Improving Business Processes After a Merger
A Thorough, Systematic Approach Can Smooth the Way
Toward Combining Corporate Cultures
Dwight Delapenha,
Elaine Easley and
Paul Morris
Grant Thornton LLC
For companies in the medical device industry, merger-and-acquisition (M&A) activity is changing the competitive landscape. Various influences drive the consolidation of merged organizations, and stakeholders have numerous strategic issues to consider. The following article provides some insight on issues driving consolidation in the industry, along with several lessons for ensuring the success of business process improvement (BPI) programs. These programs should be viewed more holistically and implemented more strategically than the “reengineering” initiatives that were so common in the 1990s. But first, let’s examine what is driving consolidation in this market.
The medical device industry consists of technologically driven manufacturers of therapeutic devices and diagnostic equipment for whom innovation is essential for market success. In the United States, 65% of the revenues and most of the talent are concentrated among the 17 largest players—but there are roughly 6,000 medical device companies, and most have fewer than 50 employees. This landscape strategically is ripe for consolidation.
In addition, successfully competing in this industry requires effective manufacturing capabilities, responsive service delivery and fruitful research and development (R&D). These are advantages primarily enjoyed by large, established industry players. Smaller, niche companies also can fit into the mix by specializing in a narrow market segment, but the need for manufacturing and R&D effectiveness at some point remains. In fact, smaller players without the resources of giants such as Johnson & Johnson, GE Medical Systems, Baxter and Boston Scientific also need to ensure that their expenditures in both R&D and product manufacturing are productive—that is, they offer maximum impact for the money invested.
Consider that the pool of available technical and scientific talent is limited, and it becomes clear that wasting time and talent in ineffective processes would put both large and small players alike at a critical competitive disadvantage.
Macroenvironmental Considerations
The demand for industry products is driven by population demographics (aging baby boomers are one oft-quoted example) and rapid advances in medical science and technology. The profitability of individual companies depends on the ability to develop innovative products and deliver them at prices that provide sufficient margin over operating costs to cover high-value R&D investments. By extension, a company’s cost structure and efficient operating processes are critical factors for achieving a competitive advantage over industry rivals.
With middle-class Americans having unprecedented wealth in US history, they demand “quality of life” comforts (and gadgets of all types) to aid their pursuit of more active, enjoyable and longer lives. The expectation of a retirement filled with leisure activity and travel means this group also demands mobility. As a consequence, medical products have to satisfy these quality-of-life requirements. The industry’s technological innovations have created specialized devices to meet these needs; however, these types of demands also drive rapid technological innovations that create the risk of technological obsolescence for high-value investments. In addition, cost pressures and industry competition have severely restricted the profitability of technology-driven medical OEMs. For companies to continue in profitable existence, the business imperative of constant investments in R&D and attaining cost effective, competitive manufacturing is critical. To execute a winning strategy, large industry players often have turned to buying innovation capability through acquisitions of smaller, niche companies.
Strategic Business Considerations
Long-term profitability in this industry segment is problematic at best for companies that have an absolute and sole reliance on internal R&D capabilities. Therefore, a diligent management team should employ a successful acquisition strategy. The combined platform of internal R&D and acquired technology can become the lifeblood of a medical device company’s product pipeline, just as it is in other technology-driven industries. This strategy is considered key to both growth and competitiveness in the medical device industry.
As evidence of this, consider a recent doctoral dissertation by Robert DeGraff for the University of Pennsylvania. His research postulated that the critical components of a product innovation capability are:
• Externally sourced product innovation capability via corporate acquisitions
• Value creation through production efficiency
• Building product lines along medical specialties
• Post-acquisition scale
• Prior acquisition experience
DeGraff’s work implies a strategic focus on improving internal processes before an acquisition strategy is executed and, after or concurrent with each acquisition, successfully reinventing the organization at an operational level from within. The successful larger entity will be better able to exist and compete in a technology-driven competitive landscape. There is ample evidence in support of this dissertation with the recent spate of mergers in this segment. Notably, Johnson & Johnson’s acquisition of Conor Medsystems, Inc. (a stent developer) for $1.4 billion was completed in February.
Evaluation of the industry consolidation and keys to success points to one element that is critical: successful BPI. Post-merger integration is a key to success in any industry but especially is crucial in one with such advanced technologies, complex processes and demanding regimes that co-exist in relation to regulatory agencies.
