The human factor

Acquiring a company in India can throw up four human resource challenges.

Even as the economic slowdown has impacted overall merger and acquisition (M&A) activity in Asia Pacific, India (along with Japan and China) is among the top five countries in the region with the highest number of M&A deals in the first three months of 2009, even as deals saw a 72 per cent decline from the same period a year ago. PricewaterhouseCoopers lists India amongst the top three emerging markets to watch out for over the next 18 months in terms of attractiveness for deals.

With the general election results suggesting a stable government at the Centre, the outlook for India remains optimistic in both cross-border and domestic M&A activity. According to a recent Economist Intelligence Unit (EIU) study, M&A Beyond Borders: Risks and Opportunities, the rapidly developing economies of China, India and South-East Asia remain attractive destinations for M&A deals, with 57 per cent of the study’s global respondents stating that these countries would figure “significantly or very significantly” in their company’s M&A strategies, well ahead of North America and Western Europe. In addition, Indian companies will rely on a mix of organic and inorganic growth strategies.

However, there are a host of human capital issues that deal makers need to acknowledge. According to the same EIU report, the two biggest human capital risk areas identified for these economies are organisation culture differences and talent shortage/retention issues.

In our experience of working with Indian companies, there are four major challenges that emerge as critical success factors in M&A transactions and span all stages of the deal:

• Tackling employee liabilities, statutory compliances and union issues: Defined benefit pension plans are less common in Indian companies. However, companies that have been in business for a longer time often have defined pension and/or health benefits. Though it is mandatory for companies to make provisions for potential liabilities arising from this in their books, a third-party valuation can uncover significant under-funding that may need to be adjusted against the deal price. Further, the provisions in the structure of various retirement trusts may need to be amended to allow the smooth integration of differing benefit schemes of the buyer and seller.

On the organised labour front, compliance with statutory benefits pertaining to “workmen” as defined by the Industrial Disputes Act, along with taking stock of union settlements, protects the buyer from unpleasant surprises at a later stage including financial obligations for overtime wages to workers, minimum wages as per government stipulated rates, and “perennial employment” claims where temporary contractual workers who have been continually working for the company can claim for permanent employment at considerably higher wage rates.

Each of these could have substantial impact on the deal price since the errant company could be legally obligated to make up for years of non-compliance on a retrospective basis. If such issues are discovered after the deal is signed, the financial obligation becomes the buyer’s headache and can erode the value of the deal. Therefore, any threat of legal penalties arising from such non-compliance needs to be offset through inclusion of suitable indemnities in the purchase agreement or cleaned up by the seller before the deal is signed. Similarly, in a unionised scenario, restrictions in union settlements related to wages, employee movement or productivity enhancement may need to be renegotiated even before the deal is signed or immediately after closing.

Despite overall economic growth during the last 15 years, employment laws and labour union regulations have remained virtually unchanged and they continue to provide significant protection for employees. For instance, it remains easy to form a union, requiring the signature of only seven people. Also, the Industrial Disputes Act prohibits restructuring and redundancies without employee involvement. These limitations are often a surprise to buyers from outside India who expect the development of the human capital environment to have kept pace with economic development.

• Employee retention and the leadership challenge: Employees who have both intimate knowledge of local markets and strong relationships with customers make “key employee retention” an imperative for realising the value of the transaction. The loss of key talent in a highly competitive labour market can, at minimum, delay realisation of the transaction value. In the same study, EIU identified talent shortages and retention issues as the greatest risks in China, India and South-East Asia. In Mercer’s experience, identification of key employees early in the deal and putting in place a “balanced” (with both short-term and long-term incentives) employee retention strategy and performance measurement plan can go a long way in ensuring continuity of “business as usual” and ensuring people synergies — that is, engaged and productive employees.

While retaining key employees allows the buyer the necessary means of executing its M&A strategy, the clear focus is on leadership. With infusion of cash and scale (that is, becoming more global), the immediate business need is often to identify, assess and retain leaders who can take the business to the next level. This is especially true for “out-in” deals where the playground shifts from India to the global arena.

• Rising labour costs: Given both the rapidly escalating wage costs and the tightening labour market in India, acquirers must have an understanding of potential idiosyncrasies in the compensation philosophy and structure of the Indian target. According to Mercer’s Global Compensation Planning Report, employees in India’s corporate sector are likely to see salary increases of 14.1 per cent on average, compared to forecasts of up to 2.7 per cent for Western Europe, up to 3.8 per cent for North America and 2.5 per cent for Japan. This has been the trend over the past few years. And in India’s research and development sector, the average cost per employee rose 16.2 per cent annually in the past three years. The presence of expensive executive compensation packages and golden parachutes can add up to considerable numbers. An added complexity is the fact that Indian salary components and benefits (that is, multiple cash allowances for housing, rent, car and so on) often differ considerably from those in the West. A clear understanding helps deal makers avoid potential mistakes.

In short, acquirers in this market need to factor the compensation scenario of India into their deal prices, in order to build innovative variable pay-driven rewards models as an effort to control wage costs during integration — so consider variable pay options like deferred bonuses or a cash-based bonus based on performance (every six months or even every quarter). According to findings from Mercer’s Asia Pacific Total Rewards Survey 2007, though Indian employees continue demanding higher salaries, they are increasingly attracted to companies providing career growth opportunities and where senior leadership serve as “role models.” Any liability arising out of severance arrangements can be potentially offset against the deal price if detected early enough in the pre-deal phase.

• Organisational culture issues: The EIU report cites cultural differences between organisations as a high-risk area for deal makers in the Asia-Pacific region. This is especially true for a culturally diverse country like India. There are 22 official languages spoken across 28 states and seven union territories. According to the 2001 Census of India, 29 languages are spoken by more than one million native speakers, and 122 by more than 10,000. Customs, ways of doing business and working styles differ significantly between regions.

Needless to say, there is urgency in an acquisition or joint venture to establish common elements that will define new ways of working. Companies acquiring in India have typically heard about the changing environment in the country, but they may not know that these changes do not take place evenly. For example, companies in northern India tend to have more assertive, arguably more “Western” cultures, while companies in southern India tend to be more traditionally “Indian” (that is, a more formal and subtle culture, emphasising protocol and indirect communication). Buyers should understand these differences across several dimensions; in addition to geography, they should consider language, local customs and industry — because the company they are considering purchasing or partnering with will certainly be influenced by these.

With contribution from Rhiju Bhowmick & Sankalp Mohanty

Padmaja Alaganandan is India business leader at Mercer’s human capital division where Rhiju Bhowmick is an associate, while Sankalp Mohanty is project manager with the counsultancy’s global M&A division