Caveat Emptor

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Expert Perspective by Grahall’s OmniMedia Editorial Board

Kevin Crowley’s July 12th article in Bloomberg announcing the planned acquisition of Hewitt Associates by Aon (Aon to Purchase Hewitt for $4.9 Billion in Cash, Stock) sparked a lively conversation amongst our Editorial Board members.  Aon is, as Crowley says: “…the world’s largest insurance broker” and Hewitt “…provides payroll and consulting services to 3,000 clients.” 

Upon the announcement, Aon’s shares initially dropped by 10% but both Aon’s and Hewitt’s stock prices are up slightly for the week.  For Aon, this result might be based on the strength of an upgraded rating from “hold” to “buy” by Bank of America Merrill Lynch analyst Jay Cohen. 

But other than some possible anxiety on the part of Aon shareholders, what does this acquisition suggest? Grahall believes that it reinforces the fact that much of the benefits administration and outsourcing services are becoming commoditized and margins are now razor thin.  In fact the biggest challenge for Hewitt, who competes against some of the largest money managers and mutual fund companies for outsourcing clients, is the other firms’ business strategy.  Most of these big financial services firms are likely running their outsourcing businesses as loss leaders to attract additional assets for management in their highly profitable investment businesses.

Of course, there aren’t assets available in health care outsourcing, another large part of Hewitt’s business. But with eventual changes from health care reform looming, many consultants predict that within the fairly near future (ten years?) employer sponsored health care plans and their administration might be nearly extinct.  Both firms have already suffered from a shrinking market in defined benefit pension plan actuarial consulting, at one time their core business, and can read the writing on the wall here as well.  Decades ago at Xerox, a senior executive once said “it is one thing to know what business you’re in. In 1915, companies that thought they were makers of  buggy whips became obsolete. Those that knew they were making accelerators and adjusted to trends were able to thrive”.

As we observed in our blog about another merger of consultancies Will Towers Watson Beat the Odds?: “It is well known that 70% of M&A deals fail to achieve anticipated synergies, with a dismal 23% of all acquisitions earning their cost of capital and 58% of mergers ‘failing to create substantial returns to shareholders’.   Why? Many reasons may contribute, but mergers often fail because of cultural incompatibility, clashing management styles and failure to change.   As Darwin said, it is not the strongest or smartest that survives, but the most adaptable.  Productivity declines in the first four to eight months are reported in 50% of mergers and organizations tend to lose 10% of their market share in the first year following a merger.  No less than eight major studies in recent years found ‘people and cultural’ issues to be the most common failure factors.” 

So in the face of these daunting statistics regarding the ultimate success of mergers, what is it that Aon sees as the opportunity with Hewitt Associates for which they are willing to pay a premium?  Well Hewitt’s 3,000 clients and their hundreds of thousands of participants certainly provide an appetizing menu for Aon’s insurance sales division.   However, to achieve these (or any) synergies, the companies will need to overcome some pretty significant hurdles.

One hurdle is the perceived difference in the quality of the consulting units within Hewitt and Aon.  Hewitt’s consulting unit is generally regarded as a top notch service provider, Aon doesn’t current enjoy the same reputation.

On the other hand, there has never been much synergy from the non-consulting units and the consulting units of the various insurance/brokerage/bank/”whatevers” and consulting units.  We are not fully sure why, but since many of us have witnessed the phenomenon first hand we are guessing it is more than just a matter of style. Michael Graham, one of our consultants, comments that “getting a consultant to take an insurance salesman, banker, or insurance broker out to their client is like getting a high school senior to take his sister out to the prom.  She may be hot and a great dancer, but he’s still more than a little embarrassed.”  

There is also a clear differentiation between the core strengths of these two companies.  That differentiation could lead to distinct business synergies but likely also suggests very different corporate cultures.  

With the CEO of Aon being high level McKinsey & Company alum with vast experience in management consulting, we wouldn’t bet our last dollar against this acquisition.  But we wonder if Aon’s management (as is the case for many others) has gotten obsessed with achieving gains in business volume at the expense of profit margin.  Hewitt’s client base is surely large, but competition is fierce. And the competition for retirement plan administration comes from mutual fund companies who generally crave additional assets to manage, and don’t care a bit about the profitability of administration services.  And on the horizon, is the prospect of dramatic change in health care programs that could reduce this outsourcing sector to a fraction of its current size.

We wish Aon and Hewitt the best of luck in this endeavor and will watch their efforts with great interest and curiosity.

Contact Grahall’s OmniMedia Editorial Board at edie.kingsotn@grahall.com

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