Culture Clash
By Julie Monahan
As banks purchase non-traditional firms, merging disparate cultures becomes an urgent strategic challenge.
When Bank One Corp. executives plunked down $7 billion to buy First USA Inc. in January 1997, they justified the stupendous price in terms of the growth the credit card unit would provide. Mesmerized by expectations of earnings acceleration exceeding 20% per year, they agreed to pay a purchase premium that is awesome by the standards of traditional bank deals: 570% of book value and 20 times trailing 12-month earnings.
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Less than three years later, a shocking reversal of fortunes at First USA provoked a major stock sell-off and prompted the resignation of John B. McCoy, Bank One's chairman and chief executive officer. McCoy, who lifted Bank One from less than $25 billion of assets to more than $250 billion in the span of a single decade, apparently met his undoing when First USA went off on its own and took extra risks in the pursuit of growth, only to see its strategies backfire.
This unfortunate episode shows that acquirers face a critical challenge when they buy dissimilar companies in pursuit of growth. On the one hand, it is incumbent upon purchasers to preserve the entrepreneurial cultures that make entities such as First USA valuable in the first place. On the other hand, it is also imperative that managers quickly develop the business comprehension and controls needed to manage risk. It's quite a balancing act, but one that simply must be pulled off if cross-sector deals are to work.
The urgency of this requirement is heightened by the fall 1999 passage of a financial modernization bill that sweeps away some of the remaining legal barriers to cross-sector mergers. The long-awaited era of the financial services conglomerate, first heralded by the Citicorp/Travelers Group merger of 1998, may finally be at hand. Just a few weeks into 2000, brokerage giant Charles Schwab Corp. took advantage of the new legislation to acquire U.S. Trust Corp.
Experts say a top priority in such transactions is to quickly establish strong lines of communication between the merging companies. This entails far more than the exchange of technical information. Through authentic listening, officers of acquiring companies not only learn about the target's business and personnel dynamics, but they also can develop and convey the appreciation and respect that helps keep pivotal performers on the job.
All of these concerns, however, must be balanced against the need for tight financial and managerial controls over the acquired business, whether or not that involves the target's existing top managers. The first step in dealing with this challenge is recognizing its many dimensions – dissimilar performance metrics, incompatible information systems, unfamiliar risk issues and alien cultures. There's a lot to deal with, and it takes a substantial ongoing commitment.
Dealmakers also must be careful in framing expectations. When companies pay huge acquisition premiums, they essentially are saying they can operate the targets significantly better than the units' own managers. This proposition perhaps has some grounding in bank-to-bank deals, where the tenets of cost-reduction are well known. But wringing value from the merger of dissimilar entities can be far more difficult, and executives who do not acknowledge that are asking for trouble.
Merger Misfires
The last decade saw a plethora of deals in which diversification-hungry banks bought specialty finance firms, credit card companies, mutual fund complexes and especially brokerage/investment banking firms. The benefits surfaced in earnings reports last year. Robust trading, investment banking and venture capital revenues helped conglomerates such as Citigroup, Chase Manhattan Corp. and FleetBoston Financial Corp. overcome sluggish growth in traditional deposit and lending businesses.
There can be a downside to such cross-sector deals, however. It's difficult enough to merge two banks; bringing a bank and a nonbank together increases the danger of merger misfires. Although the Bank One/First USA reversal has dominated the headlines recently, it is not an isolated incident. Other cross-sector deals that went awry include First Union Corp. and The Money Store; NationsBank Corp. and Montgomery Securities; and Deutsche Bank and Morgan Grenfell.
Although the circumstances of individual deals remain murky to outside observers and can vary greatly, it does appear that some merger difficulties are traceable to the chief executive officer.
Personal behaviors that some CEOs might view as justifiable pride can be interpreted by targets' officers as insufferable arrogance. While it is true that some executives of assimilated companies will temporarily tolerate disrespectful treatment in exchange for extra financial rewards, it is not true that entire teams of critical employees will tolerate flagrant disrespect indefinitely. Top performers are marketable, after all, and they will express their dissatisfaction by jumping ship.
In other instances, CEOs can be far more interested in striking deals than in following through on them. The very acquisitiveness that brought glory in simpler times can, in other circumstances, breed a financial morass. As mergers get larger and more complicated, the risks of impulse buying can grow exponentially, catching dealmakers flat-footed.
Then there are the CEOs who appear to lack an adequate understanding of what they are getting into. Not all of the powerful expertise built up during a banking career may be applicable in other sectors of financial services. Also, a specific target may have budding problems of which the acquiring CEO is unaware. It's risky enough to bull one's way into a bank-on-bank acquisition, where the risk dynamics are better known. Such aggressiveness can entail even more risk in unfamiliar types of deals.
Senior management teams bear as much responsibility as the CEO for how a target fares after it is acquired, however. And that is why a general understanding of merger sensitivities is needed.
An acquisition typically features a 100-day period between the announced intention to merge and the legal closing. That provides a fairly small window of opportunity for acquirers to resolve cultural issues, select a management team and develop an employee communications strategy. Handling the employment issue – who goes and who stays – is especially critical. "An organization is frozen until everyone knows how the new seats will be arranged, " says Jim Reichbach, global banking segment leader at Deloitte Consulting in New York. "You need to manage the fear."
