Acme Equipment CEO Rodney Collins was sitting in his office contemplating the company's three-year growth strategy. It called for 15% annual revenue growth—a figure he knew was already factored into Acme's share price. Yet the underlying demand growth in his business was only 2%. In addition to savvy marketing and product innovation, acquisitions, he believed, would be critical to achieving the growth target his shareholders expected, as well as a multiplicity of competitive advantages.

The well-publicized, dismal odds of deal success, however, made Collins worry about what his board would say to pursuing acquisitions, not to mention what it might mean for his job security. After all, study after study had shown that more than two-thirds of deals destroyed shareholder value, and CEOs often took the fall with their company's share price.

On the other hand, could Acme afford not to buy?

Collins is typical of the American senior executives who are being challenged by the current dilemma in crafting profitable growth. On one hand, the high failure rate for dealmaking makes it tempting to focus solely on what is wrong with M&A and pass up acquisitions. On the other, organic growth is hard. So most companies will have to acquire in order to meet shareholder expectations.

As a result, we believe managers should be asking questions that focus on how M&A can work for their companies, such as:

• What are the common denominators of companies that are M&A winners?
• How do the successful firms organize and approach dealmaking?
• Are these methods transferable?

Bain & Company posed these very questions in a recent study of how publicly held, U.S.-based firms performed over a 15-year period. The 724 firms in our study had at least $500 million of revenues in 2000 and were all publicly owned in 1986. We compared the firms' acquisition behavior across 7,476 acquisitions to the excess return they delivered to shareholders from 1986 to 2001. Excess return is defined as the total return to shareholders, including dividends, minus the costs of equity.

We made several discoveries, and subsequently used interviews with successful dealmakers to explore these issues in more detail. Some key findings:

• Bank on experience

Frequent buyers, on average, outperform by a significant factor both non-buyers and infrequent buyers. You've got to be "in the game" to get good.

• Think small

Shareholder returns are negatively correlated with deal size, i.e., smaller deals tend to be the most successful. You're less likely to choke when you nibble.

• Don't assume home runs

The worst strategy is to do only a few big deals. Novice dealmakers make rookie mistakes, leading to problems at both the base business and the target.

• Buy in fair and foul weather

Frequent acquirers can be further segmented based on the timing of their purchases. Constant buyers were the most successful, followed by those who concentrated their buying during recessions. The key to success: developing a rigorous program of acquisitions and sticking to it.

• Reinforce the M&A commitment

Finally, frequent buyers succeed because they're organized and they have institutionalized disciplines that set the odds of deal success in their favor.

In sum, there is no magic to making deals work. The companies that are most successful at M&A have made it an integral part of their strategies and have refined their strategic approaches, dealmaking teams and acquisition processes through repetition—just as they would support any other core competency.

Get in the game, start small, ramp up

Results of the survey determined that frequent acquirers outperformed all other companies. On average, the more deals a company did, the more value it delivered to shareholders. In fact, we found that frequent acquirers outperformed occasional buyers by a factor of 1.7 and non-buyers by a factor of almost two-to-one.

But there is another revealing difference between the successful acquirers and the unsuccessful one—the nature of the dealmaking. Companies that enjoyed the highest returns were those that focused on small deals, with the target, on average, being less than 15% of the buyer in size. On average, these companies outperformed those taking bigger bites by a factor of almost six-to-one.

Combining these two, key dealmaking criteria—frequency (high vs. low) and deal size (small vs. big)—suggests five key strategic approaches to acquisitions:

1. Mountain climbing—frequent acquirers that start with small deals and ramp up to larger ones.
2. Stringing pearls—frequent acquirers that focus on small targets.
3. Betting small—infrequent acquirers that set their sights on small targets.
4. Rolling the dice—infrequent acquirers that make a few big bets.
5. Playing dead—companies that don't do acquisitions.

Clearly, the worst strategy is to make a couple of big bets. A handful of companies actually made this strategy work, and in highly consolidated, mature sectors, there may be no other option but to buy big when an opportunity arises to gain share and economies of scale. The number of hits, however, is rare.

In fact, the coterie of companies making a few, big bets is dominated by a lot of infrequent acquirers with little or no M&A experience. That's a volatile mix—like putting a teen-age driver behind the wheel of an 18-wheeler in a snowstorm. Little mistakes can have a devastating impact.

