In the wake of big mergers engineered last year by Travelers Group and Conseco Inc., cross-selling is suddenly in vogue again in financial services. While the individual circumstances differ greatly, these deals freshly illustrate the difficulty of combining companies engaged in sharply different business activities -- banking, insurance and brokerage in the case of the new Citigroup, insurance and subprime lending in the case of Conseco.

For these and many other acquirers, the basic problem is a seeming failure to construct acquisition strategies that truly build advantage. The synergistic benefits touted by merger partners rarely seem to materialize. Rather than merely search for cross-selling opportunities, acquirers must instead develop merger strategies explicitly centered on knowledge-based selling activities. They need to exploit the power of detailed customer information in M&A as they do in other areas of their business.

It is tempting to blame acquisition mishaps on rising price-to-book values ("we paid too much") or poor execution after the deal ("we didn't manage the cultures right"). But the truth is that many mergers are built on little more than empty vision statements; managers simply fail to craft a credible revenue growth strategy to justify the combination. Unless valuations and post-merger integration plans are driven off such a strategy, subsequent performance is likely to disappoint.

Executives must begin by recognizing that every acquisition must pass two tests before it creates value for shareholders. First, stand-alone performance expectations must be maintained-from the announcement of the deal right through the post-merger integration process. Since investors have already priced hefty future expectations into today's valuations, the acquirer's stock price will suffer if there is any indication of flagging performance at either of the combining businesses.

Second, an acquisition must change the economics of either the acquirer's or the target's business. True merger synergies consist of performance gains exceeding those already priced into the predecessors' stand-alone values. Therefore, the benefits to be derived from combining businesses must more than justify the premium paid to execute the transaction. If the economics of the overall business cannot be changed, the acquisition will create no additional value and the premium will be lost.

We believe knowledge-based selling offers a credible and realistic strategy for changing the economics. KBS strategies can be grouped into two basic categories: capture point strategies and algorithm-based strategies. Both involve leveraging customer information. The difference is that capture point strategies rely on information provided by customers at the point of sale, while algorithm-based strategies rely on customer information previously gathered and stored by the financial services provider-essentially database marketing that incorporates recent advances in technology.

A good example of a capture point strategy is trying to sell customers a loan or auto insurance policy when they are shopping for a car. An algorithm-based selling system, by contrast, might alert providers to the best type of mutual fund to offer customers based on their age and income demographics, as well as the best timing and selling mechanics. In both cases, a merger should enhance the new company's ability to implement these selling strategies.

But taking advantage of these KBS strategies also requires some organizational redesign focused on information, incentives, sales processes and channels. Acquirers must leverage the technology of the two constituent companies in areas such as shared customer databases, contact records, and tracking and referral systems. Additionally, they must improve the sales efficiency of their branch networks to make full use of the new capture points acquired in the merger.

Economics Matter

Famed money manager Warren Buffett once said, "When a manager with a reputation for excellence meets a business with a reputation for difficult economics, it's usually only the business that leaves with its reputation intact." Any financial services executive formulating an acquisitions strategy would do well to ponder this wisdom from the Oracle of Omaha.

The logic embedded in Buffett's quote is this: the performance hurdles that must be surmounted in an acquisition create some difficult economics. Part of the problem is that acquisitions do not take place in a vacuum. Competitors do not stand idly by while an acquirer attempts to generate synergies at their expense. Instead, they will introduce new products or take other actions to maintain and expand their market share.

The objective of any acquisition should be to change the economics of the business or the environment in favor of the acquirer -- to create an advantage that cannot be easily replicated by a competitor. Cost takeouts were once seen as an effective way to get merger benefits, in that the acquirer ended up with a larger revenue-generating capacity on a proportionately smaller expense base. For various reasons, including ever-higher acquisition prices, acquirers are not getting the same kick from consolidation-based deals as before.

Last year's Citigroup deal heralded a renewed interest in the potential of cross-selling in financial services. This $83 billion transaction, as well as the smaller Conseco/Green Tree Financial deal ($7 billion), trumpeted the benefits of synergies between disparate business units. But results have been mixed. The new Citigroup had problems in the early going and has yet to prove that one plus one equals more than two.

Conseco/Green Tree, meanwhile, has been a huge disappointment for investors. The Carmel, Ind.-based insurance company purchased mobile home lender Green Tree in April 1998. The idea was to sell insurance products to Green Tree customers and lending products to Conseco's clients.

But the market has been skeptical about both the cross-selling synergies and Conseco's ability to integrate the largest acquisition in its history. It also didn't help that Conseco offered a huge 83% premium over Green Tree's pre-announcement share price. More than a year later, Conseco's stock still hovers in the $30 per-share range-an almost 50% decline from its $57.75 pre-announcement price and a loss greater than the announced value of the deal.

How could Conseco fall so far? The answer lies in the powerful signal that Conseco sent to the financial markets about its apparent plans for discontinuing its tremendously successful acquisition program in its core business. Diversifying into the consumer loan business was seen as a sign that opportunities for additional life and health acquisitions were diminishing. As far as the market was concerned, Conseco became a very different company.

