Consolidation has long been an uncomfortable - if necessary - spectre for financial services institutions (FSIs). Operating in a growing and increasingly global marketplace has forced FSIs to build economies of scale across product and service lines, lest they fall victim to larger, better-capitalised and highly aggressive competitors.

Not surprisingly, more than a decade of often frantic merger and acquisitions (M&A) activity in the insurance and banking sectors has made those companies fairly skilled at folding similar organisations into one another and extracting the cost-saving operational benefits. What's more, they have demonstrated this ability across geographic borders, melding different cultures and structures to create ever larger - and in some cases, more focused - companies in the process.

Still, despite many notable successes, the fact remains that almost half of FSI mergers and acquisitions fail to hit the targets for value-creation that are set for them in the planning phase. Further, a quarter of those deals fail to produce any added value at all, leaving senior executives hard pressed to justify their motivation to a base of disgruntled shareholders.

Given that ongoing regulatory reform is freeing insurers and banks to engage in cross-sector M&A, the long-running consolidation game will only grow in scope and pace. And because FSIs that engage in these kinds of deals will in most instances be branching into new businesses, the stakes are even higher for senior executives seeking to generate new sources of shareholder value by combining insurance and banking organisations.

That is because rather than simply profiting from operational efficiencies - as is the case with inter-sector mergers - the cross-fertilisation of insurance companies and banks demands that the merged company significantly boosts revenues by cross-selling products and services to its combined customer base. Further, the drive to increase revenues often entails opening new markets, as well as creating new sets of products and services that maximise the capabilities of both organisations.

As a result, going outside their industry sector presents senior executives with a host of new challenges that will test the mettle of their merger acumen. Corporate executives that are skilled at cutting costs are not necessarily good at understanding customer value propositions - especially those at work in the new sector they are entering - or at coming up with product sets that make both commercial and operational sense.

Cross-sector mergers demand greater strategic planning. Yet those senior executives that have successfully married like businesses often fail to recognise - or ignore altogether - the difficulties that lie in mixing dissimilar organisations and successfully growing shareholder value from the products of those exercises.

Corporate executives used to looking chiefly at cost reduction when undertaking inter-sector M&A deals must integrate the revenue sides of each component when merging across sectors. This means placing a greater emphasis on determining customer value propositions, as well as on understanding delivery channel dynamics.

When technology-driven initiatives such as ebusiness are added to the mix, it makes cross-sector M&A an even more perplexing task for senior managers. And that is before considering cultural issues, such as whether bankers are best-placed to sell insurance products.

To be sure, failing to overcome these challenges brings a significant degree of risk that goes beyond simply raising the hackles of shareholders. Because FSIs also have become adept at understanding what to do when their competitors merge, they present an increasing threat - both in terms of targeting the customers of the merged organisation and from cherry-picking key employees - especially when things go wrong.

Given that performance is paramount, the key to creating shareholder value from cross-sector mergers lies in proper preparation. And in most cases, this preparation begins even before companies seek out potential M&A partners or targets. This is especially important given that many inter-sector mergers fail to produce value because the combining entities simply are not suited to each other in terms of product and service lines, organisational structures or corporate cultures.

Delineating strategy and articulating it throughout the organization, as well as to customers and shareholders, will ensure that an often painful process is less so. Meanwhile, setting both short-term implementation targets for the merged business in conjunction with longer term objectives - and keeping a close eye on those goals - will provide senior executives with a clearer picture of the merged business and the ability to act quickly if and when problems arise.

Crunch time

Thanks to a host of factors - including the unceasing march of information technology, commoditisation of products and services, and the drive to create operational economies on a global scale - FSIs are consolidating at a blinding rate. And the value of those deals is increasing as ever larger organisations - themselves often the product of a series of mergers - come together in response to the drivers of change.

For example, in Q3 2000 alone, FSIs from all sectors of the industry announced nearly two dozen mergers worldwide which were each worth US$1bn or more.

Going forward, the trend shows little sign of abating. That is because regulatory barriers to these mega-mergers are continuing to fall, paving the way for cross-sector tie-ups and takeovers on a grand scale.

In the US, the adoption of Gramm-Leach-Bliley reforms of the Glass-Steagall legislation that separated banks from insurers is allowing some of the world's largest FSIs to explore what appear to be very attractive prospects for generating shareholder value from operations in other sectors.

In Europe, where universal banking models have long united banks and insurers, European Union legislation aimed at inducing more competition in the region's financial services industry is taking hold. Combined with the introduction of the single currency, banks and insurers see opportunity in reaching beyond their domestic borders to form the kind of organisations that are capable of competing on a global scale.

Further, the return to relative prosperity in emerging regions such as Asia, Latin America and Eastern Europe after the series of economic crises in the late 1990s is presenting the kind of opportunity to open new markets that is imperative for cross-sector mergers to succeed. Thus, as the economic health of those regions continues to improve, it will provide further impetus for cross-sector unions.