Bonds of Trust
A top priority is communicating with acquired employees early and often. Managers need to explain the mission of the combined company and attempt to clarify, as soon as possible, the role of these employees. If jobs are to be cut, as is often the case, that issue needs to be tackled quickly. "In an integration, speed of information counts, " says Paul Larkins, chief executive officer of Key Equipment Finance Group, a Superior, Colo.-based division of KeyCorp that has expanded by purchasing nonbank leasing companies.
PNC Advisors, for example, took immediate steps to dispel employee uncertainty after acquiring Hilliard Lyons, an investment banking firm in Louisville, Ky. The private banking arm of Pittsburgh-based PNC Bank Corp. published a periodic newsletter that kept employees on both sides of the transaction informed of how the integration was proceeding. It also posted information on the two corporate intranets. Tom Whitford, chief executive officer of PNC Advisors, says he spoke regularly with branch managers and employee groups, either in person or over the phone. "This creates bonds of trust with your new partners, " Whitford says.
Such personal contact is critical, since acquired employees are often concerned that inexperienced managers will attempt to impose on them an alien culture that's inappropriate for their industry. "You don't want to come in with storm troopers and proclaim, "We run a tight ship," says Jane Jelenko, national industry director of banking and finance at KPMG Peat Marwick LLP, New York.
Managerial standoffs can be especially harmful to an entrepreneurial investment banking organization. Bank of America Corp. (formerly NationsBank) sustained the loss of roughly 100 investment banking professionals in the wake of its 1997 purchase of Montgomery Securities and now faces an expensive rebuilding job.
Experts say banks that purchase such firms must be respectful of the cultural differences. "Decision-making in an investment bank tends to be less centralized, " says Joe Teplitz, a partner in the business consulting unit of Arthur Andersen & Co., New York. Imposing a bank-like, top-down management structure, Teplitz says, "makes the investment bank less responsive to market changes and less able to come up with creative kinds of deals."
Compensation plays a key role in retaining top talent in any merger deal, but particularly in those involving companies whose employees are accustomed to Wall Street-like salaries and bonuses. "If banks don't handle compensation issues up-front, resentment can build, " Jelenko says. Banks that acquire investment banking firms pay lucrative retention bonuses to keep key employees. But this issue requires delicate handling, since the pay-for-performance culture of Wall Street can create discord among employees tied to banking's more traditional compensation structure.
Atlanta-based SunTrust Banks Inc., for example, continues to move gingerly on compensation issues two years after acquiring Equitable Securities, a Nashville-based investment bank. SunTrust's approach is to pay its investment banking professionals what the market demands while trying to assure bank employees that SunTrust Equitable Securities can provide them with cross-sell opportunities. "The market values varying types of jobs differently, " says John Clay, SunTrust's executive vice president and managing director of corporate and investment banking. "We are not going to rewrite that book."
Preserving Momentum
The importance of ensuring smooth relationships with acquired employees is linked to the need for continued revenue generation, during and after the merger. That's particularly critical in a cross-sector merger, since acquirers can expect less in terms of expense reduction or economy-of-scale opportunities than in a bank-on-bank deal.
Customers tend not to wait patiently for management to shift its attention back to their needs, and competitors can be expected to pounce on opportunities. The acquiring organization must move quickly, therefore, if it is to capitalize on the expertise of acquired employees and regain momentum.
Key Equipment Finance did that with its 1997 purchase of Leasetec, a major vendor leasing company. During the due diligence period, Key Equipment Finance managers initiated frequent meetings with Leasetec employees and engaged in an intensive study of the vendor leasing business, which enables clients such as Cisco Systems Inc. and Storage Technology Corp. to provide private-label lease financing for their customers. "From that listening exercise, we developed a list of best practices – things we felt Leasetec did extraordinarily well, " Larkins says.
Acquirers usually discover that some of an acquiree's "best practices" can be applied to their own operations. After purchasing Equitable Securities, SunTrust moved its own debt capital group under that unit's umbrella, using the new name SunTrust Equitable Securities. The bank also built on its securities franchise by adding investment banking and trading services and expanding the division's sales force. PNC followed a similar course when it transferred its Pittsburgh-based securities servicing and clearance operations to Hilliard Lyons' Louisville location. Since then, PNC has doubled the number of customers using its brokerage services.
"We make sure that as we bring these companies in, we do not try to make them be like PNC, " Whitford says. "If PNC had their capabilities, we would not need to acquire them in the first place." It's a strategy that PNC has applied to two other deals related to investment services. One of these acquisitions, Stolper & Co., still operates from its old location, a farmhouse outside Philadelphia. "We expanded that building so those employees could stay in the same place and avoid having to come downtown, " Whitford says.
But out-of-sight should not translate into out-of-mind. Granting acquired employees a high degree of autonomy entails some risk, as demonstrated in the Bank One/First USA situation. For that reason, M&A experts advocate that acquirers lay out a clear system of controls. This can involve the target's existing management if the acquirer has confidence in that management. But the key requirements are that acquired employees understand exactly who is in charge and that the acquirer has an accurate view of what's going on with its new property.
Too little oversight or diffuse lines of authority can lead to the kinds of problems Bank One experienced with First USA, experts say. "It's a very delicate balance, " Reichbach says. "Different mergers have taken different approaches, but the common thread is that you have to have clarity on management issues. Where organizations have not realized much value, either in cost reduction or revenue generation, they have usually not defined the rules of engagement."
Ms. Monahan is a freelance writer based in Seattle.