Synergy hunter Featured

7:00pm EDT December 26, 2008

They say one man’s trash is another man’s treasure. So as big players in the orthopedics device industry, such as Johnson & Johnson, migrated away from rehabilitation and regeneration products, like knee braces, in favor of higher margin surgical implants, Les Cross, president and CEO of DJO Inc., swooped in and acquired the unwanted divisions.

Don’t look now, but Cross has built a pretty substantial business from the accumulated discards. In the past few years, DJO, which had 2007 sales of $492 million, has more than doubled its size and product offerings, primarily through picking through those unwanted pieces via mergers and acquisitions.

“A lot of the big companies view these products as low end,” Cross says. “The industry has been highly fragmented, with many entrepreneurial inventors choosing to move on after developing a couple of products. It’s not a very exciting industry, growing about 3 to 5 percent a year. All of these factors have made M&A a desirable growth strategy.”

But quick expansion by a midtier company through acquisitions can be risky, especially when you factor in DJO’s major merger in November 2007 with $450 million ReAble Therapeutics Inc. After all, without effective assimilation of newly acquired businesses, CEOs can quickly accumulate corporate debt while losing customers, revenue and sometimes even their jobs. But with five transactions under his belt, Cross has learned how to buy companies without breaking them by executing effective M&A assimilation plans that capitalize on all the possible synergies resulting from the deal. His process begins with figuring out what his company can do with the acquisition, handling the personnel transition and then maximizing the cost reductions that can come from bringing businesses together.

Understand what you’re getting into

Before making an acquisition, Cross says it’s critical for CEOs to honestly evaluate their management team’s ability to handle an acquisition and take on the extra work. Few companies have the luxury of a dedicated assimilation team, similar to the one at General Electric, and inexperienced, overtaxed managers will often neglect their day-to-day business responsibilities and fall victim to Cross’ assimilation failure scenario.

“Honestly evaluate your team because most CEOs don’t have capable managers just waiting on the bench,” he says. “Either strengthen your team or find consultants you trust to help with the assimilation.”

Next, CEOs should set a straightforward assimilation plan and timetable and then monitor the results. Cross writes a one-page strategic plan, because brevity makes it easier to communicate the plan’s goals and track the results. Then, he meets with his executive team each Monday to keep his finger on the pulse of DJO. He also spends a great deal of time communicating.

“The CEO’s job is to structure and consistently deliver the message outlining the priorities and the goals during the assimilation period,” he says. “Also remember that you need to communicate with all the stakeholders. Good communication creates line-of-sight between the CEO’s goals and the employees, which keeps everyone focused on the outcome.”

No matter how much experience and expertise a CEO might possess in executing post-M&A assimilation plans, even the most finely crafted strategies don’t always go as expected. Since the merger with ReAble, both DJO’s president and vice president of sales have resigned, causing Cross to wear multiple hats while searching for replacements. He says honesty is the best way for CEOs to deal with bumps in the assimilation road before setting a course correction.

“We wouldn’t buy a company unless we could see a clear path of what we were going to do with it, but we also make some assumptions in the process that may not be correct,” Cross says. “When that happens, face the truth, because you’ve got to know what’s truly happening. If you’re falling behind your timetable and there’s a flaw in the assimilation plan, admit it and then set a course correction with urgency. Do it today.”

Take charge of the personnel transition

“Assuming the due diligence has been done correctly, I believe most mergers fail for one of two reasons: either the cultures of the merging companies fight each other, or everyone focuses on systems integration and they forget how to run the business,” Cross says. “Beginning with day one following an acquisition, you have to protect the quality of the product and the service first.”

Cross breaks out post-M&A synergistic opportunities into two categories: cost-saving opportunities and increased revenue opportunities. He uses different strategies to exploit each opportunity, while simultaneously minimizing the top two perils he credits with producing assimilation failures. In some cases, he gets a bonus, because the strategy results in long-term cost savings and market share gains.

Take his post-acquisition human capital strategy as an example. Cross favors terminating most of the people in the acquired company because downsizing achieves cost reductions and eliminates the risk of clashing cultures. But he doesn’t release the staff immediately, so customer relationships and revenue streams are not only preserved but also expanded through sales of enhanced product lines.

“The key is to protect the customer base, so aside from the sales force, everything else pretty much goes away,” Cross says. “When you try to bring the cultures together, everyone ends up working in silos, and there’s a lot of resistance and internal competition. The risk to the strategy is in the planning, because the business must continue during the transition period.”