The integration challenge is one reason that infrequent buyers of large companies post low returns. Because the difficulty of integrating a company rises almost exponentially with its size, the larger the target, the more likely a management team is to lose focus on both businesses, with attendant declines in share and/or profitability. Frequent acquirers, on the other hand, work their way up from small deals to big deals, building on experience along the way.

Avoid rookie mistakes

Infrequent acquirers make rookie mistakes. These firms tend to take opportunistic stabs, buying a business simply because it's available or looks cheap, rather than because it best fits their strategy. They are unlikely to have the necessary organization and processes to spot a deal's red flags and black holes or to measure synergies realistically. They may evaluate the deal without consulting the operators—the managers on the front lines who are best positioned to assess the quality of the target and take responsibility for integrating the newcomer.

Without a structured process and experienced dealmakers, infrequent buyers can fall into the clutches of "deal fever," making an acquisition, however misguided, unstoppable.

Veteran acquirers know better. They have found ways to capture the lessons learned from previous acquisitions to improve the success of their dealmaking. Surprisingly few companies do this. A survey of 53 companies by The Conference Board in 2000 revealed that 55% of respondents said their companies had not been able to transform their M&A experiences into core competencies that enabled them to think about a merger as a planned process.²

Dollar-cost averaging

There are different strategies even among the frequent buyers (defined as the companies that made more than 20 purchases over the 15-year study period). We found that frequent buyers could be segmented by their periods of activity, i.e., the consistency of their deals (or lack thereof) through economic cycles.

We split frequent acquirers into four groups:

• Constant buyers—bought consistently through all economic cycles.
• Recession buyers—increased the frequency of their buying during recessions.
• Growth buyers—bought principally in periods of economic growth.
• Doldrums buyers—tended to buy in stable or slightly uncertain periods between recession and growth.

The constant buyers were by far the most successful, outperforming the growth buyers by a factor of 2.3 and the doldrums buyers by a factor of 1.8. The recession buyers came in second, outperforming the growth buyers by a factor of 1.4.

Simply put, the most successful frequent acquirers are always on the hunt for deals. They treat acquisitions a bit like dollar cost-averagers treat mutual fund shares. They buy low, they buy high. Above all, they buy systematically—winning either as a rising tide lifts prices, or by picking up assets in down markets at fire-sale prices. But they have the machinery in place to deal with both types of scenarios.

Get on the learning curve

The performance gap between winners and losers was so large that we zeroed in on the winners with the goal of identifying their "secret sauce." In discussions with the M&A czars at these companies, we confirmed that winners prepare carefully to create opportunities. They institutionalize their deal learning so they can rapidly and efficiently recognize deals that fit strategically, evaluate them, seal the contract and then successfully integrate the acquired business. This process of organizing for opportunity includes setting up a standing deal team with an effective playbook, involving line managers early in the buying process and putting in place checks and balances to kill deal fever and maintain a rational, dispassionate approach.

The winners regard M&A as an essential enabler of growth strategy. But they know that buying companies leaves little room for error. Doing the job well takes practice. As a result, the best performers have ensured that their experience hones dealmaking processes into core competencies.

In essence, winners get on a learning curve. They start with small, lower-risk deals and build capability in dealmaking. They institutionalize the processes and create a feedback loop to learn from mistakes. Only then are companies well prepared to go after larger deals, or transactions that take them away from their historical core operations into related or new businesses.

Build a standing deal team

Successful corporate shoppers nearly always maintain the nucleus of a core M&A team with plenty of transactional experience. This allows the company to create opportunities or strike expertly when the right deal surfaces. The team gets involved in every acquisition and serves as the firm's walking, talking, institutional memory bank as members learn lessons from each acquisition and use that knowledge in the next deal.

The deal team members are in charge of the purchase—from screening through to due diligence. For starters, they constantly review targets and keep a list of companies they will buy if the price is right or if the business becomes available. In the evaluation and due diligence phase, the core deal team is responsible for the economic assessment of the deal, including valuation and financial structuring, and acts as point people who can call on separate in-house legal and tax experts to assist in the most viable structuring of the purchase.

In many cases, the core deal team stays involved in integration. Its members keep the integration team focused on the investment thesis and will steer the integrators back on course if they stray. The deal team makes sure that the terms of the transaction are followed and resolves any conflicts that may arise. The members also deal with adjustments to the purchase price after closing. And they stay in touch to make sure everybody is on the same page.

The deal team is typically responsible for mapping out clear guidelines for purchase and integration in these two categories:

• The criteria to judge an acquisition; and
• The process of the purchase, i.e., how it will take place.

