October 2017 | Strategy
Over half of all mergers fail to create value in the long term, and in the short term the acquiring company’s share price typically falls. But when a company sells a part of its business, it tends to create value and improve stock performance. So why are there typically two acquisitions for every one divestiture?
“Businesses feel continuous pressure for growth,” says Wharton management professor and divestiture expert Emilie Feldman. “And, it can be exciting to expand the company’s boundaries. But paring down strategically through divestiture can actually improve both short- and long-term performance, help senior executives maintain focus, and reap rewards from investors.”
Feldman leads an elective session on divestitures in Wharton’s Mergers and Acquisitions program, explaining that while it might seem a counterintuitive offering, the session is designed to help participants develop a broader mindset. “M&A is one way to change the focus of your company, but you can also change it by moving in the opposite direction. Especially in the face of an acquisition, think about whether an area of your business should be reduced. Instead of being concerned only with growth, consider the overall scope of the company and how it might be improved by narrowing the focus.”
Because Feldman is the only researcher whose work is centered completely on the subject, the program provides valuable insights and rigorous content on divestitures that managers can’t get anywhere else. She says she enjoys sharing her work with practitioners who are or will be involved in the process. “I get to hear their real-world concerns and challenges, and can help them navigate divestitures with a systematic, two-stage approach.”
Her new framework is presented in two parts: the first centers on the decision-making process and the second on execution. Feldman says you need to look at your organization’s environment — in which circumstances should you think about divestiture as an appropriate response? And if you are considering it, which specific business makes sense to sell, and how do you do it? Once you make the decision, there are a number of mechanisms to choose from, including sell offs, spin offs, carve outs, and management buyouts.
In the execution phase, she explains the three steps managers need to take once the divestiture is underway. The first is focusing on the internal factors within the company that might need to be restructured, including compensation, HR, and resource allocation.
Second, Feldman says the focus should widen to the relationship between the divesting firm and the business they are divesting. “Did you get inputs from it? Are there managers who worked in both and got customers from both? How do you restructure those relationships that got changed because of the divestiture?”
Third, consider external factors: what will be affected outside the company? “How will you portray the divestiture to the investment community, for example,” she explains. “You are telescoping from purely internal issues, to relationships between companies, to purely external considerations. It’s a logical progression.”
Feldman says the stage with the greatest potential for failure — and therefore the one that should get special attention — is the intermediate one. “Making relationship-level decisions and dividing resources is especially challenging for managers. It’s difficult to unwind shared resources,” she explains. “Let’s say your marketing budget funded two parts of your business, one of which you’ve sold. Should you keep the budget at same level and use it all to fund the remaining business? In that scenario, you might end up spending too much. Or you could cut it in half, and potentially underfund the remaining business. It might not have been a true 50-50 split, or there may be overhead costs that were not considered.”
Ultimately, although divestitures are complex, their rewards are typically worth the effort. Understanding the process ahead of time and having a guiding framework allows managers to improve their decision-making and focus on the actions they need to take to derive maximum value.
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