M&A Leverage

The People Transfer Conundrum

The People Transfer Conundrum

By Sharad Vishvanath

One of the most vexing issues in merger integrations is how to manage people transfer to drive deal and synergy goals in a way that does not negatively impact productivity or employee engagement. This applies in all types of transactions that entail people transfer, such as carve out transactions, managed services deals in telecom and business process outsourcing (BPO) deals, spin offs, divestitures, etc.

Clients often wonder if there is a magic bullet to do this well. What aspects should they focus on as they execute this critical change initiative? The first thing to realize is that no people transfer exercise is “simple.” Secondly, you need to plan and prepare very thoroughly. Prioritize and don’t make Day 1 bigger than it needs to be. Thirdly, this is typically a huge change initiative, more so for the employees impacted than sometimes the organization itself.

Let’s examine some critical areas that we have found are especially vexing and critical to successful people transfer.

Prioritize, Prioritize, Prioritize…

To borrow from the retail industry where the one-word mantra for success is “location, location, location”, for people transfer, it is “prioritize, prioritize, prioritize.” As we look at our research and client experience over the years, the top three areas of HR challenge and drivers of success that emerge are:

1. Rewards alignment & integration
2. Culture alignment – Both operating and organizational
3. Workforce optimization and right-sizing

1. Align rewards and performance expectations This is a critical driver, whether you are transferring a sizeable or small population. Let’s take an example of a managed services (MS) deal that entails a substantial people transfer. Transferring employees accepting the new offers and joining is critical to the deal success, and compensation has a big part to play in that.

So much so, that best-in-class MS clients will walk away/void the contract deal, if a specified percentage of employees don’t transfer in the first week. If the rewards alignment piece is not thought through, this step is bound to fail or the deal economics will be breached. Our research indicates a few strategies that are key to this step’s success and should be executed at the negotiation stage before deal/ contract close.

Firstly, understand that all employees are not equal and that a broad-brush approach will not work. Divide employees into criticality groups, say A, B, C categories, based on performance, potential and skill criticality. Design your pay peg point, complete alignment period and negotiation strategies, accordingly.

Secondly, if, as the transferee firm, you have different legal entities with different reward programs, leverage that to drive best compensation fitment. This will minimize adverse impact and differentials between the existing employee rewards and the compensation they will be transitioned to as part of your firm.

Thirdly, compensation levels often may be increased by the target firm just before a deal or contract. Do your diligence, negotiate hard based on your employee criticality categories, and ensure that expectations of compensation are set right. Fourthly, typically we find, especially in MS/BPO contracts, that there is a difference in performance orientations and expectations in transferring employees. Do unambiguous performance expectation setting with the firm and employees (if you have access before a deal closes) and use performance incentive as the mechanism to address this issue and harmonize levels of total pay.

Outsourcing contracts in Europe come with unique challenges. Corporations looking to enter into a business process outsourcing contract with another party must fully understand how both the “Acquired Rights Directive” and local law impact these decisions. In many cases, the employment and any associated liabilities transfer from the old employer to the outsourcer. However, the legislation is complex and may apply differently by situation.

We have supported several projects recently to help non-EU clients understand which terms and conditions must be maintained, and where flexibility may be considered. Certain benefits, such as pensions, may not be explicitly covered by the Directive, and thus separate consideration may be required for the treatment of past-service benefits and future program designs.

It is critical to consider the structure of any outsourcing contract to determine how to capture the impact into the commercial terms of the deal. In particular, the treatment of employee benefits in these transfer situations can be a material consideration in the pricing and negotiation of commercial terms for outsourcing deals. For example, defined benefit pension issues became a material consideration on two recent projects in the UK, including the successful negotiation of a 30-year concession for a government rail contract and the outsourcing of the first ever UK public-owned prison.

In Asia (India), in a large deal in the managed services (MS) space in the Technology, Media and Telecommunication (TMT) sector, we saw a clear bias of leveraging entities to get better fitment. Accordingly, a phased approach to compensation alignment was adopted with a three-year horizon, as employees being transferred were at a much lower total pay than the parent firm. Exceptions that were aligned in year one were identified critical skills and high potentials. The total pay peg point was also managed downward, capitalizing on the more premium “employer brand” of the parent MS firm. Using the above strategies, despite having major misalignments and unrealistic employee expectations, the firm was able to successfully transfer more than 90% of targeted and all of the “must have” employees within the first two weeks.

2. Culture Alignment
Not surprisingly, the culture aspect comes up as a critical pain point, based on our research and experience. This is addressable and best-in-class clients have a few tricks up their sleeve to recommend.