The most effective organizations update their guidelines at the end of each major deal through a postmortem analysis. Many successful acquirers make the post-audit process a formalized exercise to ensure that the company absorbs the knowledge gained from preceding deals and avoids making the same mistake twice. Some even write it down, especially companies facing complex due diligence and integration issues, or those that want to make sure the knowledge stays with the company when key M&A people leave.

Clear Channel Communications Inc., which has spent more than $40 billion since 1986 building leading market positions in radio, outdoor advertising displays and live entertainment venues, offers a good example of the mileage that can be gained from a core team. The company started buying in the early 1970s, accumulating 43 radio stations and 16 TV stations by the time Congress deregulated the industry in 1996. When restrictions on radio ownership were lifted, Clear Channel had gained enough experience in buying stations, one at a time, to lead the ensuing industry consolidation. By 2002, Clear Channel had grown to 1,225 radio and 39 TV stations in the U.S., five times more stations than its closest competitor, Viacom International Inc. In addition, it had accumulated equity in 240 international radio stations and had diversified into outdoor displays and live entertainment.

Driving this process at Clear Channel is a central M&A team at company headquarters in Dallas. However, the company also has local M&A teams in each of its three major divisions—radio, outdoor displays and entertainment. At headquarters, the three-person M&A team is part of the finance function, reporting to CFO Randall Mays. It examines any acquisition priced at more than $100,000 and gets most involved on deals worth more than $20 million. It always sets the walk-away price.

The central team imposes clear criteria for any purchase. "It's a cash flow-driven strategy that aims to maximize return on capital," says Mays. Acquisitions compete against each other, debt repayment, and share buybacks for access to capital, based on the projected rate of return on capital. Clear Channel's financial criteria for cash and stock deals are stringent, reflecting its cash flow discipline. The central team also provides each division with its own standard, two-page due diligence checklist that includes how the acquisition fits into existing operations, competitive positioning, ratings (for radio), other potential acquirers and, of course, financial projections.

Each of Clear Channel's three divisional M&A teams reports to the divisional finance chief, with a dotted line to Mays. This is Clear Channel's way of making sure that any acquisition fits into the division's long-term cash projections, which are generated and maintained by the finance groups.

The divisional M&A teams work closely with line management to look for deals and evaluate them because the people in the field are better situated to scout for opportunities than the head office. "Guys in the city know what's for sale," says Mays. "If it were done centrally, you'd never be able to uncover the opportunities."

The divisional M&A teams are also in the best position to size up the prospects and measure the synergies. Working together, the teams and line management evaluate the prospects, according to criteria set by the head office. They also estimate the synergies and negotiate the price—up to the walk-away limit set by headquarters. In the entertainment division, the process is significantly more rigorous because each acquisition is unique. While the m&a teams in radio and outdoor displays do other financial work apart from acquisitions, the entertainment m&a team is 100% dedicated to deals.

Clear Channel acquisitions have helped the company boost revenues 46% annually over a 15-year period, recording a 36% average annual return, which was 21% higher than the firm's cost of equity.

Pull in line management early and often

Regardless of the deal team structure, successful acquirers always involve line management in the buying decision at an early stage. In fact, they wouldn't make a deal without the approval of the operating personnel. Involving the operators in the due diligence process is critical, because they will be responsible for integrating and running the acquired business.

Acquisitive Washington Mutual Inc. has demonstrated the advantage of pulling line management into the deal process. It has grown from a small Seattle thrift into one of the nation's top consumer banks, with nearly $27 billion in assets. Washington Mutual is now the No. 1 national player in mortgage servicing and a close No. 2 to Wells Fargo & Co. in mortgage originations. From 1986 to 2001, a quiet but aggressive buying spree helped boost revenues by 31% annually. The expansion has been good for shareholders: The average annual shareholder return was 24%, or 9% over the cost of equity. That success is even more striking because many banks and brokers have struggled to make acquisitions work.

Tellingly, Washington Mutual ensures line management gets involved early, and frequently, long before the deal is done. Craig Tall, vice chair of corporate development and specialty finance, leads a six-member core deal team—"the quarterbacks of the transaction" who pick and analyze acquisition prospects. Team members also supervise due diligence, determine the deal price and structure, negotiate the transaction, and develop tactical plans for the acquisition.