Shareholder and Management Interests
Before embarking on any initiative aimed at substantive process change, it is imperative to consider the interests and needs of the stakeholders involved. Management, shareholders and investors especially are keen on maximizing the return on the company’s equity; thus, a significant amount of attention must be focused on executing a product innovation capability that enhances the value of the business. With reference again to the DeGraff dissertation, stock price returns are more favorable following cash-financed acquisitions compared to stock-financed deals with a greater dispersion of wealth attainment by the shareholders of target firms. What is even more interesting is the benefit accruing to targets with patent awards and/or pre-market application approvals (PMAs)—these are key indicators of targets with original innovation capability. The research shows that targets with a valuable pipeline of patent awards and PMAs will command higher buyout premiums than others. This is understandable given the focus on buying innovation capability. Therefore, it appears that management of both acquirers and targets should clearly strengthen their company’s R&D capability and processes.
The BPI Challenge
The type of product under development (or for sale) is central to the process improvement challenge. Associated cost drivers will differ, as diverse types of companies can require very different investments in manufacturing, R&D and clinical processes. Medical device companies also can use widely varied channels of distribution and, in turn, require different levels of manufacturing investment.
Niche medical device companies often need an infusion of funding as they move into clinical trials and/or manufacturing. This also often is a primary motivator for their willingness to be acquired. As start-ups, these companies often are characterized by heavy R&D expenses, but they lack the resources and revenues to support them. And often, the “inventor” is both the driver of the company and a significant investor but does not always have substantive business experience. In contrast, many of these niche companies are second- or third-generation run by a management group that has brought other medical products to market. These individuals often are very experienced and able to access external resources in support of both manufacturing and clinical trials.
Companies increasingly are turning to virtual supply-chain models by contracting for manufacturing and clinical trials to minimize expenses. Each of the many possible funding sources, such as “angel” investors, initial public offerings (IPOs) and M&A activity (namely, funding through acquisition by a larger entity), creates challenges for niche medical device companies. For instance, the burdens of Sarbanes-Oxley Act compliance for public entities are widely thought to have made several niche companies reluctant to pursue IPOs.
To derive value from an acquisition or merger, companies need to recognize that start-ups often have an incomplete business structure and financial systems. Complete financial systems with appropriate controls would need to be put in place; this also can be a driver of (and key area for) BPI. Acquirers and those being acquired need to determine best practices and use them universally throughout the newly acquired company. In many cases, the company being acquired—not just the acquirer—sometimes can bring this to the table.
Another important aspect, product launch readiness, needs to be assessed by the merged entity from both sides of the deal—particularly given the constant demand and pressure for new and innovative products. If the product is in an early testing stage, the technology should be reassessed once R&D organizations are integrated to ensure efficacy and manufacturability and to best manage the new entity’s combined portfolio of intellectual assets and technologies.
In addition, if manufacturing scale-up is required, the company should assess whether it would be a better choice to manufacture in-house or outsource the process. Manufacturing technology and capital investment also need to be considered.
Medical device companies should review their regulatory strategy, and outsourcing of clinical trial management should be considered, particularly for those with limited or already stretched internal resources and talent in this area. If companies plan to market their product internationally, foreign regulatory requirements need consideration before clinical trials begin in order to minimize cost. This also will affect sales and marketing strategies that would need to be developed in the context of the new organization. Furthermore, establishing key performance metrics for all of the core business processes will enable the new company to merge organizations in a way that maximizes economic value.
As with all growth opportunities, pitfalls are inevitable but may be avoidable. The loss of key people and/or customers from lack of role definition or personal relationship damage always is possible with an acquisition.
In many cases, so-called “soft issues” are the primary reasons why deals fall through or are ultimately unsuccessful. Timing is another factor that can cause pitfalls. The extension of clinical trials and extreme regulatory problems can cause product launch failures even at the largest and most experienced firms, as illustrated by Johnson & Johnson’s recent breakdown with its spinal disc product. Additionally, a lack of understanding of the product technology can limit product redesign to improve performance or enable cost-effective manufacturing. The same is true for the loss of intellectual property (particularly organizational knowledge and expertise), which may mean “next generation” opportunities are lost.
