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Why The Northwest-Delta Deal, And Many Others, Are Stinkers by Oren Harari This article appeared in the Financial Times website www.ftpress.com , June 9, 2008 (July 3, 2008) Oren Harari explains why the Northwest-Delta merger will be a big bust for all stakeholders, and is fact a great case study of how not to do mergers and acquisitions if you want your company to thrive. Writing about the imminent Northwest-Delta merger in the April 25 "Deals Blog" of the Wall St. Journal, Heidi Moore asks: "Airline mergers have, by and large, been disastrous. So why do we want more?" Good question! And in this article I’ve got the answers. There are several reasons why the Northwest-Delta merger will be a big bust for all stakeholders (except for top managers and the assorted high-priced dealmakers who will, of course, pocket millions). In fact, the reasons for the bust are so compelling that the real value of this deal is that it affords us bystanders a good business case of how not to do mergers and acquisitions (M&A) if we want our companies to thrive. So in the spirit of management education, regardless of the industry you’re in, you can thank Northwest and Delta executives for role-modeling three counterproductive, value-destroying paths toward M&A that I’ll discuss here. Path 1: First, Piss Off the Pilots To properly screw up a deal, it’s important to begin by identifying your most important employees—the ones you will really depend on as you move forward (the best engineers, marketers, project heads, salespeople, doctors, professors, machinists, pilots...you get the idea)—and making them cynical, distrustful, scared, disillusioned, or just plain angry. When the Northwest-Delta deal was announced in April 2008, the Associated Press reported that Northwest pilots and the union representing most Northwest ground workers immediately announced their opposition. They’d been kept in the dark, and remained in the dark. The union that represents baggage handlers, ramp workers, and ticket agents was unhappy about never being consulted. Joseph Tiberi, a spokesperson for the International Association of Machinists and Aerospace Workers, articulated Management Principle 101A: "If the airline wanted the support of their employees they should have brought us in and discussed it with us earlier." Meanwhile, at Delta, Lee Moak, the head of the Delta pilot union, says that back in August 2007 he was assured by incoming CEO Richard Anderson that Delta would stand alone. "Mr. Anderson talked bluntly on Northwest Airlines’ situation and he told me he was not coming in as CEO to facilitate a merger with Northwest Airlines," said Moak. Management Principle 101B: Saying one thing and doing another is not a great way to build trust among the troops. Now fast forward to today. The pilots are still upset over little things like pay, route assignments, and vacation time, all determined by seniority. After multiple conferences (remember, this is after the deal is announced as a fait accompli), the pilot groups representing both airlines still can’t agree on a fair method to integrate their seniority lists. Seniority integration is a prickly, onerous affair under the best of circumstances, but in this case the problem is especially sensitive. Many Delta pilots are "junior" even though they might fly bigger, more complex planes than their more "senior" Northwest counterparts. On top of that, the pilots in both airlines have already given up pay and benefits during the past few years while their airlines were in financial difficulty, and many pilots are deeply skeptical that the new, merged company will ever compensate their losses. Unhappy Delta flight attendants with whom I’ve spoken on some recent flights tell me stories of widespread dissatisfaction among the pilots. I don’t doubt them. To the executives, consultants, lawyers, and investment bankers who structured the deal and stand to benefit mightily from it, these concerns of the pilots are minor, perhaps irrelevant. After all, to them employees are simply chess pieces—"factors of production" shifted around as part of the grand plan. Smart leaders know otherwise. When Maury Myers engineered a dynamic turnaround at Waste Management in the early 2000s, he declared that his first step would be regaining employees’ trust. He did so by sharing sensitive corporate data with them and by including them in key decisions. His advice was simple: "Address employees’ concerns before those of Wall Street. If they’re not on board, your turnaround will fail." The same mindset—heavy doses of transparency and employee inclusion from the outset—drove Gordon Bethune’s remarkable 1994–1999 turnaround of Continental Airlines from worst to best or near best in factors like on-time departure, baggage handling, customer satisfaction, employee satisfaction, and ultimately profitability and stock value. Ask yourself this: How sanguine would you be about getting surgery in a hospital where the doctors and nurses are angry? How happy would you be about flying in a plane serviced by pissed-off machinists and pilots? Oh, well, who cares? You’re just a customer. Path 2: Base the Deal on Fantasy Premises and Projections A healthy dollop of delusion always helps to damage the prospects of any deal. Leaders must be optimistic, but they also have to be somewhat grounded in reality. In the research that culminated in his book The Synergy Trap: How Companies Lose the Acquisition Game (Free Press, 1997), Boston Consulting Group’s Mark L. Sirower concluded that the primary cause of the near-2/3 failure rate of mega-mergers is the unsustainable belief that