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Scepticism at Lenovo’s Appetite

One month ago, on the subject of the Motorola acquisition of Motorola Mobility, I wrote “The payback on Lenovo’s investment to shoehorn itself into the Americas’ large and lucrative mobile market assumes that the magic that occurred with the ThinkPad® can be repeated with the Motorola brand.  Let’s watch this pace during the next two or three years…”

The markets evidently don't think much of Mr Yang's double mega-acquisition; let's hope he can outsmart them after all.
The markets evidently don’t think much of Mr Yang’s double mega-acquisition; let’s hope he can outsmart them after all.

It seems we do not need to wait two or three years to feel the scepticism of the markets: Lenovo shares have lost 25% of their value since 23rd January.  Now that the celebrations of the Chinese new year are behind us, could Lenovo be waking up with a nasty hangover?

Lenovo’s CEO Yang Yuanqing does not seem to be too bothered  about Motorola’s 1 billion losses in the past year, asserting that Lenovo’s know-how in manufacturing would rapidly overcome Motorola’s inefficiencies.  Mr Yang is giving himself 18 months to stem the haemorrhage at Motorola and return the company to profitability.

From Lenovo’s perspective, it is understandable that the group wants to expand and move away rapidly from its reliance on the fast shrinking PC and laptop market and is aiming to become a key player in the broader technology market and mobile devices in particular to take Apple and Samsung head-on.  Strategically this all makes eminent sense, but how much pain and effort will be needed to realise this vision?

Slimming cure or anorexia ?

An analyst at Barclays in Hong Kong estimated that Lenovo could reduce its operating expenses by 70%.  If it really takes that much of a cut to make Lenovo’s acquisition of Mototola Mobility worthwhile, then I join the ranks of the sceptics who are behind the drop in Lenovo’s shares.  I have worked on cost reduction programmes requiring 15, 20 or even 25% cuts in operating costs.  Beyond those numbers the expected outcome is a totally different business.  After a 70% cut one may wonder what, if anything, is left of the original business.  Motorola has not commented on the feasibility of these drastic cuts and is probably wise not to commit to such action, giving Mr Yang some latitude in choosing the way forward.

In fairness, Yang Yuanqing aims to grow Motorola’s sales quite dramatically by targeting emerging markets, thereby generating economies of scale as well as setting up operations in China on a very different cost base than that used by Motorola in Texas.  Still, the magnitude of the change remains huge, and what will matter in the end is whether Motorola can digest the integration of Motorola at the same time as it absorbs IBM’s low-end server business.

Coming soon, in a business school near you…

Either way, the journey on which Lenovo is about to embark is guaranteed to become an iconic case study for a generation to come in business schools across the globe, either filed next to the ominous Daimler Chrysler merger and demerger disaster, or hailed as a truly amazing feat of strategic vision and supreme excellence in execution.

I wish the latter to Mr Yang, because failure would just result in a “told you so”, whereas succeeding in the huge challenge that lies ahead for Lenovo would provide positive learning which is in short supply in the business world today.

And the winner is …

On 12th December, the Financial Times & Mergermarket European M&A Awards were held at London’s Savoy Hotel; this year the panel of experts granted to “M&A Deal of the Year” award to the acquisition of Virgin Media Inc. by Liberty Global Plc.

A report published by Mergermarket and The Storytellers a little earlier this year identified integrating people and culture as the greatest hurdle and most common reason for an unsuccessful merger or acquisition.  However, it inevitably takes time to realize whether two companies have managed to integrate and blend in a way that allows a coherent culture to emerge, and in that respect Virgin Media and Liberty Global will be no exception.

Interestingly, the awards granted by The Financial Times and Mergermarket focus on the “deal” rather than the “outcome of the deal” which can only be gauged one year or so afterwards, and ascertained three or more years later.  Considering the deal, combining Virgin Media and Liberty Global is indeed exciting, audacious, and has the potential to achieve an excellent outcome.  This USD 23 billion deal was handled swiftly, securing the award of best European financial adviser for Virgin’s advisers Goldman Sachs for a second year in a row.

Deal or Outcome, what really matters ?

