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MERGERS AND ACQUISITIONS: CHALLENGE SCALE, BEWARE TECHNICAL DEBT, AND BRAIN DRAIN

Apparently, tis the season for massive mergers in the financial services (FinServ) sector. On the vendor side there’s the Fiserv/First Data, FIS/Worldpay, and TSYS/Global Payments deals.  On the financial institution side BB&T has joined with SunTrust to become the 6th largest financial institution in the United States.  Whether it is a megamerger or something of a considerably smaller scale there are some important things to consider before undertaking a merger.

Most executives appreciate the complexity of a deal and know that mergers of most any size present a considerable level of distraction for those involved.  The number of players alone – teams from the organizations involved, lawyers, accountants, consultants and an investment banker or two – presents a unique communications and project management challenge.

However, the most significant challenge comes after the deal when the promised value to general stakeholders promised when the merger was announced must be delivered.  The historic record indicates that, like marriage, mergers have an astounding high incidence of failure in terms of achieving this goal.  It would appear, as the saying goes, that the devil is in the details many of which are described below.

Supersize Me:  Why the Gospel of Scale Should be Challenged

There is a mantra that all the large organizations, including financial institutions and their investment bankers, chant when asked about the benefit of mergers: “scale wins.” Underpinning this faith in scale are many logical precepts related to eliminating redundancy, increasing efficiency and leveraging technology.

These precepts are relevant for most banks and credit unions pondering mergers.  In fact, the gospel of scale is what has fueled the relatively high concentration of mergers in the community banking space with these institutions attempting to join ranks to gain the economies of scale needed to compete with larger players.

However, as with anything that is presented as “conventional wisdom”, the value of scale should be carefully critiqued before undertaking a merger.  In other words, before anything else, ask the question “Does scale win?”  Consider what other factors may be driving the momentum behind the merger.  Is it an idea that came from an investment banker who certainly has a sizable commission riding on getting these types of deals done?  Is the merger more about providing institutional investors the opportunity to cash out the gains they have seen or, conversely, mitigate loses?   Maybe the executives at the acquiring institution is wishing to retire and needs the liquidity he or she would gain from putting their shares in play.

Perhaps it is all these and scale?  The important thing is to understand at how these various elements are driving the deal.  Maybe it is easier to highlight the benefits of scale to general stakeholders than attempt to explain the issues related to investment bankers, institutional investors and executive exit plans.  Whatever the case for the institutions involved, it is important that they have a clear and sober understanding of what their reasons are and, preferable, be open to not only all those involved in making the merger happen but also to the general stakeholders themselves.

 

The Impact of Technical Debt on Mergers

Megabanks continue to make much out of the benefit of their scale highlighting the massive armies of people and billions in budget dollars they have available.  Many community bank and credit union CEOs seem to be stuck between fear and awe when they hear this message.  However, could it be that the “scale” the megabanks tout is in fact WHY they must have armies of employees and billions in budget.

For example, one of the three largest financial institutions recently announced it would be investing $10 billion in technology over the coming year. Nowhere in their announcement did they mention that between seven and eight billion dollars of that investment would go to maintaining legacy systems.  Research suggests that financial institutions invest approximately seven percent of their revenues in IT but usually less than 12 percent goes to innovation.

This is due to something known in CTO/CIO circles as “technical debt.”  There is a correlation between technical debt and innovation; i.e., the more of the former, the less of the latter.   Think of it as a cyclist who is pedaling a bicycle with square wheels passing stores with racks full of round wheels saying “Sorry, I don’t have time.” Technical debt is a factor for banks and credit unions of all sizes though the larger the entity the greater the technical debt in most instances.  The greater the technical debt, the greater the percentage of the technology budget that must go to maintaining it.

Few community banks and credit unions have complex internal IT departments and for this reason their exposure to technical debt manifest within the vendors they rely on to provide them the hardware and software products and services required to satisfy their customers and members.  This is why when mergers occur at this level, evaluating the vendors of the participating institutions is vitally important and must extend just beyond the terms and conditions of contracts.

A rule of thumb to remember is: As with banks and credit unions so is the case with vendors; i.e., the larger the vendor, the greater the amount of technical debt that must be overcome to keep pace with the demands of the consumers and businesses served. In fact, vendors and financial institutions who have grown primarily via mergers and acquisitions typically have even more technical debt than tose that have grown organically.

The Erosion of the Value from Mergers Due to Reductions in Force

Even if the benefits of scale are considered worth the risk of the potential downsides that can attend it, there is another detail, the difficulty of which is often misunderstood by a financial institution, or most any other organization in the same situation.  Because It is very hard to realize the benefits of scale without eliminating redundancies between the institutions involved in the merger, “right sizing” of the workforce and the reduction of the “new” organization’s physical footprint usually is a priority.

Too many executive teams fail to realize that this is not simply about calculating the total amount of the salaries and compensation that can be saved by laying off some number of people.  There is the cost of the distractions that will increase and the productivity that will decrease once the merger is made public. The cost of this distraction and productivity goes beyond the employee base to include consumers.  Those that have been considering opening an account, taking out a loan or setting up a college account for their children at the “new” institution will delay such actions.

There is another risk associated with downsizing that likely eclipses the impact that distraction and lost productivity has on a bank or credit unon involved in an organization.  As alluded to previously, the need for and size of reduction in force is usually defined by the cost savings desired.  These drivers cloud the judgements made concerning who should stay and who should go.  For example, a highly paid product owner or line of business manager is downsized, and junior people elevated to take that positions.  The logic is as simple as it is simpleminded:  the compensation of the former is considerably more than the compensation of the latter.  Seldom does this approach  account for the lost decades of knowledge and lessons learned from trial and error walking out the door.

Lastly, while it is generally accepted that the larger the organization, the less innovative and responsive to markets they become, this is false.  Size – and even technical debt – are not the primary factors at all.  To breed continuous innovation and a customer-centric mindset a company’s culture must be rooted in these qualities.  It is hard to imagine anything that would impact corporate culture more significantly than a merger.  Even if both of the organizations involved are known for cultures that foster the qualities noted above, there is no guarantee either culture will survive the merger intact.  Likewise, if neither organization involves exhibits these attributes before a merger, there seems to be little reason to hope the combining of them would produce a culture built on these characteristics.

Don’t Panic and Stick to Your Knitting

Many times, mergers in banking – whether it is amongst institutions or vendors that provide products and services to banks and credit unions – create a lot of noise in the industry publications, reports from the research firms and boardrooms.  Certainly, mergers and acquisitions that involve competitors or vendors an institution relies on should be watched closely and analyzed carefully.  The question of what, if anything, an organization needs to do in response to such actions should include short- and long-term options.  When determining what short-term options should be considered, taking advantage of the natural forces that reshape the companies involved in the merger should be near the top of the list.  It very well may represent an opportunity for those that, as my British friends say, “stick to the knitting” of wowing their customers and members.

 

Michael E. Carter is Executive Vice President at Strategic Resource Management, Inc. in Memphis, Tn.

His email address is mcarter@srmcorp.com

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