultural Due Diligence

Regular Due Diligence: Financial structure and performance | Product portfolio | Customer base | Marketing, sales, and distribution structure | Research and development | Legal matters | Management and personnel

Cultural Due Diligence: Organizational culture | Industry culture | National/regional culture | Leadership style | Corporate values | Brand values | Knowledge behavior

Conclusion: Cultural Due Diligence as a Strategic Imperative

A review of the literature reveals that for the mergers and acquisitions of today, corporate cultural due diligence is a necessary task that will ultimately determine the success or failure of a merger or acquisition. Additionally, cultural due diligence will secure the mindset of the acquired company, resulting in a reduced loss of knowledgeable employees. The future of mergers and acquisitions looks promising, as long as these duties are carefully performed.