In today’s world, there appears to be more interest in the deals than in their medium and longer-term consequences, and yet it is clearly the latter that matters to shareholders, employees and customers, albeit for different reasons.

The magnitude of M&A deals and uncertainty regarding their conclusion provide exciting material for the media to report and capture the attention of audiences who will follow the developments of an M&A deal with bated breath to its conclusion.  Capturing the same level of interest with an article dissecting the value creation (or lack thereof) of a merger or acquisition that occurred five years ago is a harder task, unless it is about a saga of monumental proportions, such as the Daimler Chrysler fiasco, of the tumultuous HP Compaq integration.

For the seller, the deal is also where the buck stops.  Sir Richard Branson and Virgin Media’s other shareholders have very good reason to be pleased about the outcome of their deal, having cashed in an estimated 24% premium compared to the valuation of their shares prior to news of the deal reaching the markets.  Off-setting Virgin Media’s £ 2.6 billion carried over losses against future earnings of Virgin’s business will also generate significant tax savings in the coming years.  So yes : an award-winning deal by all standards for Virgin’s shareholders.  But what about the other key stakeholders in this deal : Liberty Global shareholders as well as the employees and customers of the combined entity, to whom Mike Fries, President and CEO of Liberty Global had announced “This is a great day for customers, employees and shareholders of both Liberty Global and Virgin Media”?

Creating value out of an award-winning deal

On the face of it, the acquisition of Virgin by Liberty makes logical sense from the perspective of scale: the combined group serves 25 million customers located mainly in 12 European countries; that leap in growth will secure some procurement savings from their equipment suppliers but is insufficient to turn the market upside down and to justify the price Liberty paid to acquire Virgin.  So where is the Holy Grail in this deal?

Not much in the deal for customers

In presenting the benefits of the acquisition (to investors), Liberty mentioned the rising prices of broadband services in the UK.  Clearly, any benefits arising from economies of scale will not be passed on the customers.  This is not surprising, since any attempt to do so would spark off a costly price war against some sizeable competitors.

In terms of technology improvements, there is not much for customers to anticipate: historically Liberty Global’s levels of capital investment have been significantly lower than those of Virgin Media.  Service improvement resulting from technology enhancements are likely to be prompted by having to keep up with competitors rather than being led by Liberty Global.

What about investors and employees ?

A lot of the essence of what Liberty Global intends to acquire and develop results from the spirit of innovation which typifies the businesses set up by Sir Richard Branson.  Virgin Media innovated and changed the rules of its market both in terms of pricing (introducing early subscription to attract new customers) as well as in selling bundles of services.  Virgin also innovated by growing as a mobile virtual network operator, securing first mover advantage in striking good deals with established network operators.

Applying a similar approach to other European markets, made easier by Liberty Global’s presence across the continent, could in principle generate excellent growth for the new combined group.

Consequently, the true value of Virgin Media rests with the know-how and spirit of innovation of some of that company ‘s key players, which explains why the headquarters of the new combined organisation will move to the UK.  However, as MergerMarket who crowned this deal as best European deal of 2013 also report that blending business cultures is the hardest part of a post M&A integration, how will those key individuals, and more importantly the effervescent energy which prevails in Virgin business, resist being diluted and ultimately vanishing within the broader context of the combined entity?

 

Let’s hope that Liberty Global’s cable tycoon John Malone does not think that moving the business’s headquarters to the UK will suffice to keep that spirit alive.

Two ways of looking at the same thing

On 24th September, the world’s largest chip manufacturing equipment maker U.S. based Applied Materials (AMAT) announced its intention to merge with world number three Tokyo Electron, resulting in a company which will be twice the size of its next rival.

computer-chips

AMAT’s executive chairman Mike Splinter commented on CNBC that he believed “the regulators will look closely at this deal” but concluded that he is “confident it will get approved”.  Not so according to the same CNBC’s Jim Cramer who declared “This deal will not go through.  It will absolutely not go through”. There is only one absolute certainty: one of these two gentlemen is right!

Market dominance: the helicopter view vs. the microscope

In his categorical prediction, Jim Cramer also refers to some of the U.S. Regulators’ recent decision, particularly their opposition to mega mergers in the airline industry (see American Airlines – US Airways article on this blog site), which follows years of relative leniency during which industry consolidation was seen as a necessary evil to remain competitive in global markets.  The question, really,  is to define the point at which a company becomes so competitive that it effectively crushes its rivals and erects barriers to the entry of newcomers.  In other words: market dominance.

