Game Theory and Consulting Mergers – A Partner’s Dilemma?

Game Theory and Consulting Mergers – A Partner’s Dilemma?

With the recently announced acquisition of strategy firm Booz and Co by PwC (still to be voted on by the Booz partners), consulting mergers are back in the news.  These – and very probably more to come – are being driven by a significant restructuring in the consulting market as basic consulting services becoming increasingly commoditized and new groups emerge offering alternative approaches to the provision of specialist expertise, advice and resources. (You can read more in a recent excellent Harvard Business Review article, “Consulting on the Cusp of Disruption”.)

However the history of consulting firm acquisitions has been pretty dismal across the board, and nothing suggests that future mergers will buck this trend.  The reason is simple – professional service firms rely for their success on their people and the client relationships that they bring.  If those people defect, the value is lost. ‘Doesn’t apply to us’? Think again: While critical for any professional services organization, this ‘core capability’ exists within sales/account management and customer support teams of most businesses regardless of sector.

Defections can occur at any time prior to, or after a deal, and increasingly sophisticated thought is given to designing incentives that will motivate partners to stay and contribute to the success of the merged entity.   However there are powerful psychological forces acting against these incentives, which need to be understood in order to be properly managed.

In many ways, the decision as to whether to stay or defect is similar to the Prisoner’s dilemma[1].  If all partners decide to stay, then assuming that the price is right, benefits should be maximized for everyone.  However each partner must consider an unpleasant alternative – what if he or she decides to stay, and others leave?  In that scenario, the merger may not go ahead, or if it does its success is likely to be fundamentally undermined by the departure of a significant number of key individuals.  Either way the partner who has decided to stay is left in a much less attractive position.  Furthermore, a later decision to leave may produce much lower benefits as the earlier defectors have already taken the most attractive positions, while the latecomer may be fatally tainted with deal failure.   Thus even though the average benefit would be greatest if all partners decided to stay, the prospect of being left behind creates a powerful incentive to be among the first to leave.

Other competing consulting firms understand this psychology and contribute to the dilemma by making early approaches to the most successful partners in the target firm – aiming to pick off individuals or entire teams with which to bolster their market position in key industries or offering areas.  Their argument is simple – you are going to change companies anyway – why not come to us instead?   The economic logic for competitors is straightforward:  by targeting the most successful partners or industry groups, they can offer benefits that exceed those that would accrue to the average partner in a successful merger, making the decision to defect quite easy.

For the acquiring party, this dynamic creates a different dilemma.  On the one hand, offering as high a price as possible up-front should ensure that the greatest number of partners in the target company agree to join.  However unless rewards are tailored quite closely to the real ‘market value’ of each partner, there is a danger that the most valuable will be picked off, and that they will significantly overpay for the more mediocre rump of the organization.   However agreeing differential rewards can be difficult and contentious, and they tend instead to be scaled to seniority.  For example in recent discussions around the sale of one consulting firm, junior partners were expected to receive $1M, mid-level partners $2M and the most senior partners $4M each.  Overpaying for partners who do not deliver also creates tension amongst the partners of the acquiring company, where high performers are unlikely to be pleased with the prospect of subsidizing the acquisition of a “B” team at the expense of their future bonuses.   If the merger does fail, there is little prospect of upside.  The erstwhile acquirer is likely to suffer reputational damage, and may not even have the consolation of picking off the best people, as by that time they are released from the constraints of the process, many are likely to have left.

Should the merger fail to go ahead, the prospects for the target company are not much better.  The loss of successful partners and in some cases entire industry teams, the huge distraction of the acquisition process, and the question marks it raises about their ability to survive independently will all constrain their ability to sell and deliver work to clients.  Flat or declining revenues may create a crisis of confidence that accelerates the departure of good people, leading to an inevitable downward spiral.

There are lessons from this for both buyers and sellers.

For the Buyers:

  • Understand who you are buying and how much you should pay for them.   Try to ensure that the rewards of the deal match what each partner is bringing, and avoid averaging across a highly diverse partner group.
  • Investigate the culture and processes of the company being acquired to assess the magnitude of change needed and its likely effect.   A culture survey up-front is strongly recommended as a basis for more concrete planning.
  • Be realistic about who will leave and factor this into pricing.  In the case of an acquisition by an audit firm, partners serving audit clients are likely at a minimum to face significant constraints in how they serve those clients and may look to leave regardless of incentives.
  • Create clarity as early as possible about what the post-merger organization will look like, and address the difficult issues head on.   In the face of ambiguity, people are likely to imagine the worst.
  • Build excitement about the merger for both joining and existing partners, through fostering entrepreneurship, pursuing growth opportunities, and celebrating the opportunity to bring a wider range of capabilities to existing clients.
  • As soon as the deal becomes public knowledge, speak with key clients to reassure them of service quality and continuity; and begin engaging them in the vision of the new combined organization and what it will be able to to for them.

For the Sellers:

  • Investigate the culture and processes of the acquiring company and make these discussable up-front, avoiding the ‘fear of the unknown’.
  • Celebrate the company’s past achievements and future potential within the larger firm, in order to build pride and commitment to success.
  • Engage actively in negotiations about the post-merger operating model, to ensure that key elements of the culture and strategy are preserved..

Actively target partners at risk of leaving, ideally with some flexibility around reward packages to encourage them to stay.    However if they can’t be persuaded, prepare contingency plans for serving those clients after their departure.

[1] A canonical example of a game analyzed in game theory that shows why two individuals might not cooperate, even if it appears that it is in their best interests to do so; more information can be found at’s_dilemma.