Post-nuptial arrangements

The merger business may have slowed in recent months, but there is nothing like a downturn to bring out the cheque-books and...

The merger business may have slowed in recent months, but there is nothing like a downturn to bring out the cheque-books and tempt companies on the up to snaffle some bargains. If you are left to sort out the post-signing ceremony mess, what should you look for to get the best of both worlds?

Although merger activity has waned somewhat following the dotcom craze - down to £543bn worldwide for the first six months of this year according to KPMG (less than half the value of mergers during the same period last year) - corporate marriages are still occurring with unsettling regularity, leaving chaos in their wake not only for the companies themselves but also for their suppliers and service providers.

For the parties immediately involved, the fall-out from mergers takes many forms, affecting people, business processes and technology installations in substantial ways. Once a merger or acquisition has been mooted, a state of paralysis is not uncommon. Projects are put on hold and staff become demotivated.

"Even the thought of a merger can have a huge effect on both companies," comments Eric Hagan, business development manager at City Practitioners, which provides business and IT services to the investment banking community and has witnessed the effects of many mergers at close quarters. "It creates huge uncertainty, so people stop making decisions and investments."

When the $30bn (£21bn) merger between Dresdner Kleinwort Benson and Deutsche Bank collapsed last year, staff at Kleinwort's London offices celebrated by wearing T-shirts to work proclaiming "I've not been torched", reacting to comments from one Deutsche Bank executive who'd been quoted as saying he'd torch the London-based investment bank. Up to 90% of Kleinwort's staff had expected to face redundancy if the merger had gone ahead because of the level of overlap between the two investment banking operations; this suggestion had sent shockwaves through the company.

If the merger had taken place, the ability to marry the companies' IT operations would have played a critical role in determining its commercial success. Although in the case of the German banks there were many more factors to the merger failure, it is not uncommon for mergers to be abandoned because of IT integration problems.

Most mergers and acquisitions are initiated in the pursuit of greater market penetration and improved customer service coupled with cost-cutting through the stripping out of any overlap and the combining of operations. Since technology is the facilitator for many of these perceived gains, the ability to consolidate systems has become a deciding factor in whether many mergers go ahead. This is especially the case in the financial services market where merger activity levels are high and IT systems are seen as particularly critical to strategic advantage. According to the employers body the CBI, poorly executed mergers and acquisitions are risking up to £550bn a year in shareholder value across Europe. IT problems are at the heart of many of these unhappy unions.

Enter any existing IT outsourcing arrangements into the equation and the situation becomes even more complex, as there are suddenly more than two parties in the marriage. The question then arises whether continuing with the service contract is appropriate, or, where both parties are bringing outsourcing relationships into the partnership, how to converge these into a single, consolidated outsourcing strategy.

"Often, the more radical the merger, the more the challenge to the outsourcing agreements," notes Alistair Cox, services director at IT systems integrator NSC. "In our experience when large organisations raise the spectre of merging their businesses, the outsourcing commitments are often considered too late in the process - potentially with catastrophic results as the original outsourcing contract objectives may conflict directly with a newly merged organisation."

"Quite often it becomes a competition between the two companies' technology, their processes, and suppliers such as outsourcing organisations," concurs Hagan. "Because the involved parties both think their approach is best, management consultants are often brought in for advice on what to keep and what to throw out. It is rare to be able to take the best bits of both companies' strategies. In a takeover the dominant company usually makes the decisions but, if it is a merger like CityCorp and Travellers Group or JP Morgan and Chase Manhattan, the situation becomes more problematic."

Hagan advises that, in the event of a merger, joint working parties be established early on which look at each area of the operation that's being affected together, rather than audits being carved up between the two sides. "Quick decisions are important too," he says. "Don't draw these out. People need to know where they stand so they can plan their next actions."

The existence of outsourcing arrangements can take some of the heat out of the merger of IT operations as they provide a level of continuity and neutrality in an otherwise highly disrupted environment. However, these should not be excluded from the overall IT review, which is being carried out in the interests of consolidating and streamlining two companies' systems and, therefore, affects outsourced technology and processes as much as internal systems.