Opponents to the merger will be quick to point out that the resulting merged company would achieve a worldwide market share of over 25% of all chip manufacturing equipment, whereas the number 2 would struggle to maintain 13%, particularly as AMAT’s executive chairman states that beyond generating costs savings, the merger would enable the combined entity to gain a few points in market share.

AMAT and Tokyo Electron will therefore need to “educate” all the regulatory bodies consulted in this matter to demonstrate that although there is some overlap in their products, most of them actually complement each other in the end-to-end process of chip manufacturing, because that process involves a number of different tasks performed by different machines.  Seen from that angle (if they can persuade the regulators to adopt that view), the merger closes gaps and does not result in a simple addition of the two players’ current market shares.

The outcome of a debate between helicopter view and deep-dive into the segmentation of a market is quite uncertain.  Back in 1997 when Guinness and Grand Met merged to become Diageo, competitors and customers were argued that owning Gordon’s, Tanqueray, Booths and Bombay Sapphire would give Diageo complete dominance of the gin market.  Diageo, on the other hand, contended that those brands’ market shares should be considered within the broader context of white spirits (which include vodka, white rum, cachaça), so that even by including Smirnoff vodka into that calculation, Diageo would only be a relatively modest player in an enormous market.  In that instance, the Regulators did not quite buy into Diageo’s argumentation, forced the group to dispose of Bombay Sapphire, and whilst looking at the white spirits category as a whole, also forced Diageo to sell rum-based brand Malibu.

Supplier vs. customer power

It would be wrong, however, to compare the Regulators’ conditional acceptance of the Diageo merger and refusal of the American Airlines – US Airways merger to the proposal which is being put forward by AMAT and Tokyo Electron.  The regulators’ main focus is the impact on the end-consumer rather than what happens upstream in the value chain.  Allowing a consolidated supplier to dictate prices in an unchallenged manner to an atomized set of customers inflates prices and is therefore detrimental to the end-consumer.  But AMAT and Tokyo Electron’s main customers are a industry giants such as Intel Corporation, Samsung Electronics or Taiwan Semiconductor Manufacturing Company: the very companies that have continuously exerted extreme pressure on their suppliers to reduce their costs whilst at the same time requiring the development of ever increasingly sophisticated equipment to match the exponential complexity and miniaturisation of micro-processor chips.

Seen from that angle, the Regulators might view the AMAT – Tokyo Electron merger as restoring the balance between a supplier and its dominant customers rather than upsetting the balance within the pool of suppliers.  Even if that merger allows the future company to gain a few points in terms of gross margin, this will be achieved through savings and improved efficiencies rather than through increases in selling prices which will be contained by the group’s giant customers.  It is therefore unlikely to cause a perceptible impact on the end consumer price of a large screen TV, tablet, smartphone or laptop computer.

As a final consideration, the consolidation of R&D capability could ultimately benefit the end-consumer by allowing an acceleration of the pace at which the performance of microprocessors improves.

So all things considered, if AMAT and Tokyo Electron construct a cogent argumentation, it is quite possible they will get their way.  That certainly seems to be the view of both companies’ shareholders, judging by the stock market reaction to the merger announcement.

Konichiwa ?  Ugh, not that well actually!

The biggest hurdle ahead for AMAT and Tokyo Electron will probably not be the regulators’ verdict, but what will ensue.  Whilst Tokyo Electron may well be considered as one of Japan’s most “westernised” companies, it is not a Japanese subsidiary of a western company and this is important, because the combined business culture and ways of working will need to be redefined.

Already now, both sides are trying to emit the right sound-bytes in an attempt to pave a smooth way towards a harmonious integration; but anyone with some experience of post-merger integrations can see through that smoke-screen.  “A merger of equals” is the official version, though it will in fact be a 68% AMAT / 32% Tokyo Electron balance.  To restore some sense of equilibrium, AMAT’s recently appointed CEO will move to Tokyo and run the combined business from there.  It remains to be seen whether the Japanese language has an equivalent for the idiom of “the tail wagging the dog”.