Tall's deal team does not act alone but seeks advice and help from the business unit leaders who know operations best. They join the team early to analyze and evaluate the target, providing invaluable help in the due diligence process to make sure that the right decisions at the right price are made. "You're asking the people who are going to inherit what you're buying to help assess what they're going to get," said Tall.

Early help from the front lines kick-starts integration. "We get early understanding and early buy-in from business units and the corporate people on who the targets are, why it makes sense, what kind of benefits we'll get, what kinds of hiccups they might be having," said Tall. "When an acquisition is consummated, they're already fully engaged, they've bought in and they know what they're going to get. They have been asked to think about what they would do with it if they were to get it."

The operators are involved not only with due diligence but also with planning and executing the integration, which is the name of the game as far as Tall is concerned: "You can pay the right price, but if it's not integrated properly, you won't have accomplished much."

Washington Mutual also has an A team, or the acquisition team in charge of integration. It takes over from the deal team once a deal closes, although members of the deal team remain involved while business unit people continue to actively participate in the process. The A team fluctuates between 25 and 35 people, all of whom have extensive project management experience, and is supplemented by senior acquisition managers who represent both the three main business segments and key corporate functions. These managers are subject-matter experts and act as liaisons with the business units and corporate functions. Finally, a good number of people from the business segments and corporate functions are also involved, as part of the Executive Management Oversight Committee or the Program Management Office, or simply as team leaders and members.

The key to success, according to Tall: "The more you can get operating people involved in fitting all the pieces together, the better."

Find ways to kill deal fever

Perhaps most important, companies that beat the odds in m&a are prepared to walk away from a bad deal. They insist on high-level approval and often use the compensation system to ward off ill-considered acquisitions. They also set a walk-away price.

This is crucial. Consider a finding from a recent Bain survey of 250 executives. Respondents framed the most challenging due diligence problem as "allowing politics or emotions to interfere with decisionmaking." Successful corporate buyers excel at walking away from risky deals. All found ways to kill deal fever. How do they get good at this? They often insist on high-level approval for deals, right up to involving the board of directors for large transactions.

Cintas Corp., a Cincinnati-based uniform supplier, is a strong example of multi-level screening. In the 1960s, it started buying to expand its uniform rental business in markets outside of Cincinnati. Cintas bought hundreds of companies, systematically, in boom times and bust. It began by cutting its teeth on smaller deals, most for less than $10 million, some as small as $100,000.

Over time, Cintas graduated to larger deals, such as the $660 million acquisition of Omni Services, the industry's fifth-largest player, in 2002. With the experience developed and honed through many transactions in its core business, Cintas bought its way into the world of highly specialized business services, including sanitation supplies, first aid and safety products, and clean room supplies. These moves bumped Cintas to leadership in its sector and lifted its stock price 20-fold in 15 years.

Cintas CEO Robert Kohlhepp says any deal, even a small one, needs scrutiny from a cool, dispassionate executive who has not been involved in the heat of conducting due diligence and negotiating the deal. So every deal, no matter how small, needs approval from one of three senior executives, including Kohlhepp, who have remained apart from the day-to-day acquisition process. On large deals, the board must give its blessing, and set a price limit. If negotiations produce a price above that amount, the deal team must walk away. If the acquisition is a new business, the CEO himself has to approve the deal. "We don't want people going off the beaten path without the top people in the company knowing what we're doing and why."

Why does Cintas do it this way? "There were a few companies that we bought that in retrospect I said we should not have bought," said Kohlhepp. "When I looked at why we bought those companies, a lot of little things ... were wrong." No single problem would have killed the deal, he noted. "But in aggregate, they should have caused us not to make the deal. That's why it's important at the end to have somebody who's objective, who wasn't involved in the due diligence, to hear all the pros and all the cons and bless the final decision."

"The thing you have to guard against the most is that the M&A group and the operating people want to make deals. The M&A group gets their papers graded on how many deals they make. The operating people want to grow. The more they grow, the more they're responsible for, and the more their potential income. Therefore, you need discipline at a high level. You need somebody who's not right in the middle of the deal, who has an objective viewpoint, making sure we're not going ahead to make a deal just to make a deal."

Successful acquirers often use the compensation system to kill deal fever. These companies do not tie the compensation of any of the people involved in the acquisition to the completion of the deal. Instead, the M&A teams and the other participants in the deal process usually get paid according to the financial performance of the firm. It's a powerful incentive to resist the temptation to buy expensive companies in the heat of the deal. Washington Mutual's Tall explains: "Sometimes the best deals are deals you never do."

Clear Channel is explicit in using the compensation system to kill deal fever. The operators have to sign off "in blood," as Mays puts it, on the cash flows that the acquisitions will deliver. Their future compensation is tied to meeting the division's cash flow projections, which include results from those acquisitions.

The Clear Channel M&A teams' pay is also tied to the contribution that acquisitions make to the company's financial performance. The M&A teams and division presidents meet Mays at year's end to study every acquisition they have made in the previous three years to see if they delivered what they promised and to review compensation at the same time. As Mays puts it, "the deals they make are tied to them forever."

Cintas: A textbook example

Cintas provides a classic case of what a successful frequent buyer does that leads to superior results. Let's compare the Cintas story with another company in the workplace uniform business, UniFirst Corp. Founded in 1936, UniFirst played it cautiously, focusing on organic growth for most of its expansion into laundering, selling, renting and delivering workplace uniforms and protective clothing. In the last decade, UniFirst made some measured moves and completed about 20 deals worth $100 million. The result: Since 1986, UniFirst has generated a respectable 11% annual revenue growth, reaching $580 million in its fiscal year ended Aug. 31, 2002. The result for shareholders has been a 12% average annual return—1% less than UniFirst's cost of equity.

Cintas investors, on the other hand, had to buckle their seatbelts for a wild acquisitions ride. About equal in size with UniFirst back in 1986, Cintas supplemented its organic growth with a steady diet of hundreds of companies. In the last five years alone, it spent $3 billion on more than 250 acquisitions, driving 40% of its top-line growth. Cintas has leapfrogged to market leader, boosting revenues by 20% a year to hit $2.3 billion in the fiscal year ended May 31, 2002. Cintas shareholders who hung on for the ride have been well rewarded with an average annual return of 21%, or 5% more than the company's cost of equity.

"Success," according to Kohlhepp, "depends on three things: top and line management involvement, institutionalizing the process of making acquisitions and being willing to pass up a bad deal."

The bottom line

The history of M&A is littered with deals that destroyed shareholder value, but the winners point the way to success. Our analysis of the companies that succeed in this business shows that they share some key characteristics, which can be boiled down to this simple playbook:

• Get in the game in good times and bad

If you are not doing deals, your odds of outperforming go down relative to your competitors that buy steadily. Do not try to time the market; buy high and buy low.

• Start small

Cut your teeth on smaller, lower-risk deals before you try the big ones. Build your team and your competencies in an environment where making mistakes will have the least impact.

• Create a core deal team

Set up a standing team that should have transactional experience and is not subject to much turnover. It could be at head office, or in the field. Wherever based, it's critical that the same core deal team get involved in all deals. Buying companies should not be an ad hoc process. Devise clear guidelines for the purchase and integration of acquisitions. Institutionalize the processes and find ways to capture the knowledge learned from each acquisition.

• Pull the line people in early

Ensure that line management buys into the deal and that they know what they're buying. After all, the operators are the ones who will have to integrate the acquisition and make it a success. They need to be ready to act quickly on the day the deal is done.

• Kill deal fever

Find specific ways to kill the deal fever that leads to many acquisition disasters. Insist on high-level approvals or use the compensation system, tying rewards to the long-term success of the business rather than deal completion. Most important, set a walk-away price and be prepared to do exactly that—walk away.

Companies, like Cintas, Clear Channel, and Washington Mutual have mastered these techniques to turn M&A into a strategy for profitable growth. They have all found ways to capture the knowledge gained from each deal, with the result that they have climbed up the learning curve to discipline their dealmaking. The upshot? They don't just seek opportunity. They are organized to create it.

---

Notes

1. We used excess return to reveal how companies measure up to investor's expectations, given the companies' risk profiles and the performance of the broader nationwide stock market index.

2. Gates, S., Performance measures during merger and acquisition integration, Research Report 1275, The Conference Board, 2000.

Sam Rovit is a director in the Chicago office of Bain & Company and leader of the firm's global M&A practice group. David Harding is a director in Bain's Boston office and a leader in the areas of corporate strategy and organizational effectiveness. Catherine Lemire, of the Toronto office, is a manager at Bain, responsible for the development of the firm's intellectual capital in M&A. This article is based on research for a forthcoming book, "Mastering the Merger," by Harding and Rovit.

Copyright 2003 Thomson Media Inc. All Rights Reserved.