A Fact-Based View of the Workforce Essential to M&A Success

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1 WHITE PAPER A Fact-Based View of the Workforce Essential to M&A Success M&A reality too many failures to realize value

2 When it comes to mergers and acquisitions, the statistics are sobering: Two-thirds of M&A deals don t succeed because companies fail to meet their objectives. Indeed, according to a KPMG research report, 83 percent of mergers failed to unlock value. In the same research report, KPMG also noted that it is hard to find a merger where people issues did not matter. A fundamental reason is that, while most managers can talk about the execution tactics to close the deal, few can articulate what value or risk may be hidden in the workforce. As a result, whether you are the acquirer, target, or merger participant, failing to properly assess the workforce can have grave consequences to the value realization outcome. As an executive or manager assessing the organization, it s important to know what needs (or advantages) may exist. Why? Companies with superior human capital practices can create substantially more shareholder value than can companies with average human capital practices. The challenge is getting a clear assessment of the capabilities of the organization prior to the transaction. Due Diligence Often Ignores Workforce Implications In any M&A activity, due diligence is essential. The due diligence exercise is usually carried out by an accounting firm to spot legal, tax, and financial risks. However, it rarely uncovers the soft issues such as the productivity and quality of employees and their ability to mobilize their energies and resources around new objectives. Whether you are the acquirer interested in the risks and needs of the new organization or the seller looking to maximize transaction value and ensure a successful integration, getting an accurate view of organizational performance is crucial to success. Unfortunately, when one tries to assess organizational performance, traditional HR metrics such as employee turnover rate, average time to fill open positions, and total hours of training provided aren t reliable predictors. Yet there are specific areas that are measurable and can aid a successful corporate integration. The Levers of M&A Value Creation Are Based on Workforce Performance In an M&A scenario, the acquirer is looking to grow its firm profitably. The drivers to accelerate that growth can be extending the geography, offering new products, acquiring new production facilities, or growing the size of the sales force or distribution channels. At the same time, whether it is a merger of like firms or an outright acquisition, the new entity is banking on a workforce that it expects to be able to manage to higher levels of profitability. KPMG s research survey confirmed that, although companies target synergistic benefits through revenue enhancement, most of the benefits come through direct operational cost reductions. While an organization will typically execute a rigorous due diligence process, it often won t drill deep enough into workforce issues yet much of the overall savings will be predicated on workforce savings. For example, when one firm acquires another, the buyer takes on a customer base and expects to serve that customer base more efficiently than the purchased firm did. KPMG s research showed that 45 percent of the synergies come from workforce-based cost reductions with the lion s share of those, 36 percent, coming from reductions in the direct labor force. Key areas targeted for synergies Revenue benefits 36% Indirect overhead cost reductions 9% Direct operational cost reductions 36% Other 16% Mergers and Acquisitions: Global Research Report, KPMG, Thus, firms planning to achieve M&A synergies focus on reducing employee/job duplication, improving work processes, and leveraging innovative technologies. While this works in classic SG&A areas, it may not be effective in key areas such as field service, production, and manufacturing. To ensure proper value realization, an effective M&A audit and assessment of the workforce are essential. In this way, the workforce and its potential become part of the overall valuation of an organization. When this process is done well, the workforce can be seen as a financially quantifiable asset.

3 Insufficient Workforce Understanding Can Create Huge Risk In principle, cost savings that arise from workforce reductions are easy to calculate. However, acquirers often underestimate the practical challenges in capturing these savings. A number of issues can affect a merger and the ability to realize the synergies anticipated in the original strategy. Among the challenges: 1. Overestimating cost saving due to job cuts It is important that any planned reductions be achievable and don t impair operational metrics. For labor-intensive industries, significant cuts in the workforce would decrease not only direct salaries and benefits costs, but also other headcount-driven expenses such as travel, training, offices, and computers, all of which can add an additional 10 to 20 percent to the projected annual cost savings, making workforce reduction very attractive. But can existing productivity be maintained or improved? How do the existing operating metrics compare with industry benchmarks? Will the resulting organization achieve the same or improved levels? While many reduction strategies are applied in an across-the-board manner, making decisions at the role level can be a more effective method of lowering costs while maintaining effectiveness or positioning the company for a rebound, as well as identifying high-costof-hire positions or those with a steep learning curve before acceptable productivity is achieved. Likewise, understanding the trade-off involving higher wages associated with tenure is essential. In many cases, tenured employees are a company s most productive supervisors. 2. Discovering hidden problems In addition to worker-specific concerns, there are a host of related issues. Among those that could impact an M&A undertaking: Operations not in complete compliance with applicable laws such as the Fair Labor Standards Act (FLSA) and the Family and Medical Leave Act (FMLA) and related regulations High absentee rates Labor union contracts that prevent reductions or work process improvements Lack of good HR and workforce management systems On the other hand, headcount reduction is the area where most companies have achieved benefits. Yet it is possibly the most difficult to implement effectively, because of the need to be sensitive to the regulatory and cultural repercussions. Loss of staff is an inevitable result of merger or acquisition activity and will often include the very individuals the acquirer intended to keep. However, organizations must ensure that the targeted short-term gains made through cost-cutting and headcount reduction strategies are not achieved at the expense of long-term plans. To ensure that the intrinsic value of the organization is protected, managers must build a great case for the value of the organization. Quantifying Workforce Value for Mergers and Acquisitions Business managers looking to succeed at M&A must demand factual evidence of the one true factor that determines ultimate organizational success: people. Clearly, achieving planned M&A synergies means combining and transitioning two workforces to reach a higher level of performance. Smooth integration is imperative, and if you wait until the ink is dry before planning the integration, you re already too late. An integration strategy has to be planned from the beginning and put into play almost immediately. This will save time and provide a faster return of value if you know what steps are the right ones to ensure a successful merger. Uncertainty usually triggers costly problems well before the deal is done. Planning is the key, and plans that mitigate uncertainty must address the real issues and concerns of getting the workforce to where it needs to be and that must be based on fact. If unaddressed, uncertainty can damage productivity, quality, customer service, talent retention, and ultimately profitability. There is plenty of upside in executing a workforce audit. The audit may identify a pool of great talent, managers