Of course, not every one of those deals will succeed. And the fact that only about half of inter-sector M&A deals realise the goals for value creation that senior executives foresee in the planning process is leading many insurers and banks to adopt a “go-slow” attitude to cross-sector mergers.

Clearly, the task of marrying dissimilar businesses and product lines is a daunting one in the minds of senior managers. And this is despite the fact that they possess a considerable level of expertise in merging like operations. However, market pressures and the lure of new opportunities to create value for shareholders is pushing many down what will become an unavoidable route for success in increasingly competitive global markets.

Right from the start

Just as with same-sector mergers, the most successful cross-sector M&A deals are those in which the strategic planning phase begins well before potential partners and targets are chosen. Senior managers need to map out their plans of attack well in advance, looking at both the needs of their own businesses and the gaps they are hoping to fill, as well as the range of companies with the potential to shore up those shortfalls.

Indeed, there is no substitute in strategic terms for scenario planning. Knowing what management would do in a variety of situations that are more or less likely to happen is a key element of what a good corporate development and strategic planning department is all about.

Even in the face of careful evaluation, many mergers fail to deliver the expected levels of value simply because the strategic fit simply is not right. The risk associated with mis-aligned businesses arguably is greater with cross-sector mergers, given the lack of familiarity with product and service lines and operational models.

Many of the problems with evaluation lie in the fact that most senior executives only examine traditional areas of value creation - physical assets such as land, buildings and IT infrastructures, and financial assets like funds in the market and other investments. And then they only look at the assets of potential tie-up and takeover targets. Of course, these are good indicators of how businesses might be melded together, but senior managers need to take a deeper look at potential partners and takeover targets - as well as their own businesses - to ensure that M&A deals will succeed in creating value for shareholders.

In order to create and reap fully that value - particularly in light of the changes wrought by the new, web-enabled economy - senior executives must evaluate businesses by looking at three additional asset types. They include:

  • customer assets. Gaining insight into segmentation and customer profiles provides an indicator of the kind of products and services merged businesses must deliver to meet the needs of the customer;

  • employee and supplier assets. Assessing the loyalty and skills both of employees and of the suppliers that support the business provides senior executives with a more realistic expectation of the value that can be created and allows them to set their targets accordingly; and

  • organisational assets. By taking into account such corporate attributes as brand, culture, leadership style and intellectual property, senior managers can better determine how well disparate businesses will fit together.

    Assessing the strengths of their own businesses against the five asset bases (physical, financial, customer, employee and supplier, and organisational assets) enables senior executives to evaluate their own capabilities and work out where improvements need to be made. By viewing potential targets in this same light, senior managers can determine which companies possess the assets to help them meet their strategic goals and can be easily slotted into the existing businesses.

    The results from using these criteria can lead senior managers to take a different strategic tack. For example, they may discover that they do not want to merge at all. Instead, the most efficient means of meeting their goals might be to pick off the most desirable assets - either by purchasing them or by a takeover and subsequent divestiture of non-target elements of the acquired business.

    Measuring up

    Whatever the strategy, the twin keys to extracting full value from cross-sector M&A deals are communication and in careful measurement of both implementation and the progress toward reaching long term business goals.

    Senior executives must think through the strategies and articulate them across the organization, then work to develop solutions with the people who are actually doing the integration. Even if they cannot - for operational reasons - be privy to the strategic planning phase that is generally the preserve of senior management, it is important to get operations level managers in the loop and working for integration as quickly as possible.

    Setting appropriate performance measures is equally vital, both in the integration phase, as well as to the overall success of cross-sector mergers and acquisitions in delivering shareholder value. Key metrics that run in parallel provide the measures that enable senior executives to gauge the progress and to act quickly when difficulties arise. Agreeing on the top 25 to 30 leading, not lagging, measures that are most important to management is critical. It is important to cover all significant risks with the smallest number of measures.

    By linking focused, short-term targets for integration with longer term goals for business-as-usual operations, executives and managers can drive the business forward, as well as monitor what is going on directly beneath them. For example, in the area of customer retention, it is important for senior managers to closely track key customer activity, lest they become prey for more savvy competitors on the hunt to profit from disruption to business as usual. Over the longer term, the key metrics for customer retention centre on increasing sales to that same base of customers. Understand the ramifications of linked business objectives. For example, the company may be doing well relative to cost savings targets, but may also be simultaneously losing customer base.

    As consolidation pushes cross-sector M&A higher up the agendas of insurers and banks, senior executives cannot afford to be complacent or to rest on the laurels of their past same-sector triumphs. Maximising shareholder value means that rather than focusing purely on implementation, they must think strategically in order to create the conditions for success.

    Chris Mills is a Partner in Arthur Andersen's European Financial Services practice and is based in London. Joseph Teplitz is a Partner in Arthur Andersen's North American Financial Services practice and is based in New York City.

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