The Conseco reversal demonstrates that acquisitions must begin with a compelling vision that stakeholders can grasp. The major problem with a cross-selling, one-stop-shopping vision is that it does not address how the combined entity will be a better competitor. In fact, both companies immediately face a new set of rivals. The acquirer must explain why it needed to buy an entity in order to sell new products, and pay a premium to do so. Most mergers will fail if they contribute little to the combined menu that the predecessors could not have compiled independently or that rivals are not already doing.

The resulting post-merger integration will be largely ineffective if it is not driven by a credible strategy. And given the astronomical takeover prices currently being paid, many deals destroy value right from the beginning.

Leveraging Knowledge

A better approach is to figure out how the respective customer knowledge bases of the merging companies can be uniquely leveraged to produce performance gains not available to either firm outside of a transaction. This approach is designed to produce post-merger revenue growth exceeding prior forecasts for the predecessors. One component of KBS strategy is built around capture points. Capture point strategies utilize the knowledge consumers provide when they purchase a given product. A customer cashing in a certificate of deposit, for example, provides a great capture point for selling that individual another savings or investment product. The task of the acquirer is to do a deal that enhances these natural capture points in either or both of the merging businesses.

Minneapolis-based ReliaStar's 1996 acquisition of Successful Money Management Seminars provides an excellent example of powerful capture point economics. ReliaStar, a diversified insurer and asset management company, found that customer profitability generated through educational capture points such as SMMS is 50% higher than through other sources.

SMMS produces seminars on personal financial planning and investments. ReliaStar noticed in the mid-1990s that some of its most productive agents were instructors at SMMS. Those independent agents were successful largely because SMMS students became motivated and educated customers. By acquiring SMMS, ReliaStar could attract more independent agents who would use the SMMS system. It also took the SMMS concept into specialized markets such as teachers and the military. Between 1997 and 1999, ReliaStar's sales of individual life policies and variable annuities through SMMS nearly doubled.

Algorithm-based strategies also can help to form the basis of a viable acquisition strategy. These strategies require some prior knowledge of an individual, which is then used to market appropriate products to that person. Specifically, algorithms are sets of conditions computers use to comb customer data files in order to identify the best moment to offer a particular product to a customer, as well as opportunities for designing new products. Algorithms based on customer data can alert providers, for example, that a customer with children approaching the age of 17 likely needs college financing. Alternatively, they might flag a refinancing opportunity involving mortgage customers when interest rates drop below a certain level and suggest the most appropriate means of capturing the sale.

Such techniques played an important role in two recent large European bank mergers. Each acquirer ascertained it could readily apply its own superior algorithms and marketing infrastructure to the customer files of its target, significantly enhancing revenue opportunities at the newly-merged bank. Value was created because the acquired banks gained much better marketing assets than before. Unless another competitor can neutralize the new advantage, each combination will have created performance gains beyond what would have occurred independently. Of course, shareholders will benefit over time only if the target valuations driven by the strategy prove accurate.

Bridging the Gap

Identifying and then constructing KBS strategies is but one step in delivering value in the post-merger integration process. An additional problem is bridging the gap between the new strategy and the organizational design required to drive it. The orientation must shift towards building closer relationships, both with customers and across the combined firm. Leaving merged organizations to run in parallel lessens the chances of wringing performance gains from the combination. Even worse, political conflicts may actually hurt the stand-alone businesses and destroy value. Before diving into heavy cost-cutting and organizational redesign, acquirers need to address issues involving information, incentives, sales processes and channels.

First, managers must break down product silos and organize the new company around the unique information insights provided by one or both of the merging organizations. Simply focusing on a particular customer segment or training the sales forces to handle new products is unlikely to create value, because any competitor can do those things. Acquirers must instead develop an information support infrastructure that leverages the technology of the merged companies in areas such as shared customer databases, contact records and tracking and referral systems. This infrastructure can then be used for more effective marketing.

Second, managers must appreciate the counterintuitive insight that branches constitute the most efficient sales channel. This is extremely important because so much of the expense reduction in bank mergers involves closing branches. The perils are illustrated in a recent Boston Consulting Group study, which found that branch walk-in sales efficiency is six times that of phone sales efficiency, and that both exceed the direct mail rate.

Unfortunately, branches fail to capture much of this sales potential because so little employee time is dedicated to selling. While branch consolidation will remain a significant source of cost reduction in bank M&A due to the redundancy of overlapping networks, acquirers must seize the opportunity to build their KBS strategies around the branch delivery system. Branches are natural capture points. Given their production capability, they should be transformed into lean marketing platforms and, thus, an important source of profitable revenue gains following a merger.

Third, if acquiring banks are going to compete in insurance and investment products, their sales resources must be competitive with nonbank rivals. But compared with the securities and insurance industries, banks have far fewer sales people as a percent of total employees. They also pay less. That makes it difficult to attract the talent needed to compete with these rivals. Appropriate sales force and business unit incentives must be deployed to support KBS strategies.

As the rising stock market lifts stand-alone trading values, acquisitions require progressively more discipline if they are to succeed. Unless acquirers craft well-focused strategies and support them from the onset with the required organizational changes, they may not -- as Warren Buffett might say -- leave with their reputations intact.

Mr. Sirower is a professor of mergers and acquisitions at New York University's Stern School of Business. Mr. Nicholson is a vice president with the Boston Consulting Group in New York.

Copyright © 2003 by Banking Strategies, published by BAI.

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