More significant even than the challenge presented by the business culture integration is the fact that both AMAT and Tokyo Electron are operating in a highly cyclical and very tough market.  AMAT’s net income fell to $168 million in its most recent quarterly results, compared to $218 million the previous year.  In Japan, things do not look rosy either as the semiconductor industry is living through difficult times, with important players filing for bankruptcy or being bailed out by the Japanese government, leading to diminished demand for Tokyo Electron’s products in their key home market.

The relative uncertainty and more importantly the likely duration of the regulatory process may cause some instability in both companies at a time when they need to focus on surviving through these difficult times, and the integration that lies ahead will be a huge distraction.

And the end result is …

If the AMAT – Tokyo Electron merger goes ahead  – which I think is likely, contrary to Jim Cramer’s confident statement –  the price of our smartphones, tablets, large screen TVs and laptops will not jump, but that merger may have a domino effect in the industry, as the world’s number two ASML will seek alliances and acquisitions to avoid being dwarfed.

Consolidation is the almost inevitable evolution of a maturing industry.

Yahoo! chief executive Marissa Mayer’s move to acquire the blogging website Tumblr for an astonishing $ 1.1 bn is indeed a bold one.  As a former Google executive Ms Mayer hopefully knows things about what makes a website “cool” and fashionable which we other mortals ignore : how else could one explain the rationale behind paying a premium of $ 300 million above the previous valuation of Tumblr ?

Flickr-homepage

I felt some reassurance reading Ms Mayer’s statement declaring that Tumblr would continue to operate independently so as “not to screw it up”.  More importantly Tumblr’s co-founder and 26 year-old chief executive Mark Karp will remain at the helm of Tumblr – or that is at least the initial intention.  Indeed, the huge challenge in this deal will be to insure that Tumblr with its young boss and 125 strong team who probably revere him as an icon – quite justifiably – can maintain the buzz, energy, creative enthusiasm and ability to “break the conventional rules” which characterize the most successful companies of the internet age.

The colour purple – will it run in the wash ?

Yahoo-homepage

I don’t subscribe to the view of those who believe that every bubbly creative exciting entrepreneurial company is doomed to becoming a boring fat corporation if it grows much larger, victims of its own success.  Huge companies such as Apple and Google are proof to the contrary, as is Virgin Group if we look beyond the frontiers of the technology sector; but it is true that those iconic companies are the exception rather than the rule.

Unsurprisingly, Tumblr’s users are sceptical, as evidenced by tweets of “No, no, no, nooooooo!” and “Tumblr is about to suck”.  Young Mark Karp is trying to reassure them, stating that “We’re not turning purple”.  I like the analogy, and personally I would be weary of mixing bright vivid colours with dark purple in a same wash-load …

When a high buzz “cool” company is united with another that has become lacklustre over the years, does the former’s “coolness” revive the dull company, just as an antibiotic gets rid of an infection, or will it gradually dilute and fade away?  This is indeed the $ 1.1 billion question in the acquisition of Tumblr by Yahoo!

Solid business case or act of faith ?

If Yahoo! and Tumblr continue to operate and appear on the internet as totally distinct platforms, one fails to see what it is about Tumblr that will attract traffic to Yahoo!  It is hard to believe that the look and feel of Yahoo! would appeal to Tumblr users, and loading Tumblr with links to drive viewers to Yahoo! might cause frustration and irritation …  Tumblr is on the rise, Yahoo! is in decline, so it is quite clear which of the two is in urgent need of profound transformation.

“Coolness” is the outcome of a specific style, flair and contagious energy of the person or team at the helm of a business, which must percolate through the entire company.  What is it that makes a restaurant or bar “the” fashionable place to go to in a city?  There is no recipe for coolness and trendiness, and remaining on top of the “cool” wave requires an ability to constantly come up with something new as competitors are fast to copy whatever they believe consumers find so attractive.

