M &A can offer a powerful lever for executing strategy, transforming organizations, and delivering exceptional value creation. In this episode of the Inside the Strategy Room podcast, two McKinsey experts talk about how executives under pressure to create more value for shareholders and stakeholders can benefit from using a transaction as an opportunity to transform the entire organization. Alex Liu is a partner in McKinsey’s Minneapolis office and a leader in our M&A practice who helps clients execute large-scale mergers, with a focus on growth-based transactions. Chris Hagedorn is a senior partner in our St. Louis office who is a leader of our global transformation practice and focuses on transformational M&A. The pair recently coauthored a new article, “When a transaction forges a transformation.” This is an edited transcript of their conversation. For more discussions on the strategy issues that matter, follow the series on your preferred podcast platform.
Sean Brown: Why is M&A an opportunity for launching a transformation?
Alex Liu: When you think about corporate-wide change, there are really few things that catalyze something like a transaction where you’ve got public commitments to your external markets or to your board.
Chris Hagedorn: For some deals it can be a once-in-a-lifetime opportunity to unlock value. Revenue and growth opportunities are increasingly becoming a larger part of the overall deal thesis, along with opportunity, value creation, and repositioning the business with customers. And we also see that this could be a powerful catalyst for change for many different reasons that might be on the M&A agenda or the company agenda. Transforming while doing M&A isn’t for every deal or company. We’re also not saying you need to relax the rigor that needs to go into proper planning for integration and synergy and value capture. However, for certain deals where there’s a significant opportunity and/or it’s a prerequisite to capture significant upside value and also to do it quickly, transformation will help increase the odds and increase the probability of success in your next M&A transaction.
Sean Brown: How do you know when the opportunity is right to pursue a transformation as part of an M&A transaction? Are there indicators you use, like the size of deal relative to size of acquiring company?
Chris Hagedorn: Typically, the size of a transaction is a good indicator, especially if you’re bringing together two equal-sized companies with significant heft in terms of revenues, customer footprint, and employee base. Another factor is the degree to which your deal requires a significant lift in financial or operating performance or performance safety or sustainability, where you need a dramatic departure from your current level of performance. That can include distressed acquisitions.
Alex Liu: I would think about what you’re trying to do with your customers. If you’re really trying to access a whole new base of customers, perhaps through a new channel or distribution or e-commerce, or you’re thinking about creating an entirely new set of offerings, that would be another marker of transformation, because your company’s going to have to do vastly different things. Conversely, if you’re just doing a simple product or IP tuck-in, which many M&A deals are, that’s likely not a transformation, because you’re largely leveraging the current asset base that you have.
Chris Hagedorn: I always say that if the board, or the CEO, CFO, or chief strategy officer have a lump in their throat when they think about how they will pull this off and how much they’re committing to in their business case, that’s probably an indication that transformation might be the right fit.
Sean Brown: Can you take us through how you would approach the transformation when a transaction is the main driver?
Chris Hagedorn: There are four key elements: strategy, value, execution, and people. Getting strategy right is critical to the other three. The question is whether you are actually reimagining the combined business. The management team, the CEO, and the board need to spend the time asking, “What is our M&A strategy? What actually are the targets we believe fit within that strategy?” Often acquirers miss that first step when they start identifying opportunities for deal rationale for individual targets. They need to develop a renewed vision for the combined enterprise, and in a transformational deal they need to understand the opportunities for growth.
It’s important to look at the customer cross-section. Who are your customers? What are the opportunities for growth and for margin enhancement? Will your organization be structured and transact as it does today with a renewed operating model? Or is there an opportunity to do something different with how you reach customers and engage with stakeholders and suppliers, so that you enable a truly renewed vision for how the company will operate going forward? Aligning the top team around those core elements is critically important. And there is no one-size-fits-all blueprint—it always needs to be tailored to the context, applying past lessons learned to the individual transaction while also looking at finding the edge of that new vision.
Alex Liu: Transformation is not monolithic. You want to transform selectively while also taking a lens of protecting the base business and ensuring that the organization is not overwhelmed with too much change at once.
Sean Brown: Would this also work in a divestiture?
Alex Liu: Yes, because in both cases you’re really taking a thoughtful lens around “What are the markets that we should be playing in? Who are the customers we should be serving? Where are the geographies we should be playing in?” But it’s important to realize that transactions are not a substitute for good strategy. For transformation through transactions to work, you have to have a very clear strategy overall, with M&A as a component. That defines the right transaction.
Chris Hagedorn: Some of the most impactful transformations that I’ve been a part of have come as a result of setting the right strategy for the company, divesting certain business units and areas, and actually then transforming them. The need to transform and redesign organization structures is just as important in a spin-off or divestiture, to make sure you’re right-sizing the cost structure, and tailoring the business processes and operating model appropriately.
Sean Brown: Can you share any case examples of setting this broad strategy and then launching an M&A-driven transformation?
Chris Hagedorn: A global luxury consumer goods producer had an opportunity to pursue a transformational acquisition of a distressed brand with markets, customers, and products complementary to the acquirer’s. The acquirer’s CEO and board decided to use the transaction to fundamentally change their operating model, reorienting from a functional P&L structure to a brand-centric structure, to further enhance their go-to-market and marketing presence. First, they reassigned their business units, and put presidents over each. Next, they shifted over a quarter of their sales to a lower-cost, direct-to-consumer channel to increase margins and overall revenue and sales. They also changed their operations and go to market across the enterprise, setting aggressive targets and launching about 100 initiatives with individual owners to achieve the value-capture plans. Ultimately, they far exceeded their 20 percent EBITDA lift target and instead achieved more than 30 percent, and increased their enterprise value by more than half in just 18 months.
Sean Brown: Once you have the strategy in place, what’s next? Your article talks about identifying the full-potential value. Can you take us through what that means?
Alex Liu: Many transactions do well at protecting the base business. But we would encourage companies to take a full-potential mindset, looking at leveraging the transaction as a catalyst to explore. In the case of cost, that could mean pursuing off-shoring and outsourcing. In the case of revenue, that could mean pursuing new digitally enabled business models or a new go-to-market channel.
To get there, step one is really assessing what is possible, including competitive benchmarks and your current performance. We call that “independent diligence,” taking a real clean-sheet lens to all potential opportunities. The second step is deciding targets for your workstreams, assigning line leaders to develop initiatives and run them through a detailed development process of building a business case and implementation plan, which, if validated by your findings, becomes a bankable plan. You will want to think about a holistic integration financial plan for every area, every initiative, and every month so you can just simply track and manage when you are ready to execute.
Sean Brown: Are there pitfalls involved?
Alex Liu: Failure to set the aspiration high enough is a common problem. Whatever your public or external commitment is, shoot for a minimum of 30 percent above that internally. Many companies even set a goal that is 100 or 200 percent over external targets. Another common mistake is failing to activate a broad set of line leaders, and instead limiting the thinking about what is possible to the C-Suite level. That prevents ownership from penetrating into the organization. Another mistake we see is waiting until well after a close to implement a holistic financial plan. You want to have this within the first 30 days or 60 days post-close, if not sooner.
Sean Brown: How do you communicate these opportunities to the organization and to investors?
Alex Liu: Externally, you want to take a fairly conservative view with commitments that you beat, while setting more bullish internal goals and thinking about raising the aspiration. The promise to customers and employees is as important as the dollars and cents, so the change story has to equally hit on the hearts and minds and the heartstrings as well as the financial benefits.
Chris Hagedorn: Obviously, with privately held companies, you have more latitude to stretch a little bit more, but the IR strategy is always one that needs to be tailored to the context and your confidence in achieving the goals that you set out.
Sean Brown: It would be great to hear an example of how a company actually applied these principles to capture the full-potential value.
Alex Liu: In an industrial sector merger of equals, the parties explored all value pools, looking holistically at revenue, working capital, and cost. They ran 100-plus initiative owners across the enterprise through a very detailed, bankable-plan process, validating each with a business case, impact sizing, and implementation plans prior to the closing of the transaction. They also established a digital platform that enabled further transactions and shifted to shared services. Together, these moves helped them quadruple shareholder value creation.
Sean Brown: What about execution? How is that different when pursuing transformation through M&A?
Chris Hagedorn: The goal is to establish an empowered execution engine that enables a large cross-section of leaders in the organization to step up and own business cases and results, so you can run faster by having many more individuals owning and driving. There are two key elements to this: a disciplined operating cadence and executive score cards. That sounds sensible, but what we’re proposing is a different level of execution rigor. By “disciplined operating cadence,” we mean investing a significant amount of leadership time in the integration and transformation, a leader who is an extension of the CEO with the authority to truly drive high-quality, but rapid, decisions, and shorter, more focused delivery deadlines. With a shorter delivery cadence, you are more focused and execution-oriented. When you combine that with data-driven performance dialogues with the right people, meetings, and agendas, you enable faster, better, decision making and you start clearing challenges and hurdles faster, getting you to the next window of opportunity faster.
With executive scorecards, we generate a single source of truth, rather than multiple versions of where we are and perspectives on business cases. When you have that truth for each workstream and initiative, and it’s validated by finance, you can compare your actuals to the bottom line. This is very different from reviewing spreadsheets and saying, “I think we’re notionally there.”
Then you can talk about how to accelerate even further. You want to use the transformation to catalyze still more improvements that further enhance your speed and magnitude of capture toward your full potential.
The number-one factor we see is the percentage of individuals in the organization who truly own the accountability for driving the change.
Chris Hagedorn
Sean Brown: You mentioned expanding the discussion beyond top leadership to build deeper buy-in. How does that work?
Chris Hagedorn: The number-one factor we see is the percentage of individuals in the organization who truly own the accountability for driving the change. By engaging a large cross-section of your teams, you enable them to build capabilities. The more rigorous cadence and questioning of what is possible needs to be carried out through the organization. You want the speed you can have during an acquisition and integration to carry over to the rest of the organization.
The NBA shot clock is a great example of this. Before the introduction of the shot clock, professional basketball games were often slow, with the offense waiting out the game clock. Once the shot clock required them to shoot the ball within 24 seconds, the pace of games picked up dramatically, scoring increased substantially, and games became much more exciting. This is what we seek to create with a transformation office—bring a different cadence to achieve a different level of execution.
Sean Brown: How do you track and celebrate the overall impact that the transformation is creating, versus just taking note of specific milestones?
Chris Hagedorn: There are the nonmonetary pats on the back and celebrations that are critically important to motivating and creating the right culture. It’s also sharing the progress transparently of how we’re doing on both nonfinancial and financial goals. People need to understand where they are so they can adjust. Those often are just as important as individual incentives, especially for leaders and initiative owners who are driving the impact. If they win, we all win together.
Alex Liu: To be clear, tracking and celebrating is woven into every part of how work is done. Every transformation office meeting starts with recognition—“here’s who’s making it happen on the transformation.”
Sean Brown: How do you sustain the transformation?
Alex Liu: In many transactions, you do one-time projects where you get the synergies and then you go back to base business. The way around that problem is through building foundational capabilities, and there are two real aspects to those. The first is a transformational leadership set of capabilities, which includes problem solving, prioritization, having hard dialogues, adaptability, and role modeling, for example. That might sound basic, but the point is that you need a common language and a common set of capabilities across the entire enterprise, so that everyone is operating from that base level. The second aspect of those foundational skills is the functional capabilities that you need. For example, to reach the higher procurement savings you’re looking for, you’ve got to build clean-sheet models, et cetera. And of these aspects, foundational capabilities are are critical.
Investing in capabilities and talent will ensure that the changes that you’re making during a transaction are really sustainable.
Alex Liu
Sean Brown: How have you seen companies put this into action?
Alex Liu: A global leader in packaging tackled capability building and the talent by launching a standard package of excellence that focused both on performance and organizational health. All 250 of their transformation leaders received a a standard curriculum around problem solving, decision making, and having tough dialogues, and they simultaneously rolled out an advanced capability building program on operations and commercial processes, et cetera. They also went through a process of top rating talent in the organization and changed out 50 of their top 100 roles, and realigned incentives to sustaining the transformation. In doing so, they increased their organizational health index scores from the bottom quartile to the second quartile in just two years, which is pretty remarkable. Really investing in capabilities and talent will ensure that the changes that you’re making during a transaction are really sustainable.
Sean Brown: We’ve done a lot of research on the benefits of programmatic M&A, which is an approach of executing a large number of deals where the accumulation of the deals drives major change along a strategy or theme. Do you think a programmatic approach to M&A can also be an opportunity for transformation?
Alex Liu: Programmatic M&A is really a companion to thinking about a transformational transaction, and it gives acquirers better odds of success when doing a transformational transaction. The reason is that they have built the muscle for it. Even if you’re a programmatic acquirer, doing a large-scale transformational deal requires slightly different skills given the size and scale—they require a different enterprise-wide view and capabilities.
Sean Brown: What key points should readers take to their teams tomorrow from this conversation?
Alex Liu: The cycle of M&A has been very predictable in the past decade, and we’re coming off a quieter period, so we think 2024 is going to be a big year for M&A. We would encourage leaders to prepare for that.
Chris Hagedorn: I would encourage everyone to shoot for a high aspiration, identify full potential, and think about the renewal of what the combined enterprise can actually look like and be super creative in that up front. Invest the time on that.
“Our firm is designed to operate as one—a single global partnership united by a strong set of values. We are equally committed to both sides of our mission: attracting and developing a talented and diverse group of colleagues and helping our clients create meaningful and lasting change.
From the C-suite to the front line, we partner with clients to help them innovate more sustainably, achieve lasting gains in performance, and build workforces that will thrive for this generation and the next.”
Please visit the firm link to site