A primary reason for merger and acquisition or rival companies in the telecommunications industry is to achieve cost savings. One source for those savings comes from the network integration of both companies’ owned and leased network assets and expenses. These is a plethora of options to eliminate redundant network costs, but buyers of companies are often too optimistic in their expected synergy savings. As a result, they often failed to achieve their initial savings target. This article explains why many of these mergers failed to achieve their financial goals and what you can do to improve them.
There are many methods to identify network savings. Although there is no set rule for identifying network synergy savings, a general method is to group network savings by optimization types or by geographies after eliminating redundant savings.
Unfortunately, this popular process of identifying network synergy savings fails to address key issues. There are five additional considerations before investing capital to acquire a company.
Consideration 1: Coordination of Multiple Optimization Projects – Some optimization projects aim to eliminate different parts of network costs within the same geographic area. Extra attention is required when dealing with many projects. Although these projects may deal with different parts of network costs, they are often inter-dependent of each other. The network planner often fails to understand these key relationships between projects and his lack of understanding can result in under-estimation of the project timeline while over-estimating project savings.
For example, the planner initially finds two projects in one geographic area. The first opportunity is to eliminate the leased access expenses by grooming them to the seller’s metro rings. Another opportunity is to consolidate the collocation space where local traffic is aggregated. The planner would like to consolidate the collocation space first, but the buyer needs to acquire additional space to accommodate seller’s equipment as well as incurring a higher penalty for eliminating seller’s collocation space in the first year of the merger. As a result, the planner waits for initiating the collocation consolidation plan. Since the terms under leased circuits are expired and billed at month-to-month term, the planner would like to initiate the groom plan to the metro ring as quickly as possible. The main problem is that the planner has to establish an interconnection between two collocation sites to route these circuits back to the buyer’s backbone network since it is not possible to groom these circuits onto the seller’s backbone due to its current transport route. These additional expenses of establishing the interconnection between buyer and seller, the revised saving is now substantially reduced. Another option is to re-term these circuits until the space consolidation project is feasible, but this decision will lead to the lower cost savings.
It is a worthwhile exercise to evaluate the relationships across different network components and how each of these projects would affect rather than looking at each project as a separate entity. We need to ask questions such as “Does it make sense to initiate a project ‘A’ first, then to project ‘B’?” “If a project sequence is reversed, how would other project impacted?” “Does it make sense to renew a leased circuit or implement a short-term solution while waiting for another project to launch?”
The planner must appropriately adjust the timing of synergy savings, as other projects may need to wait until completion of the predecessor project. The planner may consider a short-term fix such as renewing a leased circuit while waiting to initiate other inter-dependent projects.
Consideration 2: Network Evolution – There are short- and long-term network integration strategies. Attempting to maximize short-term savings can create constraints to implementing a long-term network solution. The planner must strike a balance between short- and long-term network decisions to find the integration strategy leading to a best Net Present Value (NPV). Unfortunately, the planner is tasked to realize savings fast, the decisions he makes would not lead to an optimal NPV over a measured period.
For example, there is a limited capital funding to integrate the networks in the first year of the merger. Where there is no capital available, the planner decides to establish leased network hubs to consolidate both companies’ leased circuits instead of building a network to eliminate leased circuits. The planner is uncertain that the capital will be available in the following year to build a network; thus, he decides to establish the leased hubs with a five-year term commitment. Because the termination liability charges to eliminate the leased hubs will be substantial as well as the cost of re-grooming will be prohibitive, the network builds will not be approved in the second year of the merger as indicated by the lower NPV. The first-year decision to establish leased hubs constrained the combined company to initiate the better project in the second year.
Consideration 3: Implementation and Network Scaling – Most people are fundamentally optimistic. It is no different for estimating integration savings. Actual results often show lower than expected savings and longer than expected project timelines. Some issues that can temper optimism are:
1) An integration of network would require dealing with different processes, cultures, and systems. These issues lead to a communication break-down resulting in a higher cost of network integration.
2) A post-merger is a hectic time for companies. Additional resources brought in to help speed up the network integration efforts with people unfamiliar with the company’s process and procedures result in more errors and re-works.
3) Network builds may require obtaining a permit or private easement negotiation prior to starting constructions, which can add more time to complete projects.
4) A target company’s network may not be scaled to support the traffic demand. Just because it has network assets at the right place, it does not mean that there is enough capacity to support the project. If the network is not scaled to support the capacity demand, then the additional capital investments and operating expenses will be required to augment networks.
The planner should become familiar with possible “soft” issues associated with network integrations such as cultural and communication issues. He needs to ask key information from the seller such as the current network capacity to avoid any future surprises. In addition, the planner should collect data to help estimate the realistic timelines for completing different project types so that he can adjust savings appropriately.
Consideration 4: Risky Projects – Just as there are risky stocks with above average expected market returns, a risky optimization project tends to result in a higher potential savings. The planner must be careful when estimating synergy savings. Normalize network savings by risk levels when comparing several network optimization approaches in order to avoid disappointments later.
For example, establishing a metro ring to a customer’s premise is a risky project. Grooming to the metro ring eliminate 100% of leased network expenses. Another strategy is to place a node in an Incumbent Local Exchange Carrier’s End Office (ILEC EO) where partial savings can be achieved. Without risk adjustments, the network builds to the customer’s site show higher savings. Unfortunately, establishing the metro ring to the customer premise would require the customer to get involved in the circuit groom. Not all customers are willing to groom circuits under this scenario unless service providers share savings from groom projects. Although the optimization project at the ILEC EO would not deliver a high cost reduction, it does not require the customer involvement. Groom projects without customer’s involvement lead to higher project completion rate. As a result, the planner must appropriately adjust savings when he compares optimization projects with different risk characteristics.
Consideration 5: Circuit Life – A cash-flow improvement from network cost reduction initiatives over long-term is harder to predict for reasons.
1) Customers continue to groom, upgrade, and re-configure circuits. These activities often result in circuits being prematurely disconnected. If the planner must prepare a long-term view of synergy savings, it is likely that the majority of circuits will not be kept after few years. The planner must factor an attrition rate into estimating the practical long-term synergy savings.
2) A majority of customers request circuit renewals at a lower price point. Customers are aware of the expanded networks from the merger, and they will demand a price reduction. Any cost savings projects will be short-lived.