There might be some transfer of knowledge and consumer insights from Tumblr to Yahoo! but $1.1bn is a high price to pay for that learning experience, if indeed it does occur.  For a start, it would not have cost much to redesign the Yahoo! interface as we all know that cluttered screens are a total turn-off for most audiences.  If that transformation does not occur fast, Yahoo! will be left with the continuing issue of declining audiences and the benefits case of the Tumblr acquisition will rest entirely on the ability to massively increasing income from advertising.  Whether Yahoo!’s current advertisers will want to associate their brands and services with some of the more politically controversial or sexually explicit content of the Tumblr platform remains to be seen.

Yahoo!’s track record in M&A is a mixed one; GeoCities which was acquired in 1999 was canned 10 years later.  A wave of further acquisitions in 2004-2005, notably that of Flickr, failed to infuse the “coolness” Yahoo! was seeking, but that was before the days of Marissa Mayer.  Yahoo!’s board and shareholders have made an act of faith in believing that Ms Mayer is the charismatic leader who will send a positive shockwave through the company, put the negativity of years of decline behind and turn Yahoo! into a stylish platform.  Let’s hope they are right.

This kind of act of faith feels similar to wearing a new prototype of mechanical wings whilst standing on the edge of a cliff.  And then you jump : Yahoooooooooooo !

 

The heated debate and street demonstrations that erupted as soon as the former Prime Minister’s death was announced illustrate rather brilliantly two key elements which I see as indispensable to obtain an endorsement  – or at least acceptance –  of profound change, be it within a company or on the broader scale of a whole nation :

  • the importance of justifying the need for change by communicating also about the alternatives to the proposed change;
  • a recognition that driving change inevitably results in casualties.

Understanding the alternatives in order to accept the chosen course of action

The broadening of the gap and poor since the 1970s is a fact, but there is no consensus on whether Margaret Thatcher made Britain a better or worse place (all depending upon one’s own definition of “good”).

The media shown us archive footage of garbage bags piled several storeys high in London’s Leicester Square, bodies in storage waiting to be given a decent funeral, power cuts and empty supermarket shelves during the lorry drivers’ strike, and the violent protest and riots which spread across many parts of the country after the Prime Minister decided that enough was enough.  Interestingly, many of those demonstrating today against the Thatcher legacy or propelling the Munchkins’ controversial “Ding Dong! The Witch is Dead” song to number two in the hit parade are too young to remember the unpleasantness and violence of that era.  But what they are protesting against is the state of the world today.

Yes, today’s world is indeed a hard place, with high unemployment in mature economies under ever growing pressure from emerging markets, and many people have good cause to be unhappy.  But any situation, good or bad, can only be assessed by comparison with other possible outcomes.  Where would thirty more years of under-investment, ageing infrastructure and declining competitiveness have led the British economy?  We are living through tough times, but the alternative had no drastic action been taken three decades ago does not bear thinking about and most of the media and politicians have missed an opportunity to emphasize this point sufficiently.

Likewise when businesses embark on some radical change, such as a merger or major acquisition, most of them deploy their best efforts to communicate their vision and strategy to their staff and other stakeholders, but seldom is there any articulation of what the alternative courses of action might have been and why the one they chose is the best.  Beyond creating awareness and promoting a degree of understanding, how does the Executive team of a business hope to generate acceptance and adoption of a proposed change if the scenario is not placed in the broader context of other alternatives ?

Communicating about the alternatives to the chosen course of action is of course twice as much effort as just focusing on the latter, but it does pay dividends :  an unpalatable scenario becomes acceptable if it is perceived as the least of several evils.

Utopia : profound change with no casualties

We all know that leading change can be tough, the reason being that invariably one or several of the stakeholder groups affected by the change will prefer the status quo, or possibly a course of action other than the chosen one.  If that were not the case, the change would happen spontaneously, fuelled by the aligned aspirations and expectations of all involved.  In reality, any profound change will require many individuals to make a great effort, or accept an erosion of the circumstances they currently enjoy, or fall victim of the change.

Accepting (even reluctantly) that a forthcoming change will require an effort, and might be detrimental to one’s interest, requires an understanding of the alternatives, as explained above.  However, for those the change will cause to be casualties, only two things can help them to accept their fate : compensation or, when this not affordable, recognition.

