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The right chemistry

ROI research magazine - UNC Kenan-Flagler Business SchoolCompanies have certain capabilities – such as entering new markets, launching new products or acquiring other firms – that allow them to grow and innovate over time.

Management scholars call these “dynamic capabilities” — the capacity of an organization to purposefully create, extend or modify its resource base. They have studied companies’ ability to develop one dynamic capability, but until last year there had been little published research on how companies might successfully develop multiple dynamic capabilities at once.

To tackle that issue, a research team examined how one specific chemical firm – Dow Chemical – developed multiple dynamic capabilities in parallel.

Christopher Bingham, professor of strategy and entrepreneurship and the Phillip Hettleman Distinguished Scholar, joined forces with Koen H. Heimeriks of Tilburg University, Mario Schijven of the University of Illinois at Urbana-Champaign and Stephen Gates of the Audencia Nantes Ecole de Management, to study the firm. They published their findings in “Concurrent Learning: How Firms Develop Multiple Dynamic Capabilities in Parallel” in the Strategic Management Journal.

The findings are particularly relevant as M&A activity reached a record level in 2015. “There were a record number of mergers and acquisitions announced in 2015, yet research is showing about 50 to 60 percent of acquisition deals are blowing up,” Bingham says. “What’s going on?”

How the researchers did it

To understand how companies develop dynamic capabilities over time, the researchers looked at Dow Chemical – the world’s No. 1 plastics manufacturer and No. 2 chemical company. Over the last 20 years, Dow systematically developed strong capabilities in making acquisitions, forming joint ventures and divesting business units. These dynamic capabilities have been key to the firm’s ability to grow.

Bingham and his colleagues pulled from internal records at Dow, extensive interviews with the company’s key longtime executives and public financial data on the firm for their research.

Because they had access to company archives and conducted more than 50 hours of one-on-one, semi-structured interviews with 16 veteran Dow managers, the researchers could closely track how the firm managed to develop acquisition, joint ventures and divestment capabilities over time, and how that development related to shareholder value.

How Dow did it

Starting in the late 1990s, Dow has systematically gotten better at negotiating, handling due diligence and implementing acquisitions, joint ventures and divestitures.

The improvements began, Bingham’s research reveals, when the company appointed a small group of seasoned executives to run a newly created Program Management Office (PMO) in 1999. The group’s initial mission was to guide and document Dow’s 1999 acquisition of Union Carbide Corp. Company leaders knew that integrating Union Carbide’s operations into Dow would be a big challenge and would be key to getting the most value from the merger.

Bingham and his colleagues call this first step the “initiating structure.” In their model of the Dow experience, it is the first of three phases the company went through to develop its multiple dynamic capabilities.

During this first phase, the PMO created a series of documents that outlined how to integrate an acquired company into Dow. For most business unit leaders, an acquisition was relatively rare. But having the PMO involved in all acquisitions across the company allowed it to quickly develop and document what actions and structures (such as cross-functional committees) were required to effectively integrate new companies.

Developing and updating documents — checklists, manuals and the like — establishes a corporate knowledge base that any executive involved in an acquisition can consult.

Following each acquisition, the PMO conducted after-action reviews. These allowed the team to refine what they learned further, documenting what worked – and what didn’t. In 2003, acquisition activity at Dow slowed and corporate leaders asked the PMO to focus on implementing joint ventures. Shortly thereafter, in 2004, the PMO added divestitures to their responsibilities.

The PMO was able to take the structure it had formed for acquisition integration and apply it to joint venture integration. In other words, it generalized the structure. An important insight here is that Dow went wide across a particular phase of several capabilities (the integration phase for acquisition, joint venture and divestiture) before going deep in any one of them, such as the transaction, due diligence and integration phases of acquisition. By 2005, the company had developed and documented expertise for the integration phase of acquisitions, joint ventures and divestitures.

One executive told the research team there were so many cross-functional teams with joint ventures and divestitures that “we needed to have an overall roadmap and communication so that people understood the overall sequencing as we moved forward.”

About six years after the PMO was created, it had proven its value in the final deal state – implementation. It began identifying more pain points for Dow. This is the third phase in the researchers’ model: backward-chaining structure.

The Dow team realized that the transaction and due diligence phases that came before implementation had many of the same problems and inefficiencies that had plagued deal implementations. With its track record of success well established, it was relatively simple for the PMO to move on to these earlier phases. They moved backwards in the deal stage, tackling due diligence first and then the actual transaction (deal making).

Another finding by the researchers is that Dow’s PMO didn’t simply document processes. They also advised the executives managing the transactions.

“You want some structure, but you also want some flexibility,” Bingham says. “One of the key takeaways in this research was not only the documentation, but also the role of the coach.”

Although there were best practices that applied across many transactions, documented processes had to be tailored to transaction-specific nuances. The PMO staff functioned as coaches, helping executives figure out which documents were helpful and how to apply them to their deals.

“We recognize that each of these transactions is unique, and therefore we have the coaching ability that can inject the flexibility,” Bingham says.

Creating value

This all sounds good in theory, but did Dow’s effort add value for shareholders? To answer that question, Bingham and his colleagues looked at Dow’s share price immediately before and after announcements of various acquisitions, joint ventures and divestitures. They also looked at the change in the company’s stock value after these announcements and asked whether share price improved more over the years, as Dow developed these capabilities.

It did.

“The stock is telling you whether people think this transaction is a positive thing,” Bingham says. The answer: “They’ve gotten better at all three capabilities – acquisition, joint venture and divestiture – over time. Their performance improved because of the structure they were putting in place.”