m&a agility: secrets to success in cross-border...

© 2008 Towers Perrin

M&A Agility: Secrets to Success in Cross-Border Integration

A Webcast for Global Organizations

June 25, 2008

1© 2008 Towers Perrin

S:\EGS\2008\M&A\133770\M&A\webcast.ppt

Today’s discussion

The current M&A environment

Getting started: Towers Perrin’s point of view and the link between people and performance

Doing due diligence right ─ on a global scale

Nuances of national and organizational culture

Communicating across cultures and borders

Why governance is critical

Q&A



The M&A environment: What’s driving the deals?

Source: IMF, World Economic Outlook, October 2007; 2007 and 2008 growth rates projected.

2005 2006 2007 2008World output 4.8 5.4 5.2 4.8United States 3.1 2.9 1.9 1.9Euro area 1.5 2.8 2.5 2.1Germany 0.8 2.9 2.4 2.0Japan 1.9 2.2 2.0 1.7Africa 5.6 5.6 5.7 6.5China 10.4 11.1 11.5 10.0India 9.0 9.7 8.9 8.4

Recent Trends in Global Economic Growth



Converging economic and demographic forces

Skilled talent pools and labor shortages (e.g., IT, engineering) are expected in many countries

U.S. companies are particularly vulnerable to cross-border acquisitions because of depressed valuations and the weak dollar

Many companies are maintaining significant cash reserves that can be used to fund acquisitions

European companies may also be targets

Today, many industries (specialty chemicals, transportation, oil and gas, pharmaceuticals, financial services) are consolidating rapidly



Towers Perrin’s point of view: The people/performance linkage model

Areas of critical value

Employeebehavior

Customer behavior

Business performance

Culture

Leadership

Total rewards

Staffing and selection

Organization design

Governance

Attraction

Retention

Engagement

Attraction

Retention

Customer engagement

Revenue

COGS

SG&A

Operating margin

Stock performance

The linkage framework defines the connections between business performance, people and merger strategy in the context of national culture

National Culture

Business Strategy



The starting point for merger integration is to understand the business strategy underlying the deal

Acquire people or technologyExpand geographicallyGain market shareReduce costs: sales, marketing, inventory

Buy Competitors

Secure raw materials/inputsImprove qualityLower costs: R&D, production, inventoryAcquire hard-to-duplicate assetsRespond to deregulationEnter higher-margin industry segment

Buy Suppliers

Balance market risksExpand product portfoliosEnter entirely new businessesIntegrate product line

Diversify

Own distribution networkFreeze out competitorsLower costs: production, inventory, salesImprove identity/visibility

Buy Customers

Continued…



The starting point for merger integration is to understand the business strategy underlying the deal

Typical Reasons for Expanding into Geographic Markets

European UnionGain access to large capital, consumer and business marketsEstablish regional manufacturing or distribution centersAcquire unique assets or human capital

Gain access to emerging consumer and business marketsSecure natural resources and raw materialsEstablish low-cost export manufacturing operations

Gain access to emerging consumer and business marketsSecure natural resources and raw materialsEstablish low-cost regional and export manufacturing sites

Gain access to massive and varied consumer and emerging businessmarketsSecure natural resources and raw materialsEstablish low-cost regional and export manufacturing sitesAcquire unique assets or human capital

Gain access to large capital, consumer and business marketsGain access to technology and R&DAcquire unique assets or human capital

CEE and Russia

Japan, China, SE Asia and India

Mexico andSouth America

North America



— and, in turn, the approach to harmonizing rewards

Company ADominance

Dominant Player Absorption

The business strategy informs the overarching integration “philosophy”

Limited Integration

Mutual Best-of-Both Integration Transformation to New Company

Very little integration of A & B

Full merger of best practices from A and B to create a new entity

B’s assets are fully integrated into A

Best-of-both integration that also incorporates external and new company best practices