Businesses undergoing a transformation will take the compensation route to at least partly alleviate the adverse impact suffered by their casualties, be it in hard cash as well as additional measures designed to support the redeployment of those individuals in other employment.  But when the scale of the casualties extends to a whole nation, offering equitable compensation and re-training to millions of individuals is hardly an option.  And that leaves recognition as the only fair consolation those casualties can be offered.

Spot the difference

Obtaining acceptance for a strategy by highlighting the likely outcomes of its alternatives, and demonstrating fairness towards those who will fall victim of that strategy, are two essential conditions for that strategy to be judged favourably when people will look back on it in the future.

This will be a key difference between the only two Prime Ministers of the 20th century whose coffins were taken by a horse-driven gun carriage to a funeral attended by the Queen :

  • Sir Winston Churchill convinced a nation of the need to fight a war.  The population endured very difficult years and suffered terrible losses, but the consequences that would have resulted from not fighting the spread of Nazism were rapidly plain to see and remain clear nowadays.  Many lost their lives or were left with severe permanent injuries: they were the unavoidable casualties for a better cause. The nation reveres them, they have the status of heroes, monuments have been erected to honour their memory and acknowledge their sacrifice.  Sir Winston Churchill goes down in History as a Prime Minister and great leader who saved the nation and large parts of the world.
  • Baroness Thatcher convinced a nation of the need to improve Britain’s competitiveness by deregulating and privatising large sectors of the economy and curbing the power of trade unions.  The nation endured very difficult years, with strikes and riots.  Several industrial sectors collapsed, affecting entire communities.  But whereas Churchill’s Britain was faced with an immediate threat, Thatcherism was addressing the far longer term issue of the gradual demise of the British economy.  Today, a majority would agree that the situation would be far worse nowadays had the nation not addressed its lack of competitiveness in what was evolving to become a global economy.  Those who lost their businesses or jobs and livelihood were the unavoidable casualties of the economy’s reconversion.  But unlike the heroes of World War II, the casualties of the Thatcher era did not receive much consideration and were viewed by many as unproductive resources, the dead wood of the British economy.  Today, those casualties are all but forgotten.  Many of them will never forgive Baroness Thatcher for having ruined their lives, echoed by part of the population who feel some empathy for what was inflicted upon those casualties.  Baroness Thatcher will go down in History as the Prime Minister who split public opinion into two camps, opposed as strongly today as they were during her tenure, of a minority who will remember her as a callous autocrat who inflicted hardship on millions of people, and a majority who acknowledge her as a Prime Minister and great leader who saved the nation and large parts of the world.

There are some interesting lessons to be learnt, not only for future politicians, but for business leaders aspiring to leave a lasting legacy.

 

It is widespread knowledge that 50% to 80% of all mergers and acquisitions fail to deliver the benefits described in their business case, and a sign of blissful ignorance that so many companies continue to embark on major acquisitions or mergers whilst ill-prepared, confident that they will reach a successful outcome when in fact the odds are seriously stacked against them.

On the other hand, numerous case studies show us that companies that have grown through a series of mergers and acquisitions demonstrate repeated success in integrating these new businesses.  This proves that there are lessons to be learnt, and that repeated experience is essential to be able to plan, prepare and execute a complex integration to deliver a positive and value-creating outcome.

Business as “unusual”

Integrating companies has very little in common with “business as usual” : it requires the ability to execute a complex business transformation programme whilst driving two businesses, rather than one, which are most probably both destabilised and whose employees’ effectiveness may dip as a consequence of the distraction and uncertainty caused by the merger, whilst also reaching the commercial targets set in the business plan, the synergies expected from the merger or acquisition, and creating the target organisation with fully integrated processes, ways of working and culture.

The challenge for the team at the top is therefore huge;  it actually becomes an impossible task unless additional resources are called in and responsibilities clearly segregated between maintaining the day-to-day business on track and driving the integration effort.

What really matters

Integrating business is an art : the combination of skill and talent.  The skill is in the way one can achieve one of the essential components of a successful integration : speed.  Speed requires preparation and excellent programme management.  The talent is that of good leadership to drive durable change.  This is why serial acquirers are remarkably good integrators : they know what can be prepared in advance, they are aware of the interdependencies that need to be managed throughout the integration programme, they have learnt to plan for the usual hurdles which appear in such business transformation initiatives and have developed a flair to pre-empt issues in their early stages.  They also know what traits of leadership are essential to drive change and how gaps in some individuals’ talent can be overcome.

