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: