Mergers and the myth of synergy

The words synergy and consolidation are always linked with mergers or acquisitions. Public announcements promise huge cost...

The words synergy and consolidation are always linked with mergers or acquisitions. Public announcements promise huge cost savings. Magazine articles celebrate success. There is, however, no evidence that the promises are actually kept. I don't know of a single verifiable case where IT-related preconsolidation indicators were compared with postconsolidation results.

For the past 20 years I have been tracking the IT costs of corporate information management. For instance, in May 2001, I expressed doubts about the effectiveness of JP Morgan's outsourcing deal with four IT vendors. My observation couldn't be tracked further because at the end of 2000, JP Morgan merged with the giant Chase Manhattan bank, and its reporting as a separate firm ceased.

It just so happens that the combined bank (JP Morgan Chase) restated its historical financial reports to reflect the combined results. Expenses for "technology and communications" increased from $2.17bn in 1998 to $2.55bn in 2002.

The following is a comparison of consolidated premerger (1998-2000) results with postmerger (2001-2002) data. The analysis is based exclusively on the bank's reports to shareholders and to the Securities and Exchange Commission. It offers a rare glimpse into how the results from IT consolidation can be evaluated.

At the time of the merger, the bank's top management said, "We believe this merger will create pretax synergies of $3bn, $2bn of cost savings and $1bn of incremental net revenue." Most of the synergies would materialise within two years, company officials said. A significant share of the savings would come from a consolidation and integration of information systems.

After the merger, the combined banks had lower revenues and much lower profits. However, it's the deterioration in IT-related ratios that concerns me. The percentage of change in the indicators should reveal if consolidation delivered synergies.

To demonstrate gains, at least one of the IT-related ratios would have to show improvement. IT/compensation should decline with rising efficiencies, but it increases 6%. IT/revenue should decline, but it increases 26%. IT/profit and IT/shareholder equity should decline, but they increase 294% and 3% respectively. Every indicator has turned in the wrong direction. Though deteriorating postmerger business conditions could be used as an excuse for the declines in revenues and profits, the unfavourable rise in the IT ratios suggests that the expected synergies didn't show up.

Claims of IT savings from consolidations will remain doubtful unless there is a well-defined path showing how the gains would be delivered. It's my understanding that JP Morgan Chase didn't anticipate the enormous obstacles to achieving systems integration. How much of this was because of "governance" (that is, organisational politics) and how much came from the technical inability to merge the islands of automation will remain a well-hidden story.

The economic climate favours mergers and acquisitions. In each case, synergy is cited as a primary incentive to proceed. This is particularly true when damaged communications firms or hard-pressed financial services firms combine and centralise IT management. The federal government has also started consolidating information-handling for greater efficiency and to minimize the risk of technological failures. In each case, savings are expected to come from lower IT costs.

The disappointments from the amply funded and technologically sophisticated JP Morgan Chase IT consolidation should serve as a warning. The road to synergy is studded with mines. Top executives shouldn't promise IT improvements unless they have taken the trouble to understand what it will take to get the job done.

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