IntegratedNew

Company

Best of Company A

Best of Company B

Absorptio

n

Company B

HoldingCompany

CompanyA

CompanyB

IntegratedNew

Company

External Best Practices

Best of Company A

Best of Company B

New CompanyBest Practices

Possible Integration Philosophies

No, or very little, harmonization of A & B Transfer-of-undertakings rules

Harmonize within labor relations context, preferably redesigning reward programs to

support new culture Redesign reward programs to support new culture

─ and Implications for Rewards



In cross-border deals, due diligence is more critical than ever

Strategic acquisitions must pass the “better off” tests of creating value

Access to new opportunities that neither company would have alone; can impact sales, costs and/or capital investments

Gains economies of scale in shared activities; generally impacts costs

Transfer of skills between companies; can impact sales, costs and/or capital investments

Strategic Fit Scale

Scope

Skill



Are our assumptions regarding cost and revenue synergies correct?

Are there liabilities that we can expect from the combination (customer overlap, golden handcuffs, pension plans, etc.)?

Are there major integration costs (shared services with parent, IT systems)?

Are there risks to the stand-alone value (litigation, environmental complaints, business ethics)?

Are there risks to achieving projected synergies (culture, long-term contracts, etc.)?

Are volumes, costs, margins expected to increase/decrease?

Are our accounting assumptions correct (tax, goodwill)?

Effective due diligence requires understanding three key drivers of business value…

Stand-alone Value RisksSynergies



…and, in global deals especially, a sharp focus on key workforce and compliance issues

People Assets Adverse Margin Impacts People Costs Workforce Flexibility

Profile key managementOrganization chartSkill profileDemographic characteristics

Understatement of ongoing program costsSeverance paymentsCommitments to future cost increasesCollective agreement commitmentsExpatriatesRelocation expenses

Benchmark jobs and people costsBenchmark staffing levels

Goodwill issues/moraleProcedure stepsLegal barriersUnion/work council issuesTemporary/contract workers

Asset Liability Impacts Adverse Revenue Impacts Organizational Fit Compliance

Change-of-control triggersPension, welfare liabilities understatedContracts with executives may contain future liabilitiesBook accruals understated (e.g., vacation, sales commission)

Sales incentive designLikely employee turnoverRetention plansPending industrial disputes

Cultural barriersIncompatible job definitionsIncompatible reward structuresIncompatible process and structureDuplicate jobs

Programs and processesIllegal paymentsDiscriminationAcquired rightsPayroll and HRISCollective agreementsEmployee commitments



Brazil

Pension underfunding

Plan tax status

Minimum health benefits

Termination indemnities

Small group insurance costs

China

Provincial employment laws

Legally required benefits

Unrecognized benefit costs and liabilities

Constraints on severance practices

France

Triggering of individual and union rights

Post-retirement medical and life

Termination indemnities

Early retirement incentive and severance plans

Employee housing subsidies

Complex labor environment

Individual employment contracts

Germany

Triggering of acquired rights

Variation in pension valuation methods

Restrictions on asset transfers

Elimination of pension discrimination policies/practices

Retirement plan mergers

Complex labor environment

Japan

Complex compensation programs

Variation in pension valuation methods

Restrictions on retirement plan changes and asset transfers

Employee housing subsidies

Minimum legal benefit levels

Legal limits on reductions in benefit levels

Country-specific labor and compliance issues can greatly complicate the picture when integrating across borders

This is just a sampling of local laws and practices that can have a significant impact on deal price



Given the many moving parts, it’s important to focus on areas posing the greatest potential impact

BelgiumIreland

SwitzerlandExpats/IMEs

GermanyJapanU.S.U.K.

CanadaNetherlands

AustraliaItaly

FranceBrazil

Norway

GreeceKorea

MalaysiaMexico

PhilippinesPolandSpain

High

Mediumto Low

Small Medium to Large

Likely Significance of Employee

Benefit Liabilities

Number of Employees



Case study: Global manufacturing acquisition

Bid price: Over US$2 billion

ChallengesLimited time and limited access to the data roomGlobal transaction ─ data room documents in different languages

Target HQ in Germany11,000 staff in 33 countriesStaff concentration in Germany, Italy, U.S. Other countries: Australia, Brazil, Canada, France, Japan, Netherlands, Norway, U.K.

Programs Financial Impact (in US$ millions)Understated pension liabilities $78 – $96 Germany — insufficient pension indexation $15 – $18 Germany — true commitment not valued $5 – $10 Japan — partial funding of benefits $10 – $15 Italy — unreserved accrued vacation $10 – $15 Change-in-control provisions $30 – $35 Change in control: vesting of stock options $8 – $46 Total $156 – $235



Cultural issues — both organizational and national ─loom large in global deals and must be tackled early on

Culture is a pattern of actions, words, beliefs and behaviors that are shared by the members of an organization and that produce rules for behavior

In a sense, the organizational DNA

National culture determines manifestations of organizational culture (e.g., how people solve problems)

Core attributes of organizational culture are often (but not always) consistent from country to country within a single organization

In cross-border transactions, it’s critical to address issues not only of national culture, organizational culture and how they interact, but also issues surrounding how to connect culture and change to the business plan



Understanding national cultures and cultural differences is essential to success…

Source: When Cultures Collide, Richard Lewis, Third Edition.

Africa

Arabs

Iran and Turkey

India

Indonesia and Philippines

Korea

China

Italy and Spain

Russia

France

Belgium

Australia and Denmark

Netherlands and Norway

U.S.A.

Switzerland Vietnam

Hispanic America

U.K. Sweden Finland Canada Singapore HongKong

JapanGermany

MULTI-ACTIVE

LINEAR-ACTIVE REACTIVE

Task oriented

Highly organized

Planners

People oriented

Loquacious

Interrelators

Introverted

Respect oriented

Listeners



…as is understanding the DNAof each legacy company’s culture

LeadershipWhat they attend to, measure, reward and control; role modeling and coaching

Mission, Objectives, Values and Strategies

Customer Experiences

Shareholder Value

Business PartnerRelationship

Business ResultsE

mpl

oyee

Exp

erie

nce

Work EnvironmentDesign of physical space; socialization patterns

Programs, Policies and PracticesCriteria for recruitment, promotion and exit

Brand Promise

Organizational Structure

What definesculture

How it isdemonstrated



Culture should align with strategic business priorities to drive value

Customer Service Company ImageEfficiency Quality Innovation

Safety focusStructure/process efficiencyTrainingCoordinationData orientationPerformance managementFocus on prioritiesInvolvementWorkload/resourcingPhysical conditionsCustomer understanding

Shared understanding of company direction/ brand Shared values/prideIntegrityLeadershipBelief in product/ service quality

Teamwork/BP sharingProcess quality focusEmpowerment TrainingLong-term orientationUnderstanding customer’s quality expectationsData orientation

Diversity of thoughtSupervisor relationsStimulating environment (physical)Stimulating environment (interpersonal) Information sharingCollaboration/ teamworkSupport for risk takingRewarding innovationBias for actionAnticipating customer needsFlexible work arrangementsCredible leadership

Career developmentPerformance managementLocal flexibilityPositive working relationshipsSupportive service environmentCustomer knowledgeService orientationValuesLearning/information sharingBelief in product/ service quality

Cultural differentiators* by strategy in financial high-performance companies

Major Strategic Priorities

*Differentiators derived from employee research into the survey questions and topics on which financially successful companies excel versus their peers.



Critical issue: Is the current culture appropriately aligned with future direction?

0.10

-0.09

0.12

-0.19

0.15

-0.05

0.13

0.43

0.140.07

-0.50

-0.30

-0.10

0.10

0.30

0.50

Customer Quality Efficiency Innovation Image

Current Future

In this case, the current cultures of both parties to a deal were closely aligned, emphasizing customer, efficiency and image

However, the future business strategy called for a new emphasis on quality and innovation, enhanced focus on image and lower emphasis on efficiency



Case study: Energy industry consolidation

In response to deregulation, an energy company began acquiring smaller companies within the industry

Company leadership felt culture was not an issue because the acquirer and the targets were already culturally aligned

While this was, in fact, the case, the current cultures were notaligned with the future strategy and industry environment

Current cultures were a reflection of the industry’s historical heavy regulationCompanies had become bureaucratic and paternalistic

The goal for the new organization should have been to create a culture that fosters customer service and innovation

Ultimately, leaders recognized the need to forge a new culture that rewards employee behaviors reflecting customer knowledge and innovation



Research confirms that effective communication can make or break the integration process at the outset

Integrating benefit programs

Rigorous staffing and selection processes

Integrating pay and performance management programs

Helping middle managers accept their role as leaders

Focus on cultural alignment

Strategies to retain key employees

A well-executed employee communication program

Selection of the top team

Effective leadership from top team

Source: Towers Perrin TP Track Survey; percentages reflect the answers of those respondents who have completed at least one deal in the preceding three years.

Most Critical People Issues: First Three to Six Months of Global M&A Deal

27%

27%

29%

30%

47%

65%

75%

85%

87%

39%

47%

46%

41%

35%

28%

22%

10%

10%

20%

22%

14%

23%

12%

5%

14%

11%

6%

6%

1%

4%

2%1%

1%

2%

2%

4%

Critical Somewhat critical Neutral Not very/Not at all critical



Effective communication strategies help companies address a raft of employee questions about how the deal will affect them personally

My Company

My Team

What will happen to me?

What will happen to opportunities for my career …long term?

How will my day-to-day work change …short term?

What will happen to the people I work with?

My Work

My Career

My Future

My Money

What will happen to my ability to earn money…short and long term?

What will happen to the company I joined?



Case study: Global consumer goods acquisition

A large consumer goods company acquired a multinational division from a competitor in a multi-billion-dollar deal

Goal was to broaden the product offerings and gain distribution and sales networks in more than 30 countries, including key emerging markets

The company had stumbled in previous acquisitions by relying almost exclusively on centralized communication channels controlled by headquarters

Created uncertainty, distrust and union activity among acquired groups because the company failed to recognize that communication from HQ signaled unpleasant changes for many employees in other countries

To more effectively integrate this major global acquisition, the company devoted considerable effort to developing a balanced communication strategy

Identified the most appropriate media for delivering different messages Trained regional/national managers to play a prominent roleEmphasized personal, one-on-one messages from managers to help engage employees and inspire confidence in the transaction



Why governance is especially critical in cross-border transactions

In the broadest sense, governance is the oversight process or processes an organization follows to mitigate risks and safeguard the corporation’s interests

Addressing governance in the cross-border M&A context is always difficult and often an unexpected tripwire because of issues such as:

Lack of familiarity with local and national requirements and normative practicesPoor documentation of existing authorities and accountabilities Failure to communicate parent company governance structures and oversight requirements

To provide meaningful control, establishing authorities and accountabilities cannot be an ivory tower exercise

Research shows that institutional investors will pay a premium for good governance practices and that companies with the highest governance rankings deliver higher financial returns



How governance models differ between key regions

United States“Liberal model” ⎯ priority given to shareholders— Encourages radical innovation and cost competition Sarbanes-Oxley Act has codified governance framework

United Kingdom“Flexible model of regulation”Principle-based code that lists dozens of recommended practices— Publicly listed companies can choose whether to apply principles— If not applied, must explain in annual reports whyStructured, but with flexibility

Asia, Latin America and other European countries“Insider model” ⎯ interlocking networks and committeesFamily-owned companies common — Japan (keiretsus), Korea (chaebols), Philippines, Indonesia— Mexico, Brazil, Argentina, etc.— Italy, Spain and France (to a certain extent) Decision making concentrated at top levels



In which cross-border transactions are governance issues most sensitive?

