In our previous blogs, we shared several M&A best practices, and discussed the critical role Human Resources can play in the process. In this post, we will focus exclusively on two critical aspects of due diligence that are commonly not done well or even at all: organizational and operational due diligence.
Most organizations that have a track record of executing M&A transactions have developed internal capabilities or contracted external players for mainline areas of focus, namely financial (including valuation and negotiations strategy), legal, and environmental due diligence.
Organizational due diligence is usually the providence of the Human Resources function. Depending on HRs perceived value to the organization, they may or may not be asked to participate. HR functions that have a track record of being a “strategic partner” are always integral to the earliest stages of due diligence (before the decision has been made). The first two bullet points address the basic, “vanilla” components of organizational due diligence, while the last six detail the ones that can be the difference between an average and a highly successful integration:
- Review benefits programs: Benefits costs can be a critical factor, especially when acquiring a small cap company. Some companies possess a defacto strategy of porting all acquisitions onto the corporate benefits platform. While this strategy is efficient, passing the costs of a rich benefits program to a small company can erase the value of the deal or significantly impact the acquired company’s ability to meet its business plan. Increasing benefits costs dramatically can have a negative impact on employee retention, particularly on entry-level employees who on a percentage basis would be especially hard hit.
- Catalog and review HR practices: HR needs to understand all of the relevant organization/people metrics and trends, including any financial, legal litigation, or liabilities (unfunded pension plans). All HR programs, practices, and policies must be cataloged just as HR catalogues the performance management, human capital planning, talent acquisition, and succession planning processes. Each of these facets needs to be evaluated in terms of the deal drivers and acquisition integration targets. Last but not least, HR needs to create a review and comparison of the compensation practices. The focus of this review should be to understand the cost implications and potential synergy opportunities.
- Map cultures of Parent and acquired company: HR should take the lead in developing a tool that can be used to visually compare and contrast the culture of the Parent and acquired company. Areas of divergence should be noted and HR can take a leadership role in developing and executing a culture alignment plan. This will ensure the culture of the acquired company is tightly aligned to their business plan and the deal drivers.
- Evaluate leadership: Perhaps one of the most critical roles HR can play is to develop a transparent process and supporting assessment instruments to minimally evaluate the senior management team of the acquired company. Incumbents are ultimately categorized using some typology, such as:
√ Strong performer, must retain
√ Okay in present job but needs development
√ Should be in job with less scope
√ Release immediately (dead weight)
- Develop a manpower redeployment strategy. M&A’s usually cause considerable personnel displacement. Even if your organization has a defined employee severance policy, there are a number of channels available for redeploying manpower including skill banks, retraining programs, accelerating natural attrition, offering an early retirement package, instituting “up or out” programs, providing termination “consulting” arrangements, and loaning employees to government or community organizations.
- Develop and execute a talent retention plan. A well-crafted plan includes consensus around the definition of key talent (often the definition used for talent management process is not sufficient for an M&A. Individuals that have difficult-to-replace skills, key customer relationships, or unique technical skills are often part of “key talent”). The talent retention plan should also include a forecast of key talent loss and specific actions for reducing it. (Note: stay bonuses only delay the inevitable. Research suggests they have little long term impact on talent retention)
- Complete an organization structure review. Headcount is one of the easiest areas to realize cost reductions. By analyzing the acquired company’s business model (what is in-sources/outsourced, on-shored/offshored, centralized/distributed) and structure (spans of control, levels, etc.) considerable cost synergies can be realized. Early in the process HR can be instrumental in selecting/confirming the senior and mid level leadership teams of the acquired company.
- Proactively address the organizational/change management issues. There have been many studies completed that conclude that only about 30% of the M&A deals are successful. The biggest shortcoming is not adequately addressing the change management and people issues, such as:
√ Stakeholder assessment/alignment
√ Capability gap assessment
√ Organization alignment
Operational due diligence is the lynchpin in identifying where and how specific synergies can be realized. Completing this activity during due diligence provides an organization with the advantage of using the 100-day implementation period to start realizing targeted synergies, instead of figuring out what to do. Discussed below are the most critical components of operational due diligence:
- Complete a facilities review: Bricks and mortar represent a huge potential area to achieve cost savings. This activity is best completed in conjunction with the organization structure review. Duplication of facilities provides an opportunity to close offices, distribution hubs, manufacturing plants, etc. This can result in revenue realization through the sale of these assets as well as considerable cost reductions.
- Complete a value chain review: A value chain is a visual depiction of an organization that can be configured at different levels of detail. It’s akin to being in an airplane. If you look out of the window at different altitudes, you are able to see different levels of granularity. By documenting and comparing different parts of the Parent with the acquired company, you can quickly identify potential cost savings, areas for divestiture, and outsourcing opportunities.
- Complete a review of your process hierarchy: This typically takes the form of documenting the process hierarchy of both the Parent and acquired companies. Data can then be collected around key performance attributes, such as customer service, cycle times, headcount, quality, and cost to identify potential synergies.
- Complete activity based costing review: Traditional cost accounting tracks cost by work functions/units. Although this provides leaders of a function/unit with the information they need to manage, it fails to identify costs as they accrue across several function. ABC allows you to identify activity and cost drivers attributable to work that traverses several silos. It provides more complete information to understand how, where, and when to streamline operations.
Organizations that rely heavily on their external growth engine typically have strong capability in the mainline M&A areas. Organizational and operational due diligence are two levers organizations can use to considerably improve the probability of success.
In our next blog, we will focus on acquisition integration post deal close and provide some best practices around developing a 100-day plan.
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