There’s always a first time

Before becoming an excellent serial acquirer, every company has had a “first” and learnt from someone who had the experience and the ability to transfer that knowledge onwards, someone who has successfully driven numerous business integrations, often on a continental scale.  By working with the Executive team of the company, that experienced specialist allows the business to manage the dual focus of on-going commercial activity and integration.  This approach has the added advantage of leaving  a lasting legacy, because the organisation progresses along a learning curve during this first integration, gathering a capital of knowledge and new experience which will be of immense value for the integration of the next acquisition.

Chalk and Cheese High Above the Clouds

As a very frequent user of airline services, I have followed with interest the developments relating to the merger efforts of British Airways and Iberia under the umbrella of their common owner IAG (International Consolidated Airlines Group S.A.).  The alliance between one airline which has dragged itself up the ladder of customer satisfaction from being a strike-riddled loss-making state-owned airline to becoming a well regarded brand, with another airline which today is plagued with the ills that affected BA two decades ago, poses a formidable management challenge.

How long will it take for the same medicine to produce a similar turn-around at Iberia?  Is it indeed the same medicine that is called for in this case? What is the risk that fixing Iberia will prove a huge distraction which might dilute management focus and ultimately degrade the whole consolidated group ?

 

Investor’s Logic Versus Customer Benefits

A “Merger Project” document issued in 2010 by IAG describes in a fair degree of detail the legal structure, governance and ownership of the consolidated company, and indeed it seems the investment community still has faith in the substance of what IAG have set out to accomplish.  So far, the realization of synergies is reported to be on track, which is probably not too surprising given some of the inefficiencies that were plaguing Iberia at the start of the deal.

 

Willie Walsh InterviewIn a video interview posted in 2011 on the IAG website, IAG CEO Willie Walsh talks about the rationale for the BA / Iberia merger within the general consolidation of the airline industry, and the long term perspective this will produce for IAG.

He goes on to announce with understandable pride that IAG is on course to deliver on all its promises to its customers, such as better connectivity between the flight schedules of the two companies.  So on paper all looks fine, at least from the investors’ side. But is it really ?

 

The View from the Passenger Window

Since 1997 with the creation of Star Alliance, shortly followed by BA’s “Oneworld”, passengers have been taught to expect these alliances to offer some commonality in terms of service, comfort, product range and network coordination.  This development provided real customer benefits in terms flight connectivity and broadened the range of destinations that can be accessed through code-sharing arrangements.  It also allowed the airlines to share the cost of expensive infrastructure, airport lounges etc., thereby improving their cost/value proposition for the travelling consumer.

However, looking at what ultimately matters most to the air passenger, namely the flight experience itself (comfort of seat, cabin appearance and cleanliness, attentive staff, punctuality, food and beverage, entertainment, flight safety), the differences that exist between the airlines belonging to a same alliance remain significant.

Numerous passengers express surprise (and disappointment) when boarding a flight that bears a familiar number and prefix but turns out to be operated by a quite different airline.  It is reasonable to assume that passengers will expect an even higher degree of alignment between airlines that are co-owned rather than merely members of one same alliance, unless one brand is clearly identified as the charter or low-cost variant of the other.  Today, whilst from a business entity perspective BA and Iberia might be integrating towards being a more coherent business, one cannot overemphasize how colossal an effort remains to be made to provide the group’s passengers with a seamless experience when travelling and switching between those two airlines.

Airline Merger versus Airline Alliance

One struggles to see any end-user benefit yet arising from the BA / Iberia merger, in spite of Willie Walsh’s video statement.  Let’s take the example of a journey from London to Santo Domingo in the Dominican Republic.

BA-Iberia-AA

The fastest routes are London-Madrid-Santo Domingo, and London-Miami-Santo Domingo. The route via Madrid, using BA and Iberia, lasts a total of 15:25hrs including a stop-over in Madrid. The route via Miami involves BA and American Airlines, lasting 16:50hrs including the Miami stop-over,  costs an additional £ 68 in business class compared to the Madrid route.

