Effective Rewards Strategies for Mergers,Acquisitions and Joint Ventures/Alliances

Mergers and Acquisitions

The author consulted with an insurance company in the Southeastern United States that had acquired another insurance company headquartered one state away. Although it was clearly an acquisition that term was avoided, given the sensitivity of the privately held organization being acquired about losing its identity. On paper it was the ideal combination. The product lines and customer bases were complementary, the new organization would have more of both without costly redundancy. But the due diligence that had been done had focused on customers and products and had largely ignored people issues. There is a good deal of evidence that the major reasons mergers and acquisitions fail to live up to expectations are to a great extent associated with merging the workforces. Yet due diligence related to workforce management is often limited to looking for unfunded pension/benefit liabilities and pending litigation. The insurance acquisition was no exception. An examination of the human resource management strategies and programs that was conducted after the acquisition was well underway resulted in a less than pretty picture.

The acquiring firm was staffed at lean levels, the workforce was expected to perform at high levels and they were paid very well. The acquired firm was staffed generously, subject to modest performance expectations and paid below market levels. The acquiring firm used results-based incentives broadly while the acquired firm relied on base pay and generous benefits. The former weeded out poor and mediocre performers while the latter had virtually no turnover, and there were few if any exits initiated by management for not meeting expectations. So the question as to how and how much people were rewarded became a foremost issue immediately.

Much of the literature about mergers and acquisitions suggests that the options are to adopt strategies and programs from one of the two entities or to create a third approach. The acquiring insurance company initially believed that their human resource strategy and programs should prevail and that the acquired organization’s approach should be abandoned. But this quick decision proved to be simplistic. Every employer offers a value proposition to employees and potential employees and the nature of that proposition will influence who joins and stays with the organization, as well as how motivated employees will be. It soon became clear that the “what have you done lately for me” philosophy prevailing at the acquirer (Organization A) was not appealing to many of the employees at the acquired entity (Organization B).

Organization B employees had been rewarded for seniority, which was considered a measure of loyalty. The correlation of earnings to longevity was very high. Pay increases were very similar, with outstanding employees sometimes getting slightly larger increases than mediocre employees. Variable compensation awards were modest and more like holiday awards than incentives. And since performance at minimally acceptable levels did not materially slow the escalation of an employee’s pay the focus on performance was minimal. The sales force of B was compensated with relatively high base salaries and modest incentives, and the focus was on maintaining the customer base and growing revenue from that base slowly. Since the acquiring firm was publicly traded there were profit pressures from investors. But the acquired firm was private and the pressure for short-term results was much less, which made the contrast more understandable.

When A’s compensation philosophy became clear to employees of B, the reaction varied from shock and anger to grudging acceptance. And A did not believe taking an average of the two philosophies would achieve anything but mediocrity so it stuck with its approach. It became apparent after a time that existing customers of B began to feel under assault, since the sales representative assigned to them began to behave more like a used car salesman than a relationship manager. An increased rate of policy cancellations forced the acquirer to rethink their initial decision, although in the long run they decided the potential benefit of increased revenue from the customers they retained would more than offset the loss of the customers rejecting the new selling approach. In addition, their customers were found to be more profitable than those inherited through the acquisition.

Executive compensation also presented a major challenge. The acquirer had decided to keep a number of executives from the acquired organization in place, at least in the short run, to make the necessary changes to culture and systems possible with limited disruption. But the dramatic differences between the executive compensation philosophies and strategies presented immediate challenges. The buy-out resulted in several of the Organization B executives becoming very comfortable financially and this led them to exit the organization as soon as the acquisition was completed, eased by the lack of any restrictions or penalties for leaving. But some of the lower level and newer executives decided to stay in place. That reality caused the management of Organization A to wonder if that was the good news or the bad news. The low-risk compensation package for the executives of B also was low leverage, the difference in financial impact between great short-term success and poor results was minimal.

The acquiring organization modified its standards for determining variable compensation awards on combined results. This led to questioning by executives from both organizations. By creating what was viewed as a meaningless average of two different sets of performance standards both groups felt they were unreasonable. Organization A executives thought the standards to be too low but realized that the results contributed by B would drag down the results A had been realizing, so perhaps the two effects would cancel themselves out. Yet they objected to seeing their rewards for meeting these lower standards reduced, even though this could be considered reasonable. And executives of B viewed the new standards to be unrealistic, largely due to perceptions about what level of return on investment was achievable. Although these issues abated over the next two years the level of angst produced in the short run was a surprise to the executive management team.

