How Complexity Can Affect the Performance of a Company after a Merge

English: Pictogram for Merge.

English: Pictogram for Merge. (Photo credit: Wikipedia)

Merges are usually analyzed from financial parameters, you can look at the cash flows and you can easily determine if the result will produce a positive or negative cash flow. With this approach you can determine if the result will continue providing benefits. The value over the individual companies that a merge produce is usually due to a later process of rationalization. This is the common name that is used to designate the simple process of eliminating the duplicate structure. As you are reducing structure, you are reducing complexity, and then, the value provided by a merge is due to a reduction of complexity. If you have the salaries of the managing staff you can determine a priori looking at the accountancy the benefits that the merge will provide.

This is the case of a merge of similar companies in the same market, but other merges can be done following strategic objectives of internationalization, vertical integration and so on. In that cases, there is not a benefit due to a process of rationalization, however, the benefit is provided by a reduction of complexity too.

Complexity of Gas Natural Fenosa in 2009

Graph 1 Complexity Map of the Spanish Company Gas Natural Fenosa in 2009

In terms of complexity, not all the structure of a company is provided by managing staff. Structure is defined by relations among different agents at the company, and the most important structure is due to the physical productive process itself. Many decisions about the business are fully driven by the physical productive process. In the case of vertical integration, for instance, you are making easy to get (and provide) raw materials for the productive process avoiding the trading process and the uncertainty introduced by the markets. This is another way for the reduction of complexity. You can have created a new strong link between activities, but you have eliminated many others. The new link has much less uncertainty associated than a trading process.

GNF Complexity Evolution

Graph 2 Effect of the acquisition of the Spanish company Union Fenosa by the Spanish company Gas Natural

A merge of this kind is illustrated by the previous Graph. In this case, the buyer was showing a behavior near collapse (sharp reduction of complexity) that could be corrected through and acquisition of an electricity company (vertical integration) increasing its complexity but increasing the maximum complexity and resilience too and showing a typical increasing behavior.

But we know that not all the merges has a successful result. The reasons are related to the complexity of the companies. Although on the paper we can determine the cost cuttings of the rationalization, the process in the real world is not so easy. There is additional structure that has not got an accurate reflex on the accountancy, for instance, knowledge, or culture that can be not easily duplicated. This is the reason why in many cases, the managing staff of a smaller company acquired by a great corporation can finally get the control of the whole merged company, this should not be a real problem for shareholders, but many times, it is not possible to eliminate duplicate structure due to cultural differences, and finally the merged company have turned a healthy company into a massively complex one that is driven to fail.

For instance, the inflexibility of the labor market can produce undesired effects on a merge. Imagine the case of an innovative and dynamic company merged with an old big elephant. In this case, the staff of the latter can be overprotected and the pressures of the markets to carry out the rationalization can eliminate the staff of the former who could be the strategic reason for merging both companies, trying to modernize the latter one.

This example can show that if you analyze the companies looking only at the accountancy, the results can be a great disaster.

The use of complexity measures to simulate the merge is an advance because complexity can be measured through physical and financial variables simultaneously and even including macroeconomic variables to analyze the effect of the environment. With these techniques you can try to determine where the labor legislation can be more contributing to complexity although you cannot know the contracts of every people.

Contribution to Complexity at GNF

Graph 3 Contribution to the complexity of different physical, financial and macroeconomic variables of Gas Natural Fenosa in 2009

The previous graph is showing that a macroeconomic variable as the index of prices (IPC España at the right side of the graph) has a strong influence on the complexity of the business in a utility. That is an exogenous variable that we cannot control directly, but we could reduce the effect on the business through a strategy of internationalization. Complexity analysis can give us information about factors that can help us to establish a proper strategy of merges. In this case the number of employees (Empleados) is not a showing a complex behavior and we cannot advance a problem due to the Spanish labor legislation because the company can fit well the number of the employees to the requirements of the business.

Other important aspect that we can get from the previous graph is that financial variables are less contributing to complexity than physical ones, this is showing two things: first of all, finance are well managed, and later, that production is more complex to manage than financial affairs. This fact is common in every business in a normal situation of the economy. Everybody can understand that it is usually more difficult to design, to get the administrative permissions and contract people to build a gas line than to get a credit. Of course, in a debt crisis things can become very different.

In order to finish I would like to ask you for thinking about this issues:

          Merges can be seen a matter of complexity improvement instead of value creation through rationalization.

          Merges can be analyzed from a strategic but objective viewpoint through a quantitative complexity analysis.

          The physical process of the companies can be much more important for the success of the merge than the financial ones.

          The merge does not end with the constitution of the new board of directors, the merge is a process of several years required to make the resultant company more efficient.

 

 LDS in Saconsulting's Office at Serrano Street

 

Mr. Luis Díaz Saco

Executive President

saconsulting

advanced consultancy services

 

   

Nowadays, he is Executive President of Saconsulting Advanced Consultancy Services. He has been Head of Corporate Technology Innovation at Soluziona Quality and Environment (Unión Fenosa Group) and R & D & I Project Auditor of AENOR. He has acted as Innovation Advisor of Endesa Red representing that company in Workgroups of the Smartgrids Technology Platform at Brussels

 

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