Introduction

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. India is among the top countries in the region in terms of M&A activity in the first quarter of 2009 even as deals saw a 72 percent 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.⁽¹⁾

According to a recent Economic Intelligence Unit (EIU) study, M&A Beyond Borders: Risks and Opportunities, the rapidly developing economies of China, India and Southeast Asia remain attractive destinations for M&A deals, with 57 percent 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 organization culture differences and talent shortage/retention issues.⁽³⁾

Critical success factors

In our experience working with Indian companies, there are four major challenges that emerge as critical success factors in M&A transactions:

1. Tackling employee liabilities, statutory compliances and union issues
2. Employee retention and the leadership challenge
3. Rising labor costs
4. Organizational culture issues

These four challenges span all stages of the deal:

• Unfunded or under-funded liabilities pertaining to retirement benefits;
  commitments arising from union settlements and severance agreements; and any statutory compliance gaps on a blue-collar workforce can significantly affect the deal price and/or attract legal penalties.
    
• Potential leadership challenges or loss of key talent can erode the value of the deal in the closing or integration stages.
    
• India’s rapidly escalating salaries and the difference in salary structures compared to the rest of the world need to be accounted for while planning and executing an effective integration.
    
• The enormous organizational cultural diversity of India, both within and when compared to acquiring companies from other geographies, must be actively managed to mitigate potential friction, misunderstandings and
  loss of employee engagement and productivity.

We will address each of these four major challenges individually.

1.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 thirdparty valuation can uncover significant under-funding that may need to be adjusted against the deal price. Furthermore, 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 organized labor 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:

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 noncompliance 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 unionized 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 labor and union regulations have remained virtually unchanged and they continue to provide significant protection for employees. For example, 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.

There are some signs of change and other ways to manage through these restrictions. Unions are beginning to show somewhat less resistance to change. A recent Supreme Court decision held that the right to strike is not fundamental, but rather requires that strikes follow due process to be legal. In some industries – pharmaceuticals and technology being the best examples – this “traditional” human capital environment is less of an issue because the talent is relatively mobile. Buyers can often find a different route to the same end. For example, unions are generally not an issue in joint ventures, making this a common form of transaction.And early retirement programs have been used as an alternative to more direct redundancy plans.

2. Employee retention and the leadership challenge

Those employees who have both intimate knowledge of local markets and strong relationships with customers make key employee retention an imperative for realizing the value of the transaction. The loss of key talent in a highly competitive, labor-deficient market can, at minimum, delay realization of the transaction value. In the same study, the EIU identified talent shortages and retention issues as the greatest risks in China, India and Southeast Asia. In Mercer’s experience, identification of key employees early in the deal and putting in place a “balanced” (with both shortterm 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 – i.e., the full engagement and productivity from employees.

While retaining key employees allows the buyer the necessary means of executing their M&A strategy, the clear focus is on leadership. With infusion of cash and scale (i.e., 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.

3. Rising labor costs

Given both the rapidly escalating wage costs and the tightening labor market in India ⁽⁴⁾, 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 percent on average in 2008, compared to forecasts of up to 2.7 percent for Western Europe, up to 3.8 percent for North America and 2.5 percent 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 percent annually in the past three years.⁽⁵⁾

Additionally, 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 (i.e., multiple cash allowances for housing, rent, car,etc.) 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 (especially in the software industry where base pay in India for certain job skills is dramatically increasing) – 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 “rolemodels.” Any liabilities arising out of severance arrangements can be potentially offset against the deal price if detected early enough in the pre-deal phase.

4. Organizational culture issues

The EIU report cites cultural differences between organizations 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 7 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” (i.e., a more formal and subtle culture, emphasizing 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.

Why do deals in India?

Despite these challenges, it still makes good business sense to pursue deals in India for the simple reason that, among emerging markets, India offers great potential for tapping into an enormous consumer market.With a population of 1.1 billion people and a $350 billion retail industry expected to explode over the next few years, Tesco,the world's number three retailer, has plans to set up shop in India with a wholesale cash-and-carry business and a deal to help Indian conglomerate Tata Group grow its hypermarket business.⁽⁶⁾ Tesco is also mirroring a move by US rival Wal-Mart, which has teamed up with India’s Bharti Enterprises, as the world's top store groups seek a foothold in India’s retail industry,amid forecasts it could double in size by 2015.⁽⁷⁾

In addition, the proposed Indian Bharti Airtel merger with South Africa’s MTN would be the world's biggest non-pharmaceutical deal so far in 2009. Their aim is to achieve full merger as soon as possible.⁽⁸⁾

Buyers must build into their pre-deal planning a thorough understanding of the unique dynamics of the Indian business and human capital environment.They will then be better prepared to manage their way through them. Deals in India can be very successful, but they need to account for the things that make India unique. Buyers need to ground their planning on facts, and not on assumptions and generalizations.Understanding India is the key to doing successful transactions in India.

How Mercer can help

Mercer’s Global Mergers & Acquisitions consulting business advises clients on their transactions,including mergers, acquisitions, joint ventures, initial public offerings,spin-offs, divestitures, start-ups and business transformations. With our dedicated, experienced M&A consultants deployed in 40 countries,we help clients realize the value of their deals through their people.

At each stage of the deal, from pre-target through integration and execution, we help clients focus on deal success using a collaborative approach and proprietary tools. Mercer specialists partner with each client to bring clarity to the business context, provide analytical support for all people-related policies and programs, and provide guidance in managing and deploying the workforce in ways that ensure the achievement of business goals.

Recognizing that HR professionals have a substantial role to play in M&A,Mercer offers Mercer M&A Ready^TM workshops that help HR and other professionals identify and manage the people issues so vital to successful transactions. These workshops (for Europe, Asia Pacific and the Americas) provide participants with a strategic focus, proven processes and valuable analytical tools.

Are these workshops valuable? One senior corporate executive put it this way:

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