Willie Walsh would like the 10% time saving and £ 68 fare difference (rather negligible in regard to total cost) to be the decisive factors that will swing the customer’s choice in favour of flying with IAG-owned airlines.  Any passengers on board flight IB 3486 from Santo Domingo to Madrid on 19th February, onto which they had been rescheduled from a previously cancelled Iberia flight, and which crossed the Atlantic with blocked washbasin and toilet drains and soaked carpets in some areas, will now know they made the wrong choice…  And this does not even consider the risks associated with the stop-over in Madrid where luggage handling staff were partly on strike. Maybe an additional £ 68 would have been well invested for trouble-free travel on American Airlines and British Airways’ code-shared itinerary.

When Backstage Trouble Hits the Front of the Stage

In the above mentioned video interview, Mr Walsh quite remarkably states that “one of the real advantages of IAG is that we’re detached from the day-to-day operational challenges that the airlines face, which means we can spend more time focusing on the long term strategic issues“.  That’s really lucky for Mr Walsh, because beyond the usual airline worries about fuel costs and security, Iberia have a mountain of other operational issues to resolve and there is a true chasm between their company’s image and what the British Airways brand now stands for.

Iberia Riot
Iberia staff riot in Madrid airport

Let’s give credit to Willie Walsh and his predecessor Colin Marshall, who sadly passed away in 2012 as Lord Marshall of Knightsbridge, for having transformed British Airways from its former status of state-owned sloppy airline to what it has become today. So although I am not an airline expert beyond the fact that I fly between 80 and 130 times a year, I am confident that Mr Walsh not only knows what is right for his investors, but also understands what his customers expect and how to run an airline effectively. Even if things have not always been easy at British Airways and industrial relations are tense at times : there is a clear sense of “The show must go on” and customer service levels are maintained as much as possible, even through difficult times.

Iberia departure board 6th March 2013
Flight cancellations resulting from strike action by Iberia staff

Not so at Iberia, where the conflict has broken out into public display, prompting any reasonable air passenger to turn to other airlines to avoid the disruption, cancellations and general ill-ease of being served by such disgruntled staff. This can only compound the problems of the ailing airline into a downward spiral. The coming months will be crucial in determining IAG’s ability to manage industrial relations in a South European country where the rules of play are markedly different to those that apply in the UK.

A Sour Lesson from Past Experience

I trust Mr Walsh to be smarter than the management of Swissair who in the late 1990’s thought they could transfer the know-how, reputation and quality of what had until then been an exceptionally well regarded airline, onto a series of acquired entities to gain a pan-European or possibly global scale, resulting of the lamentable collapse of Swissair in October 2001.

Back then, based on a “hunter” strategy developed for them by McKinsey & Company to protect the airline against possible isolation resulting from Switzerland’s reluctance to engage in any form of integration with the rest of Europe, Swissair embarked (without the support of their consultants during the crucial implementation phase) on a series of investments or outright acquisitions of poor-quality often loss-making airlines, including Portuguese TAP and Belgian Sabena.

Swissair grounded Oct 2001
The end of Swissair – Oct 2001

Rather than testing and learning from one acquisition before broadening the scope of this aggressive growth programme, Swissair somehow thought that process improvement and a sense of quality would automatically percolate across their rapidly expanding group, thereby ignoring some of the most basic fundamentals of Change Management.

The high levels of debt resulting from the expansion programme, coupled with the management’s inability to simultaneously address the issues they faced very rapidly brought the emerging group to its knees.  The rest is history.

IAG’s ambitions are high.  The group is not just about the merger of British Airways and Iberia, but aims to acquire many more.  Willie Walsh said prior to IAG’s formation that he had drawn up a list of 12 possible partners from an initial pool of about 40 (source : Bloomberg).  BMI was snatched up when it became available, primarily for the purpose of obtaining more slots at London’s Heathrow airport.  But looking into the near future, contrary to the view he expressed in his 2011 video interview claiming he would maintain a high-level strategic view and not get sucked into operational matters, I believe that Mr Walsh and his team will now have to take account of some of the operational challenges they need to crack to “digest” the BA – Iberia merger before tackling the next big acquisition.

The dishes of a banquet cannot all be eaten together without the risk of a serious indigestion.