January 03, 2001, 1:54 PM — Amidsize Midwestern bank learned a painful lesson last year when it acquired a savings and loan (S&L). During the premerger due-diligence phase, the bank was given an IT head count by the S&L. The head count hinted at a time bomb that would later destroy the financial projections on which the deal was based.
"We got initial staffing numbers, and it looked like a very small IT organization," recalls Julie Giera, a vice president at Cambridge, Mass.-based Giga Information Group Inc. who observed the acquisition but declines to give the real names of the banks involved. Nevertheless, the bank made assumptions about the types of people in the S&L's IT shop. "Unfortunately, after the deal was done, it turned out that all the technical expertise -- software development, maintenance programming, all of it -- was delivered by a consulting firm. What was left [inside the S&L] were project managers.
"The bank was held hostage," Giera says. The consultants' rates zoomed from $65 to $150 per hour, causing the bank to overshoot its consulting budget by 560%. Worse, the time needed to merge IT and other operations increased by 50%, from 12 to 18 months.
Sizing up another company's IT systems before signing a merger or acquisition deal is difficult because time for such due diligence is usually short, and the parties are fearful of giving up confidential information in case the deal falls through. Nevertheless, there are ways to spot time bombs and to see if all those IT cost savings the CEO is promising are really attainable.
Peter Campbell, CIO at XO Communications Inc. in Reston, Va., is a veteran of mergers and acquisitions in the telecommunications industry. Given some metrics about one's own IT, it's possible to get some quick insights from the other company's financial data, he says.
Campbell splits IT into two big groups: applications and operations. Applications are divided further into categories such as billing, customer care and budgeting, while operations are broken into groups such as mainframes, midrange, end-user computing and networking. Costs in the various categories are then related to overall business metrics such as number of employees or revenue.
"For example, I see that for every dollar of revenue, we spend 5 cents on mainframe operations, but they spend 10 cents," Campbell says. "With that kind of benchmarking as a starting point, you have a basis for discussion. Why do you cost 10 cents and I only cost 5 cents?"
That kind of analysis can spotlight areas that may cause problems after the merger or acquisition deal is signed. And it helps home in on areas where cost savings are most readily obtainable. For example, Campbell says, his company may have one desktop support person for every 120 employees, while the acquisition target serves just 80 employees with each support person. Campbell says he might then project a 33% savings in support costs at the target company by moving it to his model of centralized support and automated software upgrades.
But Campbell cautions against comparing the cost of apples to the cost of oranges. For example, if one company leases PCs and the other buys them, or if one company assigns them to IT and the other to end-user departments, it may be difficult to compare their costs meaningfully. "YYou may end up finding some interesting accounting issues," he notes.
The analysis and benchmarking that Campbell recommends may well spotlight your own weaknesses, he adds. "What you have to guard against is the arrogance of the acquirer," he says. "You are after best practices, and you should see efficiency gains in both companies."
Know Thyself
Indeed, any evaluation of another company's IT systems should begin with a self-assessment by the acquiring company, says Joel Goldhammer, a vice president at A.T. Kearney Inc. in Chicago. "What's the state of my architecture? How's my network? What ERP systems do I have? Where am I getting most customer complaints?"
The strengths and weaknesses so identified can then be weighed against those of the other company. For example, Goldhammer says, "if I feel that my biggest problem is getting my call centers to work well and they have outstanding call centers, that's a synergy I can get really excited about."
Goldhammer adds that detailed "best-of-breed" comparisons of every application at each company are a waste of time. "It's at too low a level of detail. You need a plausible answer that's quickly implementable with high reliability. The cost of the last 5% isn't worth it," he says.
Michael G. Parks, CIO at NorthPoint Communications Group Inc. in San Francisco, was an IT executive at Wells Fargo & Co. in 1998 when it merged with Norwest Corp. Parks says Norwest hadn't bothered much with IT due diligence when it acquired smaller financial institutions.