The rest of the incumbents of the two workforces also experienced culture shock. Employees of A were used to a “eat what you kill” approach to base and variable pay management, so they were not greatly disturbed by the new philosophy, since it was what they had been used to. But employees of B believed the new approach to be unrealistic, based on the way they worked and the way they behaved with other employees. The culture in B had promoted cooperative, help your neighbor behavior and the stark differences in base pay increases and incentive awards based on individual performance seemed to ask them to cease cooperating and start competing. This was not the intent of management and it necessitated a rethinking of the approach, or at least how it was communicated.

Although the two organizations in this case were domestic U.S. entities, mergers and acquisitions that cross geographic and cultural lines presents additional challenges. Cultural conflict is very common when organizations attempt to use the same philosophies for defining, measuring and rewarding performance across the globe. Individualistic cultures prevailing in the United States and most of the Northern/Western countries can conflict with the more collectivist cultures prevailing in many Eastern/Southern countries. High power distance cultures that respect authority and hierarchy can conflict with cultures that are more egalitarian (Trompenaars). Trompenaars offers the “3 Rs” of cross cultural management: recognize when differences exist, respect different views and reconcile the issues those differences create. Cross-cultural combinations are increasingly common and have required strategies that address the issues they create.

But whether combinations present organizational culture conflicts or workforce culture conflicts the pressure to achieve alignment culturally and to combine strategies and programs for defining, measuring and rewarding performance raises critical issues when two organizations become one.

Joint Ventures and Alliances

There are a variety of approaches to cooperative initiatives. One is a joint venture, where two or more organizations contribute resources to a new entity, created to achieve specific objectives. If the joint venture is legally and financially separate from the participating organizations, it creates workforce management issues that differ in many ways from those raised in mergers and acquisitions. Examples of this approach are seen in many of the contractors working for the U.S. Department of Energy (DOE). Two or more independent organizations propose to operate labs and other facilities for DOE under contract, using a new entity to which they contribute. The reasons for this are generally that no one organization possesses all of the critical capabilities required to fulfil the mission. Some of the contractors managing national research labs represent a combination of a university and a for-profit corporation. The thought is that the university will provide the research capability and the corporation the management capability. But the cultures prevailing within universities are generally very different than those common in for-profit organizations. Although it is a tenuous generalization, it can be predicted that the research people from the university partner will attempt to make everything as good as it can be, irrespective of cost, while those from the private sector organization will aspire to things being as good as they need to be, considering cost.

Another example was the creation of New United Motor, Inc. (NUMI) by GM and Toyota. GM had closed a plant in Fremont, CA, because its performance was abysmal and its industrial relations climate a disaster. Toyota offered to reopen the plant, with many of the same workers GM had written off as hopeless and working with the union GM believe was impossible to work with. Toyota installed their lean production system, completely changed the structure and employee roles, and NUMI began to produce cars profitably.

Joint ventures raise significant challenges relative to defining, measuring and rewarding performance. In the DOE contractor organizations the partner doing the research is apt to have a different view of how performance should be defined than the business partner. Although both might accept an approach that considers overall performance as being critical, the business partner will be more inclined to define and measure performance at the individual level as well. The research partner would be likely to believe that work is done interdependently and that attributing results at the individual level would be difficult, while the private sector mentality is that performance can and should be measured at the individual, group/unit and overall levels. This would create differing views about the approach to merit pay and the balance between individual and aggregated rewards. Furthermore, the appropriate amount of performance dependence would probably be viewed differently. Technical research personnel typically are differentiated based on their level of expertise rather than their short-term performance, however defined. So if a common rewards strategy is to be utilized these contrasting views must be reconciled.

The NUMI case also raised issues about how performance is defined, measured and rewarded. Even though both partners were private, for-profit organizations, the difference in the work was organized and roles defined led to very different systems. Toyota reduced the number of separate jobs dramatically and shifted the focus on rewards from short-term results produced by individuals to skill acquisition. Employees were expected to do whatever was needed when it was needed, rather than adhering to rigid job descriptions, making broadly skilled employees more valuable than specialists in most roles. In this case the Toyota approach prevailed, which did not create the issues of separate pay systems. Yet since everything had changed from the GM way in the new organization, the approach was seen as being so foreign to GM that the joint venture did not last.

