Distance Makes the Acquisition Grow Colder
- Geographic distance separating the acquiring and target firms reduces the likelihood that acquisitions will be completed, particularly for acquisitions within the same industry.
- Distance makes it more difficult to access “soft” information (such as vision, culture, team dynamics) that is crucial for a firm attempting to acquire another in the same industry, due to the need to integrate operations.
- Direct experience in acquisitions lessens the negative effects of distance.
- Firms should develop expertise in local acquisitions and more robust due diligence procedures before pursuing national or international opportunities.
Once a potential corporate acquisition is announced and due diligence underway, there is powerful momentum to close the deal. After all, there are investments in research and legal fees, executive credibility, and stable stock prices at stake.
But cancellations do occur, and more often than one would think. The analytics firm Dealogic estimates that, in the first quarter of 2016, roughly $481 billion in proposed mergers or acquisitions in the U.S. failed to reach the finishing line. Research by Abhirup Chakrabarti of Smith School of Business shows that, between 1981 and 2004, about 33 percent of cross-border acquisitions and 26 percent of domestic acquisitions reported in the Thomson Reuter database were recorded as incomplete, with cancellation rates growing over the years.
While some acquisitions fall apart due to antitrust concerns, eleventh-hour competing bids, or new information coming to the surface, Chakrabarti, an associate professor and Distinguished Faculty Fellow of Strategy, suspects something else is at play for many of these aborted deals: geographic distance.
Research has shown that geographic proximity helps relationships develop and improves the likelihood that they succeed. Taking this a step further, Chakrabarti argues that geographic distance separating the firms in play reduces the likelihood that acquisitions will be completed, particularly for companies acquiring others within the same industry.
Here’s why: Acquirers need both hard and soft information to evaluate potential targets. Hard data — financials, legal information, sales projections — are quantifiable and straightforward to collect. Soft information — such as vision, motivation, expectations, opinions, team dynamics — is “difficult to quantify, context-specific, and easily distorted at a distance,” says Chakrabarti.
"The influence of spatial geography may be easy to underestimate as managers misjudge the ability of information technologies to overcome inherent limits to information flow across distance"
He argues that geographic distance makes it more difficult to access these sources of soft information. This is the sort of intelligence that should be crucial for a firm attempting to acquire another in the same industry, since corporate integration is at issue. Will the target firm be a good cultural fit? Will R&D, manufacturing, marketing, and human resources blend effectively?
Unfortunately, many corporate decision makers are lulled into a false sense of security. They think they should be strong at related acquisitions because they know the competitive dynamics of their industry. So if they acquire a firm that’s 500 kilometres away, they say, it should matter even less than if they were acquiring a firm in an unrelated industry about which they know little.
Chakrabarti disagrees. “When you buy a firm within the same industry, there is the need to integrate,” he says, “whereas if the firm is in a different industry, it’s generally allowed to function independently. But if you do a related acquisition and you don't integrate it, you don't get the benefit of the acquisition.”
Experience Bridges the Gap
Chakrabarti set out to test this line of thinking. Working with Will Mitchell of Rotman School of Management, he designed a study using a sample of 1,603 domestic acquisitions announced between 1980 and 2004 by 724 U.S. chemical manufacturing firms.
Their findings, published in Strategic Management Journal, showed that related acquisitions were indeed less likely to be completed when the acquiring and target firms were located far apart from one another. According to their regression analysis, there was a 22.7 percent drop in the odds of completing a related acquisition of a target firm that operated in the same zip code versus one located across the country.
These findings were driven partly by smaller, less experienced, and single-unit firms, which suggests one mitigating factor: direct acquisition experience. Firms inexperienced in making acquisitions can be tempted to apply their limited knowledge to subsequent acquisitions under very different conditions. By contrast, when firms are adept at acquiring others within the same industry, says Chakrabarti, “they are better able to understand the known shared concepts and utilize their prior experience to subsequent acquisitions, improving their likelihood of completion.”
Two other factors helped acquiring firms overcome distance: prior experience with acquisitions in the geographic state of the target firm and learnings from subsidiaries, parent units, or intermediaries.
Lessons to Learn
The takeaway for organizational strategy leaders is to pay special attention to overcoming the negative influences of distance when assessing a potential acquisition in their own industry. Gathering the “soft” intel that so often is the difference between a successful and failed acquisition requires boots on the ground. “To the extent that due diligence continues to focus only limitedly on soft information,” the researchers write, “the influence of spatial geography may be easy to underestimate as managers misjudge the ability of information technologies to overcome inherent limits to information flow across distance.”
Chakrabarti says it’s a good idea to develop expertise in local acquisitions and more robust due diligence procedures before pursuing national or international opportunities. He points to the experience of Cisco Systems, whose early leaders recognized the challenges of distant acquisitions. “Initially, they stated that they were very concerned about distance, so about 70 percent of their first 20 acquisitions were local,” he says. “Then about 20 percent of their acquisitions between 100 and 110 were local. They have geographic proximity as a factor when they approach acquisition opportunities.”
— Alan Morantz