Increasing operational complexity – including the need for integrated supply chain management systems, real-time and global logistics processes, the extensive use of offshore subcontracting and manufacturing, and IT shared services models and outsourcing agreements – makes assessing a target company’s operational elements more important than ever before.

Regarding its purchase of Chrysler in 1998, Daimler-Benz has conceded that it neglected to properly scrutinize the Detroit automaker’s operations before finalizing its bid. In particular, the German company admitted to having glossed over such crucial factors as excessive inventories, car-buying incentives that kept increasing and the diminishing consumer appeal of the Chrysler brand at that time.

To the experienced acquirer, this is an example of how not to conduct due diligence. Yet, the DaimlerChrysler fiasco is hardly unique. Rather, it’s a pattern that has been repeated time and time again, as demonstrated by other well-publicized mergers and acquisitions that have failed.

History, after all, shows that about half of all such transactions destroy value for the buyer’s shareholders, and about three-quarters fall short of the expectations prevailing at the time the deal was announced.

According to the findings of a survey from the Third Annual Due Diligence Symposium, some two-thirds of respondents point to weak due diligence as the main reason why many mergers collapse within a few years.

The problem is not with the main elements of due diligence – verifying the accuracy of financial statements, sales forecasts and valuation – but rather when dealmakers pay little attention or even choose to ignore crucial operational issues.

Increasing operational complexity – including the need for integrated supply chain management systems, real-time and global logistics processes, the extensive use of offshore subcontracting and manufacturing, and IT shared services models and outsourcing agreements – makes assessing a target company’s operational elements more important than ever before.

Keys of Operational Due Diligence
Supply chain and IT are two operations areas that deserve special attention. In a recent Accenture study, for example, nearly half of supply chain managers said that during merger integration efforts, their companies focused only on generating cost savings at the expense of other metrics, such as quality, inventory turns, supply disruption and order fill rates. Respondents to the survey said a company’s supply chain is usually the leading source for cost synergies, accounting for as much as 50 percent of the savings achieved.

Often, executives driving the mergers look upon rationalization of such assets as warehouses or truck fleets, which are viewed as a prerequisite to merger success, as issues that can be addressed later in the merger process. This is a mistake, as is the non-completion of IT integration efforts. Today’s IT organizations are considered so complex that any changes require a very long lead time. They alone can prevent merger synergies from being realized quickly, if at all.

The best-in-class dealmakers, including companies like Cisco Systems and Bank of America, are successful in getting past traditional due diligence – which focuses for the most part on pinpointing the greatest visible risks and clarifying what is being purchased – to expand their understanding of their targets’ operational elements. Their dedicated merger teams are comprised of IT experts who familiarize themselves with the vulnerabilities and merits of their targets’ IT systems and IT operating models, and supply chain specialists knowledgeable about their targets’ inventories and pipeline.

They help expose major risks and potential deal-breakers quickly, before participants have gotten too close to the altar and are reluctant to walk away. They can accurately assess the true investments needed as well as the “to be” operating costs of the joined enterprises. Those numbers can be used to adjust post-merger cash flow projections, as well as allow new sources of value to be identified and used as part of the valuation of the target in adjusting the purchase price up or down.

The following three examples illustrate the benefits of utilizing operational due diligence:
1. Exposing major risks early – Consider, as an example, a large computer reseller whose target was an online PC store. The asking price for the takeover was predicated on the online company’s expectation of significant growth. The acquirer’s operations due diligence team, however, found that its target would not be able to support such growth as a result of its logistics infrastructure and systems. A few months prior to the transaction, the online PC store had outsourced maintenance and development of its IT system. The deal was called off because the buyer believed this carried unacceptable risks – not because the online store was outsourcing, but because of how the contract was structured.

2. Understanding future investments and “to be” operating costs – In conducting operational due diligence for a private equity firm considering the acquisition of a company in the music industry, Accenture unearthed a runaway project in IT operations. It was found that maintaining the project would have increased specific portions of operating expenses by 70 percent in perpetuity. Without direct participation in the operational due diligence phase, the buyer would not have discovered this investment requirement and the growth of the business would have been impaired.

3. Identifying new sources of value – Accenture supported a major East European mobile operator in its bid for the majority share of a state-owned telecom company. The original rationale for the acquisition was defensive as the mobile operator wanted to protect its existing market position and did not anticipate any significant synergies. However, the due diligence process uncovered $1.5 billion in net present value of synergies beyond what was originally estimated.

Practicing Due Diligence
Given these three benefit areas, private equity and corporate buyers can enhance due diligence in the following ways:

1. Involve seasoned functional experts – The new due diligence team might include experts in manufacturing quality control (to compare underlying philosophies of quality assurance, for instance), logistics, environmental, IT and/or customer service. Experts can spot disconnects that may affect the cash flow of the standalone valuations and the sustainability of cash flow, and they can usually do so with limited access to the target company.

2. Bring these operations experts onboard early in the due diligence process – This is especially true for supply chain and IT personnel, who are too often tasked with “getting things to work” after the deal is done. In the case of IT, long lead times and significant investment are necessary. It takes time to properly understand viable applications and technology alternatives for the “to-be” state, renegotiate contracts and procure equipment, and move data, build interfaces, and retrain IT staff.

3. Use experts to build truly realistic versions of the future-state operating models and future cash flows – Their calculations will incorporate major operating risks, such as bringing capacity on line to support growth over the required time frames. They need, for example, to identify investments required for migrations to new sourcing models.

Dealmakers need to place the same importance on operational due diligence as they do on valuation, traditional due diligence and merger integration. Otherwise, the corporate divorce rate will remain high, with sour M&As continuing as the rule rather than the exception.

Nan J. Morrison, a partner in Accenture’s SITE/Technology consulting practice, can be contacted at This e-mail address is being protected from spam bots, you need JavaScript enabled to view it Guy Kinley is a partner in Accenture’s corporate strategy practice and can be contacted at This e-mail address is being protected from spam bots, you need JavaScript enabled to view it Kristin L. Ficery is an Accenture partner and can be contacted at This e-mail address is being protected from spam bots, you need JavaScript enabled to view it