synergy will guarantee sizable cost reductions and market dominance. Sirower notes that these projections are fouled up by uncomfortable realities like the fact that competitors don’t stand still while your merged company is busy integrating, culture clashes are often ruinous, and financial pressures from the deal itself are often so substantial that they can generate myopic, self-destructive management decisions. In the case of Northwest-Delta, fantasy premises and projections abound: This merger will radically lower costs. It will be fairly straightforward to execute. It will thrill investors. It will allow the new company to dominate the air travel market. The realities are these: The merger will create bragging rights for the world’s biggest airline, to be sure. On the flip side, the merger will create a massive, slow, unwieldy, and über-complex entity with fat fixed costs: more than 1,100 jets of different varieties, over 80,000 employees (none of whom are officially slated to be terminated), over 6,400 daily flights to over 1,000 destinations worldwide, and seven major domestic hubs (none of which are officially slated to be closed). The improvement in operational efficiencies is expected to be modest, as is the elimination of redundancies and capacities. Integrating the companies—the myriad systems, the disparate cultures, the fact that one workforce is far more unionized than the other—will be a cash-sucking nightmare. Low cost, low price, niche competitors as well as foreign-government-supported larger carriers will continue to proliferate. Fuel costs will stay high. The financials of the new beast will be so precarious that its ability to hedge fuel will be diminished. Investors have already severely dinged the stocks. That’s the reality flash. Wait, there’s more. Robert Crandall, retired CEO of American Airlines and current CEO of the air taxi startup Pogo, made the following argument in the April 21, 2008 issue of the New York Times: "Consolidation will not resolve the woes of individual carriers, nor will it fix the nation’s aviation problems[...]the case for mergers is unpersuasive. Mergers will not lower fuel prices. They will not increase economies of scale for already sizable major airlines. They will create very large costs related to consolidation. And they will anger airline employees[...]." I’ve saved the biggest delusion for last. I call it the "dinosaurs mating syndrome": the belief that two bureaucratic, backward-looking, unsuccessful corporations will somehow spawn a successful and impregnable giant if they join forces. Nothing new or groundbreaking in value comes from the Northwest-Delta merger. It’s more of the same deliverables, augmented logarithmically. (Seriously, does anyone reading this article really believe that the new company will be a nimble, innovative giant committed to providing a great, imaginative price-value experience for passengers, leading to sparkling returns for investors?) Let’s be frank: The unspoken assumption is that two companies that have individually managed to generate lousy financials will be able to magically continue their same comfort-zone approaches to business simply by jumping into bed together. Ultimately, a "dinosaurs mating" merger might temporarily prop up the new beast by providing more scale and marketing reach, but the end result is almost always extreme vulnerability in a fiercely contested global free market, where speed and innovation count for more than size and market share alone. Path 3. Ensure That Your Executive Leadership Views M&A as Competitive Salvation Finally, to ensure implosion, you need leaders who have no concept of how to mobilize organizations to do extraordinary things—so instead they do deals. One of the reasons that more than half of mega-mergers wind up destroying shareholder value is that despite the crummy track record, too many executives view M&A as their number-one "go-to" strategy. This has nothing to do with logic. As I suggested earlier, there’s no logic in two firms that have both recently crawled out of bankruptcy and suffered hemorrhagic losses (in the first quarter of 2008, Delta lost $6.4 billion; Northwest, a "mere" $4.1 billion) concluding that by blowing their remaining cash together in harmony, they can somehow achieve financial vitality and market leadership. But the moment that ex-Northwest executive Richard Anderson was named CEO of Delta, speculation in the investment community was rampant—not that he would inspire something imaginative and powerful in operational efficiencies, supply-chain management, technology, or customer care, but rather that he would shepherd a mega-deal with another big carrier. And despite Anderson’s public protests to the contrary, the inevitable occurred: not just the merger, but the accompanying gauzy declarations of strategic nirvana. Said Anderson, the heir-apparent to head the combined company: "Delta and Northwest are a perfect fit. [The merger opens] a world of opportunities for our customers and employees." Not to be undone, Northwest CEO Douglas Steenland said, "This gives us a head start on our competitors." And of course, the press played along, with headlines like the April 15, 2008 lead story in the USA Today: " Airline World to Get New Top Dog." All these comments are typical of leaders’ quotes that have preceded numerous deals that have ultimately tanked. Just for starters, think about the glowing rhetoric from the U.S. and Germany that preceded the DaimlerChrysler fiasco. I’m no psychiatrist, but as I note in my book Break From the Pack: How to Compete in a Copycat Economy, I suspect that many leaders’ promiscuous reflex toward rushing to nonsensical mergers arises from some deeper motives: No vision, no alternative. "The analysts are screaming and the board is on my back to do something about the lousy financials. Since I have no breakthrough plan or imaginative growth strategy, a nice acquisition will do the trick and prove I’m a can-do leader." Opportunism and expediency. "I love quick fixes, and there’s nothing quicker than being able to literally double our size and press exposure by—poof!