Lack of trust: governance models in certain regions, countries

Lack of transparency: understanding and penetrating complex networks Family-owned companies, conglomerates

Emerging Markets Target

U.S., W. Europe Target

Perception that targets in North America and Western Europe will have difficulty accepting foreign ownership (particularly from emerging markets)

Pronounced differences between family-owned companies in emerging markets and liberal model of the United States

U.S., W. Europe Investors

Emerging Markets Investors



Key elements of the governance framework

Effective and Accountable Boards Board charterRules of governance

Internal Control Environment

Compliance Program

Reporting, Monitoring and Auditing

Policies and proceduresCritical process mapping and identification of risks and risk mitigantsDecision-making responsibility matrix

Stakeholder Management

Code of conductPolicies and proceduresCompliance trainingRisk assessment and risk management planning

Audit function Financial, operational and compliance reportsBusiness and compliance review processes

A corporate social and environmental responsibility program, plan and initiatives

Leadership and CultureMission and value statementsGuidelines for leadershipAnnual business and compliance plans

Management Tools



Best practices in cross-border governance

Address governance issues early Consider basic RACI* model during due diligence or early in the integration processTest local, country, national normsAssess compliance risks and “vulnerability gaps”

Establish clear rules of the road and communicate them bi-directionally

Assess changes against a value creation/destruction framework

Key areas of focusDecision-making body and guidelinesOrganizational culture of complianceSuccession planning Performance metrics that include compliance measuresApproved protocols and limitsDocumentation and dissemination of process

*Responsible, Accountable, Consulted, Informed.



Case study: A global professional services firm

After acquiring significant operations in Asia, a global professional services firm elected not to act on signals that governance processes in several of the Asian countries were ineffective and needed to be clarified

No culture of compliance in certain locationsAcquirer lacked familiarity with local requirements and normative practices

Within months of closing the deal, the firm became the target ofinvestigations by regulatory bodies in Japan and Korea

Japan and Korea offices barely escaped forced closing, but facedsevere sanctionsFuture business was jeopardized

The offices were forced to overhaul their governance practices — in particular, the compliance program and internal control environment

Closer attention to governance issues earlier in the process would have avoided big headaches and significant compliance and reputational costs



Sample analysis of target company workforce…

Variability

Hig

hLo

w

FavorabilityLow High

Highest Risk

18% Flawed in XYZ Overall

Lowest Risk

32% Secured in XYZ Overall

Moderate Risk

32% Exposed in XYZ Overall

Slight Risk

18% Vulnerable in XYZ Overall

Exposed Vulnerable

Flawed Secured

Source: Towers Perrin-ISR compliance framework, which surveys employees to gauge the ethical characteristics of the workforce; a secure environment is one in which favorability on ethics questions is high and variability in those opinions is low (i.e., ethical practices are sound and that sentiment is widely shared).



…and a closer look, by country

313328213230242744232630303944522947

% Exposed

1526338

1513371019281314159

20304718

% Flawed

1328China/Hong Kong930Thailand

2051United States

2239New Zealand1937South Africa2233Canada2527Brazil1225Argentina711Japan421Korea

1620Chile

32

323930422337

% Secured

23

211810211512

% VulnerableCountry

Australia

IndiaMexicoSingaporeVenezuelaRussiaTaiwan



Some final thoughts on best practices for cross-border M&A transactions

Conduct thorough due diligence that encompasses financial and workforce issues and addresses critical integration issues (e.g., culture, governance)

Address national culture early and build awareness with leadership team(s)

Communicate aggressively, focusing on the business rationale but taking into account local/national cultural and communications norms

Assess organizational culture and alignment against business strategy

Review governance model against a value creation/ destruction framework



Questions?

[email protected] [email protected]



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