Simulation improves the odds in M&A game

By Jason Bloom

Friday 3rd May 2002

Plenty of research has surrounded the high failure rate for mergers and acquisitions (M&A) activity, yet organisations continue to pursue either mergers or acquisitions as a core growth strategy.

Why? The reason appears to be the real increase in growth and value that only M&As can deliver.

There are big risks but potentially big rewards if organisations can get it right. But getting it right is the fundamental problem - M&As are complicated. Forecasting future value based on uncertain products, markets and competitors is hard enough.

Couple this normal business complexity with uncertain merger synergies and dis-synergies, as well as uncertain employee and customer reaction, and you're left with a highly complex business problem.

Other industries have learned to deal with highly complex situations through simulation.

Learning to fly a new 747 jumbo jet is a highly complex activity which involves, among other things, changing weather patterns, potential mechanical problems and different take-off and landing scenarios.

Pilots rehearse using flight simulators; they practise by learning to deal with these different potentially hazardous events, so if they ever do happen they are prepared and can react quickly and effectively.

The US military has long used simulation as a way of preparing its combat soldiers in advance of any real combat situation. The Gulf War operations were first rehearsed many times using simulated combat scenarios, well before any soldier was put in harm's way.

Organisations are starting to understand the benefits of using a similar approach when dealing with complex business decisions including M&As.

Advances in computer simulation software, as well as advances in computing speed, mean it is possible to build business simulations that allow decision makers to practise before they actually have to commit.

These simulators allow key stakeholders to "play out" different scenarios, such as competitor reactions, potential production cost increases and loss of key human resources in the company.

The organisation can see the impact of these potential scenarios, then develop strategies to combat them if they should occur. It's not about developing a crystal ball to see into the future; rather it's about looking at different future scenarios that could unfold and being ready, just in case.

These simulation models needn't be expensive either, with off-the-shelf generic models starting at a few hundred dollars. Once organisations are familiar with the simulation techniques and tools, they can either build their own or commission a consulting company to build the models for them.

Simulation can be extremely useful for understanding the M&A impacts of intangible factors, such as a company's brands, reputation or human capital.

Lots of attention is often paid to financial statements and due diligence but very seldom does the focus turn to intangibles.

Yet these intangibles often play a significant role in driving business value, and their oversight is a key reason for M&A failure. Simulation models can help to determine the value of these intangibles, as well as to show the potential negative impacts on business value should they disappear.

Another problem with the traditional financial focus in M&A transactions is that valuations are often based on historical information such as accounting profit or the balance sheet.

In reality the real value of any organisation is based on its future rather than on its past. Simulation helps organisations to look at different "what-if" scenarios; both good and bad.

When we consider recent New Zealand M&As such as Air New Zealand and Ansett, and Sky City and Force, we see it was a combination of events that conspired either to destroy value or to limit the value that was expected to be generated from the deals.

All these events could have been modelled before acquisition.

Organisations can not control future events or predict them, but by modelling "what-if" scenarios in advance, they can be better prepared to cope with such events should they unfold.

Another major advantage of using simulation is the ability to model in "real time." Decision makers can have interactive discussions, and "play out" different strategies and scenarios on a computer screen. This gives the organisation a clear advantage by improving the speed with which decisions can be made and communicated to others.

In the end it comes down to the fact that a merger or acquisition will often be the most important decision an organisation has to make. Getting this decision right is paramount and is often essential for the continuing career of the company, the chief executive and the board.

Simulation gives organisations an edge. It enables them to better understand the dynamics of both their organisation and their industry, as well as making them more prepared should the inevitable occur - which it often does.

Jason Bloom is a director of Decision Lab

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