—putting my signature on a contract and then delegating the post-deal implementation trauma to underlings." Mega-fear. "We’re getting killed! What do I do? I haven’t a clue. Merger? Fine, I’ll do whatever it takes." And if all else fails, mega-payoff. "The merger may be a dog, but my net worth will soar no matter what happens." As I also describe in Break From the Pack, great business leaders are always on the prowl for judicious acquisitions. But their M&A goals are rarely about size, scale, market share, and scope—which is why they tend to be very cautious about doing high-price mega-mergers. Instead, they tend to seek small targets that have compatible cultures; can be quickly integrated; and, most important, fill specific strategic gaps. They focus on finding acquisition targets that help to bring in exceptional top-notch talent, allow entrée into fast-growing markets, boost new cutting-edge organizational knowledge in critical areas (science, technology, logistics, marketing, and such), and markedly improve the organization’s agility, innovation, foresight, and customer care. CEOs Steve Jobs (Apple) and John Chambers (Cisco Systems) are good role models: You don’t read breathless headlines about their companies’ M&A activities because the deals under Jobs’ and Chambers’ commands are relatively small, precise, and aimed at building intangible assets (intellectual property, talent, speed, and so on). At the end of the day, great leaders don’t view acquisitions as panaceas for competitive woes; they see them as periodic, laser-beam accelerators to the attractive organic growth that already marks the organization. Do you really think that the above descriptions apply to the leadership of the Northwest-Delta deal? Am I being too hard on Northwest and Delta? Perhaps. But as investors and customers, we should be more than a little impatient with the never-ending theatre of value-destroying mergers across all industries. A series of studies by Booz Allen & Hamilton published in 2001 showed that fewer than half of these mergers succeed. "By whatever measure you choose—stock price, revenues, earnings, return on equity—most deals fall short of expectations." More recently, Wharton accounting professor Robert Holthausen estimates the merger failure rate as between 50 and 80 percent. Even Martin Sikora, the editor of Mergers & Acquisitions: The Dealmaker’s Journal, readily agrees that "the accepted data say that most mergers and acquisitions don’t work out." Reflect on these statistics. They suggest alarming returns on enormous investments. Small wonder, then, that the last big domestic airline merger, US Airways and America West, has thus far failed to live up to the hype. As American Enterprise Institute editor and aviation blogger Evan Sparks notes in his April 25, 2008 entry: "At the time, the 2005 [US Airways-America West] merger was hailed by Wall Street; indeed, after the merger the airlines’ stock price rallied. But then, in 2007, the stock tanked, and the airline itself didn’t perform so well either. It took a year and a half to merge the respective reservations and booking systems of US Airways and America West. The two airlines’ pilot groups are nowhere near agreement on a master seniority list[...]and morale among the old US Airways crew is plummeting. [...]All of these challenges have affected the passenger experience. The Department of Transportation’s latest Air Travel Consumer Report indicates that US Airways has the highest complaint rate of all U.S. airlines." Sound familiar? It should. So why don’t they get it? Why would United Airlines, shortly after emerging from bankruptcy proceedings, prowl the landscape for a mega-merger? When will investors start howling in protest at the vacuous use of their capital? (A quick anecdote: A couple weeks ago I was at a Continental desk at an airport. The agents were polite but mechanical, until I mentioned that I was glad that the exploratory United-Continental deal fell apart. Immediately, several agents looked up and gave me big beaming smiles. I suddenly had new friends. They get it. Why don’t we?) The beauty of free markets is that they encourage the emergence of companies that create opportunities in an environment that entrenched, unimaginative players insist is impossibly bad. Leaders like David Neeleman (AirBrazil), Richard Branson (Virgin Atlantic), Warren Buffet (NetJets), Lawrence Hunt (Silverjet), Cheong Choong Kong (Singapore Airlines), Michael O’Leary (Ryanair), Tony Fernandes (AirAsia), Don Burr and Robert Crandall (Pogo), among others, are redrawing the air travel landscape in fresh, compelling ways—and the result is a cornucopia of new technologies, new partnerships, new niches, new formats in operations and cost containment, new plane designs, new employee relationships, new customer experiences, and even new business models. Knowing how these leaders approach their businesses, I am confident that while they may periodically choose a selected acquisition target to fuel profitable growth, I am doubly confident that they won’t fall prey to the three value-destroying paths to which many leaders of legacy airlines seem to be addicted. << prev - -   July 3, 2008   - - next >>