Ian Leask, managing consultant at Compass Management Consulting, offers the following advice to companies reviewing the relative merits of existing outsourcing arrangements in the event of a merger. "The IT manager must ensure that (a) an objective view of the existing contracts can be provided based on irrefutable facts, (b) the end solution is an environment that will deliver on goals and objectives, and (c) the newly-merged IT operation is in a position to manage the remaining supplier relationship for ongoing value."

The types of question that must be asked to achieve this are:

  • Have the business requirements changed and is one of the outsourcing agreements in a better position to address these?
  • Is the outsourcer running the operation as effectively as possible?
  • How do costs compare with best-of-breed operations?
  • Are the processes clearly mapped and understood?
  • Is the right blend of capabilities in place between the outsourcer and the organisation so that responsibilities clearly map from one organisation to the other?
  • Is there a focus on managing the relationship, or micro-managing the supplier?
  • Are all processes clearly mapped and understood?

If the upshot is that one contract needs to be terminated, or revised, there could be hefty cost implications. For a one- to three-year contract, the penalty could be more than 50% of the value of the contract which has still to run. Some terminations can run into hundreds of millions of pounds. "It is not uncommon for one outsourcer to be dropped, which usually involves a termination fee," says Charles Drayson, an IT partner at Andersen Legal.

While newer outsourcing contracts tend to make provision for the effects of company mergers, many older-style contracts have not taken this into account.

Where contracts have been designed to cover companies against the impact of terminations in the case of a merger, hopefully these should also include provision for a degree of co-operation from the outsourcer after the contract has been severed - what's known as a termination assistance clause. "This should include help with migration, the passing over of equipment and the gradual hand-over of the service, whether back to the internal IT department, or to a second outsourcer," Drayson says. Organisations considering terminating existing contracts should look for such clauses before making any hasty decisions.

That said, few outsourcers can afford to burn their bridges by exiting a contract with sour relations and, for a fee, will be glad of the opportunity to phase out the work gradually with as much support as possible. This process could take a couple of years, so harmonious relationships are important.

A bigger issue is likely to be staff redeployment, as any employees who were transferred to the outsourcer will now need to be reintegrated into the company. Following the European Transfer of Undertakings/Protection of Employment (TUPE) rules, which seek to protect staff rights when outsourcing arrangements are formed, unions may need to be consulted to ensure obligations to original employees are honoured. When one outsourcing arrangement is being dropped, this could result in an additional surplus of staff. If the merger is international, this could be a particularly thorny issue, since countries in southern Europe are notoriously sensitive to employee rights in such scenarios.

"The best advice is to prepare for these eventualities in advance as much as you can," says Drayson. "If you haven't, it's possible to add in a co-operation agreement later," he adds, though once a merger is under way it will be too late to renegotiate original contract terms with an outsourcer whose future relationship with your organisation is uncertain.

Even if the merged company decides to keep an existing outsourcing relationship, another consideration is the extent to which the original contract may now need to be changed. Requirements may differ as the company's goals are repositioned, so active projects may need to be redesigned or service level agreements may need to be revised. Even more likely is that the original size and scope of the contract will need to be adjusted one way or the other. Chris Holder, partner at technology law firm Shaw Pittman, notes that any growth or decline in the size of company or workload greater than 20% will typically mean the contract needs to be renegotiated.

"The main objective should really be contract consolidation - linking together existing outsourcing arrangements in order to cut costs and ensure a consistent service throughout the new company," concludes Raza Khab, head of consulting at Servusb2b, a business support specialist. "In a perfect world, the new business would let a single super-contract, covering the business as a whole. This would help to cut costs by eliminating duplication and reducing management overheads. Letting a super-contract is not easy though because of penalty clauses and lock-ins, so the next best thing is to renegotiate contracts to ensure the various outsourcing providers have clear business rules for working with each other."

Outsourcing issues after a merger

  • Outsourcing arrangements often get overlooked when the implications of a merger are being considered in the early stages - this is a mistake. Early planning and rapid, clear decisions are essential
  • In mergers where there is no obvious dominant party, the services of an independent consultant may be needed to help decide which IT systems and processes - and outsourcing arrangements - to keep and which to reject
  • Although lock-in and penalty clauses can be a hurdle to consolidating outsourcing arrangements, the majority of today's outsourcers would prefer to co-operate in the event of a merger rather than leave things in a mess and risk their reputations. Aim for a smooth transition for all concerned, and seek help with any transition between outsourcers and/or your internal IT department, even if the original contracts made no provision for this
  • Staff issues need at least as much attention as the pure technology issues. If outsourcing contracts are being changed or terminated, make sure you honour staff commitments, especially those which are legally binding under the European TUPE Act.

Ten tips for post-merger arrangements
Ian Dunshire, partner at KPMG Consulting responsible for systems integration in retail banking, has been closely involved with some high-profile mergers including Midland/HSBC and Lloyds/TSB. He offers the following 10 tips on handling post-merger arrangements.

  • Don't try to treat outsourcing arrangements in isolation from business strategy. Driving out the new IT strategy needs to be an iterative process involving joint planning between the IT function and all other key business areas
  • Involve your outsourcers from the outset. They will be amazingly creative to come up with ideas to secure your ongoing patronage
  • Gather the facts quickly on the effectiveness of outsource arrangements. Look into the contractual position (eg penalty clauses for early termination), the past performance of the outsourcer against service level agreements, current and future costings
  • Compare the options on a level playing field. Take sufficient time to get the facts together to enable comparison of outsourcer versus outsourcer and outsourcer versus internal function to be measured on an objective basis. Internal and external comparisons can often be difficult (and emotionally charged)
  • Prepare a performance checklist for assessing outsourcers. How well has the outsourcer performed? What are the performance trends?
  • Try to avoid acting on pre-conceptions. Judge on the facts rather than emotion. Try to avoid the trench warfare that often occurs when merger partners take sides too early
  • Communicate internally and externally. Attrition of key staff from both the internal and outsourced teams is a major hazard in the post-merger days. Keep all staff as informed and involved as is practical to avoid the inevitable rumours and innuendo. Remember that outsourcers have feelings too
  • Don't dither. Assess the facts and act. Conventional wisdom allows a 100-day post-merger honeymoon period in which to demonstrate ability to deliver
  • Manage the ongoing outsource arrangements tightly. Whether the arrangements are to continue or not, it is important to keep your eye on the ball and maintain service levels
  • Don't resort to outsourcing to solve your post-merger business/IT problems. The advice "never outsource a problem" remains true in post-merger times. Fix the problem first, involving the outsourcers as necessary, before pressing the outsource button.

Case study: Last-minute outsourcing saves investment bank merger
When systems integrator and outsourcer Parity Solutions was called in to a large investment bank to help free up the flow of information between it and the organisation it was acquiring, the job quickly became a mercy mission. The bank had realised very late in the day that it couldn't access vital information from the company it was taking over to complete the due diligence process and the takeover - already progressing financially - was in jeopardy, recalls Eddie Dodds, head of Parity's commercial sector division.

Three different IT infrastructures were involved - the two companies involved in the $2bn takeover, plus a consultancy which had been brought in to facilitate the acquisition. When they found they couldn't solve the problem between them, they had no choice to outsource the project to a fourth party. For Parity, this resulted in a two-year facilities management contract.

Parity stepped in as change management consultant and developed a bespoke project office environment that could be used for exchanging documents securely over the Internet without having to use e-mail. Its staff arrived on the Monday and had a working prototype by the Friday. Within 10 weeks, the full system was up and running. As well as designing the system, Parity managed it for the two companies in an early application service provider-type arrangement - running a secure server that allowed 12 senior project managers around the world to exchange information securely day or night, using document templates that complied with due diligence requirements.

The two-year contract carried the companies until the administration associated with the merger had been completed and archived, at which point the Web server was closed down.

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