Successful BPI: Lessons Learned
With all the challenges to consider, and so much at stake in this context, these initiatives require a thoughtful and systematic approach. The best approach will leverage lessons learned and expertise garnered from prior projects successfully implemented. Mergers don’t have to be the Wall Street equivalent of a shotgun wedding. As you move forward, it is critical to:
1. Make sure the acquired and acquiring organizations share compatible objectives for the merger and future-state vision. This vision enables your new entity’s guiding principles. Assess how well the combined infrastructure aligns with business strategy in terms of processes, people and business systems. This is especially critical if integrating two companies through a merger or acquisition, because each entity may have very different situations in each of these categories.
2. Use a metrics-driven approach to BPI to identify weak areas and priorities. Combine this with project management that is committed to and focused on the objectives defined in step one.
3. Use a variety of analytical tools to assess the current state, once metrics and measurement are in place. Examples include:
• Pareto analysis of errors, lost productivity or other problem areas
• Internal benchmarking to identify best practices (easier to do now with two organizations for comparison).
• Process-related analysis (value-added activity analysis, process mapping and critiques).
• Role and responsibility analysis (core versus non-core activities, time-allocation analysis), particularly for front-line managers and for resources where time and effort are at a premium due to their importance or specialized expertise.
• Assessment of how constraints will affect the combined organization—regulatory risk assessment can be very different in the two entities.
• Evaluation of resource requirements that must be filled from outside of the combined organization—eg, manufacturing or clinical trials.
4. Recognize that dissimilar cultures exist in the two organizations and that change management is important. Use experienced individuals who are accustomed to this and can strategically diffuse political tension and avoid a winner/loser mentality among merged organizations. This can help make the process analysis and redesign activities less threatening, and experienced advisors can help with critical elements, including change management and project management support.
5. Ensure there is intense focus to drive the business integration/transformation in a timely manner. Many times, the business return on investment and synergies evaporate when time is extended, focus is missing or momentum is stalled. Seek early victories to build momentum.
6. Establish a steering group to oversee the changes with a cross-functional and cross-company team. The best and brightest from the combined organization can help make the initiative a success—this is no different than managing any top-priority enterprise-wide initiative. Dedicate the necessary resources and make internal, senior executive sponsorship and support visible and unequivocal.
7. Establish a program management office or at least a project management team to run all the projects that will become part of the integration process. Consider a shared services or a service center approach for ongoing communications, training and support for the new organizational changes and policies and procedures to be adopted.
8. Be especially sensitive to mitigate loss of key personnel during this transition phase. Retention bonuses may help in the short term, but companies still need to make the longer-term career path attractive. Recognize critical skills that need to be retained. If part of the synergy of the combined entity is to reduce redundancies, make the changes quickly and communicate the plans to the rest of organization so that people you want to retain don’t leave because of misperceptions of job insecurity. Once cuts are made, communicate that they are over to help avoid these misperceptions.
9. Inform customers (and other external stakeholders) early and often of the benefits to them—but also to mitigate potential customer defections. Customer communication is key. Obtaining their input both formally and informally as the program proceeds can help to avoid numerous risks and pitfalls that internal resources may be too involved or taxed to recognize at first.
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The medical device industry will continue to face merger integration challenges in the future. Properly selecting the right acquisition targets and leveraging process improvement methodologies will be critical to success in unlocking the value identified in an acquisition’s business case. Industry players experienced with integration and improvement of new processes have an opportunity to leverage their effectiveness in an industry that is ripe for consolidation. Competitors without deep internal resources and expertise can extract considerable returns by turning to seasoned advisors for guidance as they execute M&A deals and by ensuring that the processes in place in the combined entity make effective use of valuable resources.
Dwight Delapenha is a partner at the New York location of Grant Thornton, where he serves clients including life sciences companies, software manufacturers and media and publishing companies.
Elaine Easley is a New York business advisory services (BAS) senior manager. Before joining Grant Thornton in 2000, she held management positions, focused on the development of medical devices, for Fortune 500 companies operating in the life science business sector.
Paul Morris is Detroit BAS senior manager. With 10 years of industry and management advisory experience, he specializes in strategic and business planning, mergers and acquisition, operational improvements, financial modeling, forecasting and budgeting.
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