ABSTRACT
Mergers and acquisitions operations continue to be one of the most explored growth strategies in all markets, and this is indeed the case in the elevator industry. The volume of investments grows year after year. It is the fastest way to grow in international and domestic markets, but the reality is that a high percentage of the operations carried out do not meet the expectations of the investors once the integration phase has been completed. There are several causes of failures in mergers and acquisitions processes, such as lack of commitment from the management, an unrealistic business plan, cultural shock, etc. But the most common one, and the one with the highest risk in an acquisition decision, is information asymmetry. During the negotiation phase a large amount of data is collected, and subsequently analyzed during the due diligence period, but it may not correspond to the reality during the integration phase. In this article we will propose how information asymmetry can be avoided through the application of information and communication technologies (ICTs) via internet of things (hereinafter IoT) devices in the elevator industry. This can also be applied to other industries.
Keywords : IoT, IT Due Diligence, ICTs, Digital Strategy, Information Asymmetry, Adverse Selection, M&A Performance, M&A Success.
INTRODUCTION
In the elevator industry, there has historically been a great deal of mergers and acquisitions (hereinafter M&A) activity between companies of different sizes, with the aim of accelerating strategic growth in certain international markets, or just in domestic markets. The aim is to become present in areas where the buyer’s presence is low or non-existent. The operations consist of the purchase of a company that has maintenance service contracts for elevators, or simply the purchase of the portfolio of maintenance service contracts for said elevators.
These M&A processes between elevator maintenance service companies are led by multinational manufacturing companies. As a rule, the candidates for acquisition are multibrand local companies, servicing different brands of elevators manufactured by multinationals, which for the most part still work without a defined digital strategy and with a much simpler quality management system than multinational companies. They use incomplete or poor procedures, with a work methodology based on experience, such as: “This is how we have always done it,” which is not sufficient for obtaining, processing, and subsequently analyzing data. In M&A processes between elevator maintenance companies of different sizes, the calculations and premises used by multinational companies to evaluate suitable candidates for acquisition are based on experiences and Excel-type spreadsheets. The data provided by the selected candidate may differ from the reality, meaning that M&A projects that appeared beneficial in the pre-acquisition phase may result in failure in the integration phase, damaging the profit & loss accounts (hereinafter P&L) and the brand value of the purchasing company. In other words, the decision is based on subjective criteria that cause an overestimation of returns and an incorrect business plan due to asymmetric information that does not correspond to the reality (Akerlof 2001).
Why is there asymmetric information? Because the data used for the analysis and business case study in the pre-acquisition stage have not been obtained, treated, and processed correctly due to the seller’s simple digital tools. When an M&A operation takes place between different sized elevator maintenance companies that have different digital strategies, information asymmetry is the biggest cause of failure.
BACKGROUND
Currently, mergers and acquisitions processes are growing significantly around the world (Cartwright & Schoenberg 2006). For example, in 2004 there were 30,000 M&A operations around the world, equivalent to 1 operation every 18 minutes. However, despite the growth this entails, investors continue to experience low returns in the months following integration. For investors, the return on investment is still highly questionable.
Authors who investigate the factors that motivate M&A operations (Calipha, Tarba, & Brock 2010) have found that the success rate of M&A operations is below 50%. The factors that motivate M&A operations can include, among others, the entry into new markets, the acquisition of resources and talent, or simply the application of synergies. In a survey (Accenture and Economist Intelligence Unit 2006) conducted with executives of companies involved in M&A operations, the following responses were obtained: 47% answered that the causes of failure come from the coordination and integration of the process; 43% responded that they come from the execution of due diligence (hereinafter DD); and 40% responded that the causes of failure were due to lack of motivation of the organization and lack of business cultural integration. An argument commonly used to explain failures in M&A operations is that too much attention is paid to financial parameters and not enough to business and human organization, as well as operational parameters.
The DD process must resolve all doubts and questions during the pre-acquisition phase. Continuing with unresolved doubts and uncertainties can be critical during the integration phase. When different information appears in the integration or post-acquisition phase, this is what is called information asymmetry. Therefore, resolving ambiguity in the DD process is a success factor.
Information asymmetry is linked to the risk of the buyer paying over the odds. In an M&A process there may be a potential “lemon” problem (Akerlof 2001) that can generate costs. According to Akerlof, asymmetric information exists when the seller has more information than the buyer. The seller can hide part of the information to avoid the risk of reduction of the offer prices by the buyer. During the negotiation phase (Dierickx 1991), the problem already appears when the seller cannot or does not want to transmit certain information to the buyer, so the buyer does not have all the real information. Cuypers, Cuypers, and Martin (2017) carried out an investigation on 1,241 articles over a 30-year period, and they argue that the party that obtains greater value in an M&A process is the one with the most experience and that obtained the most information.
When considering and comparing, for example, the valuation of tangible products, information asymmetry also plays a relevant role. In a study carried out by Afzal, Roland, and al-Squri (2009), for two different groups of people, one of them receiving symmetric information on a product, and the other receiving asymmetric information on the same product, different valuations were obtained. The valuation closest to the real worth of the product was made by the group that received symmetric information.
When M&A operations aim to penetrate international markets, the cost of the operation is still much higher due to information asymmetry. Boeh (2011) carried out a study of 3,000 M&A operations and recreated a theoretical information asymmetry reduction model based on the hiring of a consultancy firm for the management and coordination of the M&A operation. Some reduction mechanisms have been proposed.
Reuer and Akerlof (2005) propose three methods to resolve information asymmetry: selecting a different purchase structure, entering into a contractual agreement, and using information from other markets. Reuer and Ragozzino (2008) propose reducing information asymmetry through prior alliances and through an early interaction between seller and buyer. In a study carried out in Israel on startup acquisitions by two ICT companies, Brueller and Capron (2021) note that this early interaction comprises three phases (the “3 Cs”): a first phase in which the seller has to be Complementary to the buyer, since buyers are generally defensive of their core business; a second phase involving key Customers who validate the operation; and a third and final phase, using executive Champions who sponsor the transaction.
Obtaining information is expensive. Nayyar (1990) points out that information asymmetry is usually the biggest source of costs for both parties: seller and buyer. There are alternatives to tackle the costs of information asymmetry, such as including responsibilities, guarantees, signaling in contracts, etc. But they are usually not sufficient or satisfactory. In fact, in some companies there is a specific function to improve the performance of M&A operations, since capacities can be developed through lessons learned (Trichterborn, Zu Knyphausen, & Schweizer 2016). More and more companies that are active in M&A processes incorporate departments that are responsible for the valuation of the possible acquisition.
When an investor decides to acquire a company, a general strategy is always defined, but a specific strategy for IT integration is often not defined. Digital strategy disparity can have an impact on return on investment and on integration effectiveness in the post-acquisition phase. Sundberg, Tan, Baublits, Lee, Stanis, and Tanriverdi (2006) refer to a study by Accenture Consulting on IT integration in 57 acquisitions between 1997 and 1999: 42% did not carry out DD in IT, and the consequence was that the acquisitions did not produce the expected returns. In the elevator industry, this situation also occurs when the two companies have different digital strategies.
With the recent development of digital technology and the large amount of data recorded by devices, companies are increasingly driving digital transformation to create value. Value creation can only come when strategy formulation and strategy implementation are connected (Correani, Massis, Frattini, Messeni, & Natalicchio 2020)
However, small and medium-sized enterprises (hereinafter SMEs), susceptible to being bought, do not invest in technological resources, and do not have ICTs to manage their maintenance portfolio and their clients. In many cases, the information is processed in simple Excel spreadsheets and manual databases. SMEs are still at an intermediate level of digitization compared to Industry 4.0 (Pirola, Cimini, & Pinto 2019). All companies have the need to exploit the opportunity that digitization offers, so that they can use the data collected to increase knowledge and improve decision-making. Profitability is not only achieved through the experience and talent of people, but also through the collection and processing of information through technologies and processes such as big data in order to make correct decisions. Information processing, internal and external, is necessary for any efficient growth strategy, such as expanding into new markets or new business opportunities (García-Canal, Rialp-Criado, & Rialp-Criado 2007)
With globalization, the mortality rate of SMEs has increased significantly. They must adopt digital strategies and decisions to meet the challenges and survive. One of these challenges is the application of ICTs (Gamage, Kumara, Rajapaskshe, Ekanayake, Abeyrathne, Prasanna, & Tayasundara 2019). By contrast, multinational companies have higher driving forces and lower barriers to Industry 4.0. The desire to increase control and allow real-time performance measurement is reason enough for SMEs to undertake digitization (Horváth & Szabó 2019). These technologies on their own are not enough to benefit any company; they must be incorporated into daily activities and processes. They must also be considered within the company’s sustainable technology strategy (Galo & Cano-Pita 2017)
SMEs, by not investing in technology or in their own R + D + I, can be left behind and stop being competitive. The industrial internet of things (IIoT) is impacting the business model of companies and the future of business. The IIoT refers to the interaction of industrial objects with information technologies, with companies, with their customers, and with their employees, thereby making tasks more productive (Jiwangkura, Sophatpathit, & Chandrachai 2018).