An alliance differs from a joint venture in that it does not involve the creation of yet another entity. A major U.S. pharmaceutical company that has a drug it wants to sell in Europe but lacks a sales force there might enter into an alliance whereby a European pharmaceutical uses its sales force to sell the drug that does not compete with any of its products. In this case it is unlikely that either would have to consider changing how performance is defined, measured and rewarded. But if a semiconductor firm pools some of its research personnel with those of another firm so the combined knowledge and skills make it possible to invent something neither group could do separately a different set of challenges materializes.

Employees working for two or more organizations working together will inevitably raise new management challenges. They begin when staffing decisions are made. One organization may contribute its most competent researchers to the alliance while another contributes people who are not critical to its other ongoing work. Or one organization may direct its assignees to share discoveries while another may direct its assignees to gather as much intelligence as possible while protecting their employers’ critical tacit knowledge. The way the two organizations organize and perform their work may also differ, making integration difficult. And how performance is defined, measured and rewarded may also be different in the two contributing organizations.

When two groups attempt to function as a team, different performance and rewards strategies can create conflicts. Employees are generally skilled at finding out what others make, but it they cannot find tangible evidence they will operate on assumptions and rumors. Combining employees from different organizations will almost certainly make it harder to know what others make or to find out so perceptions become reality to them. And research on pay secrecy suggests that not knowing will cause people to assume they are worse off relative to others than they actually are. Equity theory predicts that the real or supposed differences will cause problems, since combing people from the two organizations creates new “referent others.”

And performance and rewards for teams should motivate both individual and collective performance. As a result incentives often are based on both. But if one organization measures and rewards its people on individual performance and the other more on collective performance it can result in very different behaviors being motivated. This issue is very likely to be significant when cultures are crossed, as mentioned earlier. So organizations entering into alliances that require their assignees to work interdependently and cooperatively must decide how these issues are reconciled.

Spin-Offs/Internal Start-Ups

There are situations when an organization wishes to spin off a portion of itself into a stand-alone entity. The new entity can be completely separate or can remain a part of the parent but allowed to operate independently. When the newly created entity was a part of a larger organization there will likely be pressure to conform the systems used to those that are in place in the parent entity. Whether or not this is appropriate will depend a great deal on the compatibility between the two organizations. A lesson learned by those who benchmark HR strategies is that what worked well in one context may be a disaster in a different context. Saturn was created with a culture and with systems that differed from those at General Motors. It was never fully integrated and the parent was unable to learn from the start-up because of the major differences in culture. Saturn was not allowed to be the type of organization it was created as, even though the reason for its creation was to experiment with alternative ways of doing business. Palo Alto Research Center (PARC) was a part of Xerox, treated much like Bell Labs was by AT&T. It was to be free to invent, unencumbered by the parent culture. It did invent—brilliantly. But the creations became huge money makers for other organizations because Xerox could not learn from its creation or recognize the potential of the inventions and capitalize on them.

By developing strategies and programs that define, measure and reward the kind of performance the organization needs it may be possible to motivate people in spin-offs or start-ups to ensure their creator benefits from their results. For example, the organization can offer significant equity in the parent and/or create incentive programs that are at least partially dependent on organization-wide results. These initiatives would make it more likely that those in the new entity would be concerned about their efforts positively affecting the parent/creator. There still could be a different culture, that supported innovation, but aligning rewards with results that benefitted the parent/creator could help make it clear that there were rewards for turning innovation into commercial results.

Conclusion

The different types of combinations and cooperative efforts can warrant different strategies for defining, measuring and rewarding performance. The first step in formulating strategies that fit the specific situation is to decide what the objectives for the initiative are and how all organizations involved are to benefit. If a shared destiny is created, as with mergers, acquisitions and joint ventures, consideration must be given to what impact differences between the organizations will have and how they are to be reconciled. Contrasts between organizational cultures or workforce cultures may the primary concern in situations where the workforces are to be combined, although cultural contrasts may affect the effectiveness of people in loose alliances. Differences in what for, how much and how people are rewarded can make a common approach difficult.

Recognizing differences and the issues they raise must be done when deciding whether or not the combination or cooperative venture is entered into. A lack of due diligence can condemn the parties to attempting deal with conflicts that cannot be reconciled, and to facing them when it is too late. The record of mergers and acquisitions is not good. Many failures and disappointments can be avoided by realizing that due diligence must extend beyond legal and financial issues to those related to building and sustaining workforce effectiveness. Anticipating potential conflicts can enable the parties to decide if they can reconcile them or if they are intractable. The realization that how effectively and appropriately performance is defined, measured and rewarded is a critical determinant of workforce effectiveness can result in better decisions about combinations and cooperative efforts.