4 who are doing an exemplary job, and teams that regularly outperform benchmarks. Alternatively, the audit may identify gaps in talent and expertise, and this will enable managers to know where to apply remedial efforts. Use an Audit to Assess the Workforce The bottom line is that an audit can provide the detailed information that can link workforce plans to the M&A synergies desired and, ultimately, to shareholder value. Executive and M&A advisers must study the current workforce including its trends and patterns and determine what actions they must take to ensure that the workforce will meet the future needs of the organization. Measurement is essential for any company that aims to keep its workforce and its workforce management aligned with business objectives. Metrics built into the workforce strategy (for example, for retention, employee development, and productivity) will help in evaluating the effectiveness of the strategy and reveal any remaining gaps that need closing. This information helps senior leaders and managers make better decisions about how best to deploy, engage, reward, and retain employees in pursuit of business goals, and how to recruit new employees to best fit business needs. It also helps employees understand more clearly what they need to do or do differently to support the business, as well as how their performance will be measured and rewarded. The first step of an effective workforce audit is to prioritize workforce efforts, and for most firms that means reducing costs, especially regarding waste. Kronos can provide a focused assessment targeted at identifying workforce cost reductions and establishing implementation priorities to quickly deliver the targeted synergies. Among the critical considerations of an audit: Reducing excess labor cost before reducing headcount Faced with a short time frame to reduce costs, making across-the-board cuts is a common method of achieving reductions and sharing the pain. But this cuts fat and muscle indiscriminately. A more effective alternative is to identify wasteful practices due to inefficiency, abuse, and fraud. Pay premium stacking, inefficient use of overtime, buddy punching, gaps and gaming of pay rules, and FMLA abuse are all situations that increase labor cost without any corresponding increase in output. Eliminating such waste first may not have an impact on output, yet it lowers the cost structure prior to contemplating headcount reductions. Additionally, this effort has the advantage of maintaining and even improving morale, as employees see strategic and beneficial management actions. Indeed, independent studies by Nucleus Research have found that 3 percent of payroll costs can be attributed to these types of payroll inflation. Kronos can identify these situations by analyzing existing timekeeping and other workforce and payroll processes. Identifying who is most important to the organization eliminates peanut butter decisions when headcount reduction is required Kronos has pioneered new metrics that provide powerful insight into production and workforce performance. As a result, Kronos can make recommendations on how to link HR data to production data to address issues such as when turnover begins to hurt productivity and at what level of tenure productivity gains begin to flatten. These new metrics allow better decisions to be made when determining how to effectively reduce headcount while minimizing the impact on production. Relying purely on management and supervisor discretion has its drawbacks, as decisions are a mix of judgment, emotion, and relationships. Kronos brings as many facts as possible to the table to support management judgment with data. Identifying hidden costs, risks, and opportunities for consolidation With more than 30 years of experience in workforce management, Kronos can review existing workforce management systems to identify where system consolidation can take place and can make recommendations on centralized and regionalized strategies in order to align with M&A objectives. Additionally, Kronos can identify labor-intensive processes for time collection, attendance, requests for time off, scheduling, or payroll data collection that could be automated.

5 Reviewing existing pay practices can identify inconsistencies and highlight exposure to fines and litigation due to pay and work practices in violation of laws such as the Fair Labor Standards Act and the Family and Medical Leave Act. During times of change, these issues can rise to the surface and be the source of significant expense, as employees feel uncertainty due to the changes. Summary: 5 Steps to Help M&A Success A well-thought-out M&A workforce strategy should: 1. Provide a framework for target screening, transaction execution, and merging relative to the workforce 2. Include an audit of the most essential asset, the workforce 3. Communicate a compelling strategy to your employees, or they will resist the change process required for an effective merger 4. Involve line managers early and often they make it work 5. Factor your unique people, process, and technology considerations into the target-screening phase The resulting action plan should provide the details for operating managers to execute the actions necessary to effectively complete an M&A transaction. It should include the design and implementation of specific workforce solutions that help the organization select, organize, manage, develop, and retain or divest its workforce. These actions work together to produce the desired workforce outcomes and, in turn, the desired business outcomes. Contact Kronos for more information on how we can help you understand the value of your workforce. (800) kronos.com Kronos Incorporated 297 Billerica Road Chelmsford, MA (800) (978) , Kronos and the Kronos logo are registered trademarks of Kronos Incorporated or a related company. All other product and company names mentioned are used for identification purposes only, and may be the trademarks of their respective owners. All specifications are subject to change. All rights reserved

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