Think alike? Swipe right.

Innovation flourishes when corporations with similar cultures merge.

By: Louise Lee

Like people seeking a mate, companies seeking merger partners use many criteria to pick The One. What’s the potential partner’s culture, for instance? What’s its industry? How deep are its pockets?

But in picking a new merger partner, companies sometimes use criteria that don’t ultimately help the combined firm to achieve success afterwards; in particular, their selection criteria do not increase innovation that leads to new products, according to reserach by Vithala R. Rao, professor of marketing and quantitative methods at Johnson. Moreover, the converse can happen: Companies sometimes don’t consider traits in a potential partner that could actually help post-merger innovation, thus missing opportunities to benefit from joining with that firm. Companies “May be paying attention to the wrong information,” says Rao, who co-authored the research with Yu Yu of AIG Science and Nita Umashankar of the University of California, San Diego (“Anticipated vs. Actual Synergy in Merger Partner Selection and Post-Merger Innovation,” Marketing Science, vol. 35, no 6. [Nov.-Dec. 2016]: 934-952).

Vithala R. Rao
Vithala R. Rao is the Deane Malott Professor of Management and professor of marketing and quantitative methods at Johnson. His current research includes competitive bundling, diffusion of attribute information for new products, and trade promotions. A widely published scholar, Rao serves on the editorial boards of Customer Needs and Solutions, Journal of Marketing, Journal of Marketing Research, and Journal of Business-to-Business Marketing.

Much past research has studied what happens to firms after they merge, but Rao, whose research interests include studying how managers make choices, wanted to learn what influences the selection of a partner and how those criteria affect innovation at the resulting company. The researchers examined 1,979 mergers from 1992 to 2008 among 4,444 companies across the biotechnology, computer, electronics and communications industries around the world. To measure innovation at a combined company, the researchers used a tally of the patents it obtained; the patents a company received, the higher the innovation level.

Rao and his colleagues found that companies that are culturally similar, or that, for instance, have a similar hierarchy of power or place the same value on group consensus, are more likely both to merge and to experience a rising level of innovation afterwards. Those companies join for the “right reasons,” the researchers found “if the culture is close, they can assimilate better,” paving the way for increased innovation later, says Rao in an interview.

If [merging companies’] culture is close, they can assimilate better.” – Professor Vithala R. Rao

On the other hand, the study found that sometimes companies merge for reasons that, it turns out, don’t help innovation. For instance, simply operating int he same sector of an industry makes companies more likely to merge but in itself doesn’t lead to more innovation. In that case, the firms may be overestimating the supposed benefits of working in the same industry, essentially hooking up for the wrong reason. Operating in the same field “may not help (with innovation) much because they’re doing the same things,” says Rao. “It’s not expanding their opportunity; it’s reinforcing rather than expanding.”

In other cases, companies may not consider or even recognize other valuable traits in a potential partner that could lead to innovation later. For instance, the study found that the prospect of having a large pool of combined financial assets didn’t affect the chances of two firms’ merging but later actually helped their level of innovation, probably because they had more financial flexibility. Likewise, the possibility of having greater depth and breadth of technical knowledge didn’t contribute to companies’ decision to join but nonetheless boosted innovation afterwards. Those findings suggest that companies may be prone to overlooking certain criteria, missing opportunities to merge with a partner with whom they could enjoy a rising level of innovation.

Worse, some firms actually decrease their potential for future innovation when they merge, the researchers found. In the study, for instance, prospective partners sometimes failed to consider their combined debt level, even though higher debt load hurt innovation by lowering financial flexibility.

Rao says that company leaders should be aware that corporate unions don’t always produce anticipated effects for benefits and can also have unexpected effects, both positive and negative, for unexpected reasons. “We know some synergies are anticipated, but in reality, some are realized and some are not,” he says. One lesson for any CEO, Rao adds, is to watch out for the potential pitfalls of unanticipated effects and protect against them. “If you acquire, make sure you get the synergies you expect by proactively implementing policies that support the merger. Make sure the potential pitfalls don’t happen.