First, evaluate the operating culture gaps and organizational culture gaps as two different issues. In our experience in many cases the issue often lies more in the operating culture differences.

Secondly, run a structured operating culture gap analysis and culture future state articulation either before, or right after, the deal/contract close. This will measure gaps and articulate the desired state in operating culture anchors, such as performance orientation, standardized process vs flexibility, centralization vs. decentralization, decision-making protocols, speed of decision-making, talent buy vs. build philosophy, etc.

Thirdly, articulate your “non-negotiable” priorities and draw up a prioritized action plan with no more than three or four immediate initiatives to bridge the most critical anchors. The rest can be phased over a two-year period. Don’t bite off more than you can chew on immediate implementation; remember that culture alignment is an ongoing process.

In the large MS deal referenced above, process transformation, zero tolerance on compliance issues, process orientation, and leveraging the firm’s tools and system shifts were classified as “non-negotiables” from an operating culture standpoint. These were identified upfront during the negotiation stage and a time-bound plan to execute this transition was put into place right after Day 1.

Any employees not willing or able to conform were counseled, coached, and if all failed, there were instances of exits from the system on performance grounds. That’s how clear and “non-negotiable” the message needs to be. It provides clarity of direction and intent that is instrumental as you propagate a new desired culture.

On other aspects of culture, like decision-making flexibility, talent growth, performance orientation in rewards and career, etc., a more gradual staged approach was developed.

They ran a “culture audit” on Day 1 on these softer culture aspects, launched interventions based on gaps, and measured progress periodically through follow-up audits.

3. Workforce Optimization
This is perhaps the hardest reality in many transactions or managed services deals where operational efficiencies or cost synergies are a major strategic rationale in the deal. The key here as well is to have a two-layer approach. Evaluate the geographies from a “growth” or “mature” market perspective. Growth markets should be managed differently, even when cost synergies are a critical driver. Talent can be a critical differentiator in growth success and the cost of growth in these markets, current slowdown notwithstanding. So, for growth markets, focus on redeployment/reskilling of excess resources as you integrate or improve processes/tools that may create redundancies. International firms may also create a talent-export pipeline to other geographies that are similar, and experiencing growth on analogous business models or skills requirement.

For “mature” markets with margin and growth pressures, redundancies are an inevitable truth. Thus, best-in-class clients would identify a phased plan starting six months to a year out, which allows full knowledge transfer from redundant employees, and would bake that into the deal agreement or an MS contract. For example, in an MS deal, typically service providers will insist on full freedom in optimizing workforce to drive efficiencies from six months to a year after Day 1. Even here, talent “export” should be the first line of defense where feasible.

In the case of inevitable redundancies, our research and experience show that firms would ordinarily follow the lowest common denominator of the target firm’s severance, their own severance policy, and balance that with market practice. As long as the economics can be worked out, a firm needs to appear to be fair and balanced. Relying on the bare statutory minimum for severance may not be the smartest strategy in markets that have frugal severance norms, as it creates negative engagement in the residual workforce and negative brand impact within and outside in the market.

In a large BFSI merger in Asia, there was a huge efficiency improvement merger rationale that would inevitably cause redundancies. But there were also areas of growth beingdriven and redeployment was taken as the first line of defense to “resource” fund those growth initiatives. In the MS deal example, even in high growth economies where growth and margins were under pressure due to saturation of penetration, redundancies where necessary were executed one year into the contract. That said, good redundant resources once trained in the “new operating culture” were exported out to other geographies to help grow that market and execute similar deals.

Again, the complex labor law environment in the European Union will also govern an employer’s ability to execute collective dismissals. Entities that take over certain services in the outsourcing space may also face challenges managing the cost of redundancies. In the EU, when a specific service is transferred to a new entity, the employment relationship of those performing related services will automatically transfer. In general, if employees aren’t offered a position with comparable terms and conditions, there will be a redundancy cost triggered. Employers will also need to navigate the process of consultation with employees and their representatives or works councils through any perceived changes. The best approach includes a material commitment toward change management, detailed employee communications, and outplacement or retraining programs, where applicable.

In conclusion, the three action steps outlined above are the most critical to a successful people transfer in transactions. Though these are complex and vexing issues, there are some tried and tested strategies that can manage this risk well and ensure a smooth people transfer, while driving the deal strategies and goals.

Sharad Vishvanath, Partner, Asia Pacific Head, Aon M&A Solutions (sharad.vishvanath@aonhewitt.com)

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