Many CEOs fear telling acquired employees they’re going to be laid off because productivity, morale and customer relationships may suffer during the critical transition period. Cross advocates open dialogues with the soon-to-be released workers and gives them plenty of notice about when their positions will be eliminated.

“I use an open, honest and fair approach with the people who are part of the acquired company,” Cross says. “They normally remain on the payroll for one year and know that at the end of that time their positions will be eliminated. My experience is that people respond well when they are treated fairly. While they may be sad that they’re leaving, they have plenty of time to adjust.”

Cross offers retention bonuses to workers who stay through the transition period as well as severance packages, because the incentive plans assure that most of the staff will remain in their roles and the business will run smoothly. In addition, retaining the work force of the acquired company for a year gives DJO’s management team the necessary time to transition operational functions so they don’t get derailed by Cross’ second reason for assimilation failure: focusing on systems integration and forgetting how to run the business.

Cross advocates one exception to his policy of terminating all acquired workers: He keeps the acquired company’s sales force. Building increased revenue through cross-selling opportunities and driving sales force productivity is the goal behind every DJO acquisition. To optimize the marketplace synergies and retain market share and customers, Cross says it’s vital to retain the sales force. But leading salespeople is often like herding cats, so Cross creates a marketing and retention strategy aimed at the sales team as part of his assimilation plan.

“You have to quickly win the hearts and minds of the inherited sales force, so they stay focused on the customers,” Cross says. “It can be tricky because sometimes the merger results in reduced sales territories, since you’re adding more sales staff. To get them on board with the changes, it’s important to emphasize the upside. For example, we’ve given our salespeople a continuous flow of new products, so they have a lot more stuff to sell. This industry is only growing 3 to 5 percent per year, but we’ve been able to translate that into double-digit compounded growth, and that’s a reason to stay.”

Cross counts on his VP of sales to do most of the heavy lifting when it comes to winning the hearts and minds of the salespeople, but he also crafts and delivers personal messages to the group because their retention and performance dramatically impact the return from the acquisition investment.

“In the past, I don’t think I personally invested myself enough in the process from the beginning,” Cross says. “As a result, I think our sales force and our customers were more confused about the transition than they needed to be.”

Take advantage of cost reductions

Besides the savings from a reduction in head count, Cross assumes he will find manufacturing cost-saving synergies because he relocates the acquired company’s manufacturing process to DJO’s plant in Mexico. But he doesn’t necessarily assume that DJO’s manufacturing process is superior. The goal is to improve or maintain product quality by adopting the best manufacturing process, even if the decision doesn’t result in immediate cost savings.

“We are Toyota junkies, so we believe in lean manufacturing, and we have one of the top 10 manufacturing plants in North America,” Cross says. “If we believe we have a better way to manufacture the acquired product, we’ll shut down the other plant and begin manufacturing the product in Mexico immediately. If we find the other company has a unique manufacturing method, we’ll build up inventory while the DJO operations team works to transition the process. Our goal is better, cheaper and faster — but it has to be better.”

Cross allows his operations team to make the manufacturing process assessment and the recommendation, and even if he can’t garner all the anticipated savings immediately, he says DJO’s continuous improvement process will eventually ferret out manufacturing process savings.

Manufacturing synergies are easy to spot according to Cross, while savings from cost of goods synergies are harder to predict. Often supplies are secured through long-term fixed price contracts, and current inventories must be depleted before new pricing can be secured using greater expenditures as a negotiating tool.

“Cost of goods synergies are tricky to forecast,” Cross says. “I would discount your estimates. In other words, if you planned on $10 million in savings, I’d expect more like $7 million to $8 million.”

The result of this careful process at DJO has brought substantial growth. After the company charged to $492 million in sales in 2007, its recent merger helped grow it again in ’08, as it pushed past $733 million in its first three quarters, with a realistic shot at $1 billion. That success makes DJO an industry leader within the orthopedic device marketplace, a $6.7 billion industry based on 2006 estimates.

Going through all the steps can be a bit tedious at times, but Cross has learned that sticking with it is worth it — and a successful destination requires that you take measured paces.

“I think, in some cases, I pushed change too quickly with the ReAble merger, and I’ve learned from that and taken responsibility for the mistakes,” Cross says. “But I’ve learned that being a CEO is a marathon, not a sprint. So I remain calm and take a long-term view to get through the assimilation process.”

HOW TO REACH: DJO Inc., (760) 727-1280 or www.DJOglobal.com