The internet of things (IoT) describes the search for interaction between people and everyday objects through the internet. With the IoT, communication between objects and companies implies entry into the era of Industry 4.0 and has improved the availability of data in large companies, as well as the efficiency of their processes. But SMEs are a step behind, and also on the defensive, even though the IoT has tremendous potential to increase efficiency (König, Röglinger, & Urbach 2019).
DESCRIPTION OF THE PROBLEM
In elevator maintenance service companies, as in other maintenance service industries, the biggest cause of failures in M&A operations is the asymmetry of technical information on operational variables established between the pre-acquisition phase and the post-acquisition phase, which causes uncertainty and confusion in the integration stage and is not detected in operational DD. This information asymmetry stems from the different digital strategies that each party has developed and implemented, since most M&A operations are carried out by large multinationals or investment funds that have the resources for powerful IT tools, while SMEs do not.
In the research conducted to find out more information about the causes of general M&A operations failures, and this specific problem of information asymmetry, 155 articles have been reviewed, of which 86 have been selected from different disciplines using different keywords. Among these articles, we have also studied the different digital strategies that companies have, based on their size and resources, and how these different digital strategies can affect an M&A operation between companies of different sizes, considering that small companies have not yet embraced Industry 4.0.
WORKING HYPOTHESIS:
Based on the reviewed and selected articles on M&A processes, it can be said that there is a very extensive literature with many research studies over a number of decades, in which many conclusions have been reached and new lines of research recommended. However, it can also be concluded that there is still a lot of pending work that can contribute to the academic research and the successful practice of M&A processes.
The pre-acquisition phase has also been written about, with much reference being made to ambiguity. Many failures are attributed to unresolved ambiguity in this phase prior to the signing of the contract.
This article focuses mainly on operational DD in the pre-acquisition phase. This phase is where the real operational information is often not detected. That is, it can be the source of an unresolved ambiguity that must be minimized or avoided. Technologies provided by Industry 4.0 must also be adopted in operational DD.
Each elevator has a lot to contribute with its daily, weekly, and monthly records of operations detailing all failures and behavior statistics. Thanks to the IoT, elevators have their own voice, which just has to be recorded and analyzed properly. Obtaining this information on operational variables directly allows us to understand from a technical point of view how the elevators are operating. If the elevators acquired are not in proper working condition due to poor service maintenance, the buyer may face moderate or serious additional profit and safety risks, which are unforeseen and undesired.
According to all of the above, we can propose the following hypothesis:
“Information and communication technologies (ICTs) can reduce the information asymmetry between E&E maintenance companies that participate in an M&A process, and consequently increase the success of the transaction.”
Therefore, it can be stated that:
1. Information asymmetry that emerges in the integration phase reduces the success of M&A processes.
On the one hand, in many cases the buyer is not able to determine the quality of the information provided by the seller and does not have all of the information. And on the other hand, although the seller generally has more information, he does not share it entirely.
George Akerlof (winner of the 2001 Nobel Prize in Economics), in his book The Market for Lemons , which is based on his research in markets with information asymmetry, defined the “junk market” model, where the second-hand product seller knows if his product is good or bad, while the buyer does not. Normally the buying party does not have the necessary information to know the negative characteristics of the seller’s product, and this is a disadvantage that can be exploited by the party with more information (Akerlof 2001).
What variables are considered in M&A processes in elevator maintenance companies?
The variables considered are the ratios of the financial statements of the company to be acquired, and the operational variables from the key performance indicators (hereinafter KPIs) of the balanced scorecard or dashboard of the seller, and their subsequent analysis for the study of synergies and profitability. An example of some important operational variables about maintenance service is given below in Figure 1: