Due Diligence : the HR component in a Merging & Acquiring process

1. Due Diligence : the HR component in a Merging & Acquiring process Lecture 9 Rightsizing Workshop, Muscat

2. Contents • Introduction : Strategic reasons for M&A • Due diligence in M&A operations • From classic due diligence to strategic • Interest and stakes in HR and management aspects of due diligence • Example of approach and application • Conclusion: what are the impacts on a systematic approach of HR Due Diligence development ? Rightsizing Workshop, Muscat

3. Strategic reasons • Economy of scale, critical mass and rules of yield growth • Entry barriers, patents purchase, diversification and time consumption • Globalisation • Deregulation • Focus strategies and politics • Purely financial reasons $ Rightsizing Workshop, Muscat

4. Starting point : the paradox of transnational M&A Great progress was made lately in mastering acquisition operations in the « pre » and « post » acquiring phases..However… ... A high failure rate still remains when transborder operations happen : • According to studies (*), 4 out of 10 clearly failed, with very negative impacts not planned, decreasing dramatically or destroying the value of the companies • These failures are partly due to human and cultural factors • Other perspectives of prejudice : for the acquirer and the target company, for the local stakehoders and for the market integration …M&A are to develop in the next years • Looking for critical mass or size on niche markets • Higher cost of technological development while competition increases throughout Europe / USA / Asia M&A are essential but the managing process is still not mastered (*) Solving International Rightsizing Workshop, Muscat

5. In terms of management, leadership Human Resources and social relations Cultural aspects In terms of organisational Excellence Coming back to our plenary discussion in 2004 Impact of the Strategic Partner : Risk or Opportunity for the HRM ? TECHNICAL ECONOMICAL Rightsizing Workshop, Muscat

6. To loose control (independency) from management point of view Corporate culture Cross-cultural conflicts Loosing the national brand Moving facilities Allocation of tax and funds Risk to be fired (decreasing number of employees) Moving to new HR policies To loose the best employees who have key know-how and are not able to accept new corporate cultures Change of working hours Increase of expenses due to implementation of all changes (new logos, dress code etc.) Know-how (management skills, tools) Possible promotion Better sources Strategic contacts and support Database of possible candidates More positive brand (reputation) Opportunity for the training and development of employees Step forward Change of strategy To loose the low skill and non-efficient employees Sharing the risks (financial or other) RISKS & OPPORTUNITIES Rightsizing Workshop, Muscat

7. Less opportunities of internal promotion (especially for Top Management) Alignment of two cultures ? Less opportunities of employment (national, locals) during the limited period of partnership Strategic decisions take longer time (e.g for a new equipment) Technical issues : maintenance, spare parts… Language barriers..!! Communication issues Undisclosed obligations (e.g. purchase of hardware from certain specific equipment providers) Financial assistance (be careful of ratio of shares not more than 50% and less than 40%...) Technology awareness Managerial aspects (new abilities, skills, new roles, style of management,..) Potential development (image, finance, technology,..) Change of culture (customer orientation, behaviours,..), Mixture of culture (take the best of both cultures) Improvement of quality of life for employees (e.g. through payroll) Different strategic of thinking (e.g. renting vs buying) RISKS & OPPORTUNITIES (1) Rightsizing Workshop, Muscat

8. Everlasting marriage unless limited time given in the contract (ex. management contract) No training for the local people Short-term results expected by Strategic partner (contradictory interest with long-term expectations of the operator) Competitive market (and not monopoly anymore!) The strategic partner might take over the control of specific projects in the development countries Nationalism factor…social aspects… Quality of network (new equipment) Win-Win approach (both companies win) Marketing opportunities (outside the country) Get the best equipment / technology platform at a lower rate, better infrastructure.. Investment opportunities Have satisfied customers because of variety of choice of service at a better price.. (no more monopoly) Cultural exchange (development of communication) Development of other markets (tourism, general public..) : think global!! RISKS & OPPORTUNITIES (2) Rightsizing Workshop, Muscat

9. Financial aspects Bad social climate / Stress Downsizing : what about the future of the employees? Discrimination (in terms of wages for example) Political issues Potential security aspects (frequency spectrum) Resistance to change Experience in Privatization, in restructuring, in commercial awareness Financial management Know-how Worldwide network (partners) Administrative aspects Capital investment (good for state!) RISKS & OPPORTUNITIES Rightsizing Workshop, Muscat

10. Opportunities / Risks • Investment • Improve the relations with the Unions • Build new culture, New blood – cross-culture • Capacity building and training opportunities • Transfer of skills, knowledge and processes • Rationalizing manpower – opp. to review the structure, staffing levels, efficiency etc • Cost-cutting, performance improvements, project management • Job losses • Transfer of power : “dirty” work left for HR such as : • Negotiating with Unions • Reviewing terms and conditions • Newcomers to replace or supervise existing HR : loss of power distance ; loss of some more “powerful” positions • What about the skills? • Nepotism Rightsizing Workshop, Muscat

11. Opportunities / Risks (contd) • Exposure to other working cultures • Quality management (TQM) • New working ethics, Social responsibilities • Re-skilling, mixed skills • Creation of biz opportunities by outsourcing certain non-core tasks • Talent sharing with the Strategic Partner • Diversity management • Knowledge sharing • Motivation • Expansion of democratic space • Succession planning and career development possibilities, • Negotiating a GOOD partnership • Technology transfer, product/system development spin-offs which may create new job opportunities • Leadership development • Capacity building : joint-ventures • Transfer of technology • Methodologies • Cultural clashes / undermining cultural values • Interconnections : imposing traffic routing via strategic partner backbone • Unethical business practises • Promoting and developing people within the organisation becomes more difficult • Psycho fans Rightsizing Workshop, Muscat

12. Interest of Strategic Due Diligence Acquire and target shall fit together as overall organisations Rightsizing Workshop, Muscat

13. Interest of Strategic Due Diligence as a response to the paradox OF PRE-ACQUISITION PHASE POST-ACQUISITION PHASE Internal decision- making process Data Room Phase • Leading the DD (data room, management meetings,..) • Elaborate provisional business plans • Write the proposal Phase of Due Diligence Rightsizing Workshop, Muscat

14. A « human capital » dimension as a key component of the strategic Diligence Interesting aspects of the Human Capital dimension In pre-acquisition phase : A necessary tool to the financial approach In post-acquisition phase : An essential tool to assure success in merging or joint-venture creation in the next 100 days A key dimension to master in the framework of active development and integration Rightsizing Workshop, Muscat

15. … but not systematic today In pre-acquisition phases, because of Financial Officers and Bankers methods that : • Give preference to financial analysis (patrimony, multiple, yield) • Forget non-tangible aspects like human capital because they : • Lack time • Lack skills in non-tangible evaluation • Lack tools and proven methods • Do not associate Human Capital experts and Human Resource Director … This can have serious impact at post-acquisition phase such as : • Key managers leave the target company • Motivation seriously decreases at middle management level • Social climate degradation • No compatibility between the two corporate cultures • Problems with system and tools integration (in HR : classification, Comps & Bens, …) Rightsizing Workshop, Muscat

16. … Natural Reflex • Ask for more training from the strategic partners • Downsize clumsily • Hope for exagerated increase of wages • Under-estimate value added of strategic partner in terms of Information System improvement • How to best prepare ? • How to « sell » positively ? • On which aspects shall we insist during negotiations ? Rightsizing Workshop, Muscat

17. Big attention driven on the «Management-leadership » • The four key domains of human capital diligence Done mostly instinctively as it is perceived as not requiring expertise skills A lot of improve- ments done lately especially in trans-national operations. However, lack of tehnics and tools. Due Diligence Human Capital Most privileged aspect because absolutely necessary in post-acquisition preparation; however, focus is too often made on Information Systems Most formalised aspect which has really progressed lately; can be deeply analysed Rightsizing Workshop, Muscat

18. Management, Leadership • Interview the key managers and respect the confidentiality of the pre-acquisition aspect • Evaluate their ownership to the internal appraisal system • Measure their knowledge of the promotion and career management system • Analyze the Compensation & Benefits system (quantitative and qualitative aspects) • Evaluate their knowledge of the organisational environment Rightsizing Workshop, Muscat

19. Human Resources and social relations • Internal barometry, satisfaction surveys of the personnel • Number of strikes, % of absenteeism,.. • In the executive population : is there any differentiation wanted? • Places to freely exchange and communicate for the employees • Rate of active participation in labour unions • ... Rightsizing Workshop, Muscat

20. Organisational Excellence • Organizational analysis (existing reports proving will of progress, total quality management system,…) • Regular internal Audits (quality system and/or others) • Excellence models used (eg: EFQM) and self-evaluation of the organisation • Workshops, communication sessions for the personnel • Implementation of communication systems for the workers and other non-executives Rightsizing Workshop, Muscat

21. Cultural aspects Culture : set of values, behaviours and objectives within an organisation, a team, a project… • Good inter-cultural mix at different hierarchical levels, in the organisation as a whole and in projects • Knowledge rate of foreign languages • Taking into consideration the inter-cultural communication aspects in the personnel appraisal system Rightsizing Workshop, Muscat

22. What does this type of new due diligence bring? • Avoids first-impressions, too intrusive investigations, stereotypes.. • Helps characterize, be objective, and measure whenever and wherever possible the real adequation between the targetted management team and the acquirer project, especially in terms of : • Individual motivations, personal objectives • Team dynamics • Management and leadership at the Top executive level • Starts the dialogue on an objective and solid basis between target and acquirer in the post-acquisition integration perspective Anticipate on specific source of risks that can heavily weigh on the business plan implementation Rightsizing Workshop, Muscat

23. Are both visions coherent and compatible together? Do both Top management share the same analysis of the environment and business plan? Of the HR policy? Do the management systems at Top level correspond to the acquirer philosophy (comp&bens, talents management, succession planning system,…)? Can the Top management at target support and implement the acquirer’s strategy ? What are the resistances to change? Three major steps for this new due diligence OVERALL FIT 1 2 3 Vision and strategic planning of the acquirer Leverage for added value Diagnosis and recom- mandations Rightsizing Workshop, Muscat

24. Investigation methods structured by time and access to information constraints that need two type of approaches • A more «intuitive» part that calls for • Intimate convictions • Feel for «fit» • « In situ » observations • A «scientific» part with proven methods (audit) • Check list • Interviews • Round-table • Data analysis (key indicators) • Tests with pilot phases/cross analysis • Psycho and personality tests … like a private detective… Rightsizing Workshop, Muscat

25. Other success conditions (1) • Good definition of the objectives (synergy makes 1+1>2) • A method for detecting future problems (golden parachutes,… « Who are those people we are buying? ») • Not to pay too much but not to loose the opportunity (WIN-WIN approach) • Good knowledge of the different stages of the acquisition then integration ( «consolidation» phase) • Confidential phase • Communication and decision-making phases • Building the new structure and organisation of the integration phase • Implementation of change Rightsizing Workshop, Muscat

26. Other success conditions (2) • Know how to make decisions as early as possible in the process • Choose a method and a rythmn of integration • Personnel policy and concerns of the HR Directors • Build a communication policy • Manage stress and moral linked with anxiety • Manage over-staff cases • Avoid WIN at acquirer and LOOSE at acquired • Organise mutual knowledge • Use mixed teams • Involve and motivate personnel proposing new challenges aiming at 1+1=3 Rightsizing Workshop, Muscat

27. Example of case study : a European acquisition in the Telecom sector Rightsizing Workshop, Muscat

28. Conclusion : what’s at stake ? • From the Acquirer’s perspective(companies, banks, investment funds) : • Integrate fully management dimensions, HR, social and cultural issues • Weighing strictly financial and economical approaches • From the financial bodies and HR specialists: • Better collaborate and evaluate • From the academic perspective : • New fields of research : For example study of the impact of human capital on the cost of capital, develop a method for evaluating human capital • From the HR function positioning perspective : • New role of Expertise in terms of evaluation of non-tangible within a M&A operation • New role as a leader of integration process Rightsizing Workshop, Muscat

29. Conclusion Strategic due diligence which takes into account human capital aspects allows Human Resource to reinforce its strategic role Rightsizing Workshop, Muscat