M&A Talk with Guests J. Keith Dunbar and Andrew Sherman

The Crisis of Employee Disengagement and It’s Impact on M&A Success

09 February 2017

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People are the valued resources and the engine and growth in many, if not most, M&A transactions. And yet, at least in the United States, more than two-thirds of the workforce is not engaged. Is this a cultural issue, a shortcoming of leadership, an oversight? And what then is the impact on the potential success of an M&A transaction? We have two thought leaders with us today, both with vast knowledge of the intricacies of M&A to discuss the problem, its implications, and some perspectives on solutions.

Andrew Sherman is an accomplished attorney with expertise in a number of differing specialties and is currently a partner at Seyfarth Shaw LLP. He is also an educator and an author, his just released book is entitled “The Crisis of Disengagement: How Apathy, Complacency, and Selfishness Are Destroying Today’s Workplace.”

Dr. Keith Dunbar, after retiring from the US Navy as an intelligence officer has been focusing on examining the role of human factors, especially leadership capabilities, as a key driver of M&A success. Keith has formed his own consulting firm, Potentious, and is an author as well.

M&A Talk is a podcast series highlighting practitioners in the space, with the goal of bringing new and different perspectives to improving the outcomes of Corporate Development and Integration.

A transcript of our conversation with Andrew Sherman and Dr. J. Keith Dunbar follows.

John Lester: This is John Lester, your host of M&A Talk. Welcome.

People are the valued resources and the engine and growth in many, if not most, M&A transactions. And yet, at least in the Unites States, more than two-thirds of the workforce is not engaged. Is this a cultural issue, a shortcoming of leadership, an oversight? And what then is the impact on the potential success of an M&A transaction? We have two thought leaders with us today, both with vast knowledge of the intricacies of M&A to discuss the problem, its implications, and some perspectives on solutions. 

Andrew Sherman is an accomplished attorney with expertise in a number of differing specialties and is currently a partner at Seyfarth Shaw LLP. He is also an educator and an author, his just released book is entitled “The Crisis of Disengagement: How Apathy, Complacency, and Selfishness Are Destroying Today’s Workplace.”

Dr. J. Keith Dunbar, after retiring from the US Navy as an intelligence officer has been focusing on examining the role of human factors, especially leadership capabilities, as a key driver of M&A success. Keith has formed his own consulting firm, Potentious, and is an author as well.

Gentlemen, Thank You and welcome.

Andrew Sherman: Thank you. Great to be here, and I just wish my firm name was as cool as Keith’s.

Keith Dunbar: Thank you for that, Andrew. And thank you, John, for inviting me and Andrew to talk about this really important topic - helping companies make M&A successful.

John Lester: Let’s jump right into it. Andrew, would you be so kind to set the stage by defining the problem and sharing with our audience its impact?

Andrew Sherman: Yeah, let me tie that into why I wrote the book in the first place. The book is not based on my personal thought leadership or expertize in this area, it’s kind of indirect. 

You recall, John, I wrote a book a couple of years ago called “Harvesting Intangible Assets” which is all about corporate innovation, and I’ve written books on M&A, and what I finally realized, and Keith I’m sorry if it took me a little while to figure this out, is that if we don’t have an engaged workforce you’re not going to get innovation, you’re not going to get business growth, you’re not going to get M&A. At the very heart of everything is the company’s human capital. So I wrote this book from the perspective of a concerned citizen and as a practitioner in related fields.

The thing that really got me going was reading a Gallup study from a couple of years ago. Let me just set the stage with some numbers. Out of our current workforce 19% of the workforce describe themselves as actively disengaged. That means that they are very unhappy at their work and actively recruiting others to share in their misery. 52% describe themselves as not engaged. They perform at a C or B- at best level without any meaningful enthusiasm or connection to their work. 25% describe themselves as merely engaged, kind of your B+ student. They’re doing their work with some degree of passion, but not a lot. And they feel a mild connection to the company, the mission, and the values. Only 4%, four out of a hundred, describe themselves as deeply engaged, feeling a strong bond with their work and their company, and really become amazing internal champions of innovation and productivity. 

We just went through this horrific election and there were all these issues being debated and nobody mentioned engagement even once. Yet, we can’t be globally competitive when only 4% of our workforce describe themselves as deeply engaged. We’ll see in a little while how this impacts valuation, pre-closing due diligence, post-closing integration. This issue has a very big M&A component to it. As you said, in many, many cases companies are conveying a workforce and a series of intangible assets much more than they are conveying in a transaction, desks, chairs, laptops, or servers. So that’s my setting the stage of the issue. I’m sure that Keith has a few thoughts on this as well.

Keith Dunbar: From my perspective, and I’m going to come at it obviously from the M&A component, as soon as a deal is announced, whether you had disengaged employees or engaged employees in your company, if you are the target of an acquisition, they quickly become super disengaged, because they’re concerned about, “Am I going to have a job tomorrow?” There’s no information coming out about what’s the next steps, what’s the timeline? It really creates this very uncertain, complex, and ambiguous environment for employees. Again, if you go back to Maslow’s hierarchy of needs, they need to make a living, and so in a lot of cases they’re going to start looking for options to mitigate whatever risk they see in a particular acquisition. And all of this leads to this disengagement that obviously affects productivity of the organization and its ability to continue to do what it’s supposed to be doing that made it a target in the first place.

So it’s been showing signs of great growth, or it’s got great potential, and now this event happens and your employees become disengaged. Why I really focus on this aspect of collective leadership in mergers and acquisitions, looking at both the acquiring company and the target company, because at the end of the day you need leadership throughout the organization to make an M&A successful and to keep employees engaged. That ultimately comes down to their ability to maintain these relationships with their employees and motivate them and influence them to continue to perform at a really high level, and to keep them engaged in what’s going on as this event occurs around them, and to them. 

Andrew Sherman: We’ve already identified the obvious, right? Disengaged employees don’t innovate, disengaged employees aren’t productive, disengaged employees are just focused on themselves and their own needs, disengaged employees certainly aren’t tossing around at night at two in the morning thinking of ways to improve the value of the company. That’s just the beginning. The research also proves that disengaged employees, their companies that they work for have lower customer rankings, have higher incidence of safety incidents, higher incidence of theft, absenteeism, quality control problems, IP misappropriation issues. You’re talking about getting to the very roots of shareholder value.

When we tie this back to M&A in a few minutes even further, imagine you’re a buyer doing due diligence and you run into a target company with very low levels of engagement. You’re going to see the outputs of that in the legal and operational and financial due diligence in all of those areas. Higher incidences of frustration, of perhaps sexual harassment, of discrimination. If you are a leader of a company and you don’t get your act together on this, we’re talking about potentially multiple EBITDA points, and multiples less, because the due diligence’s going to open up all of these terrible things. So the issues are very closely tied to what would you pay for a company that has alarming levels of disengagement versus a company that has alarmingly good levels of engagement?

John Lester: Two quick questions I just want to clarify for the listening audience. In the research that you did, and Keith in your research, is this generational?

Keith Dunbar: Yeah, so that’s a great question. I can’t necessarily speak to generational aspects in my work, because … Obviously, at the end of the day Baby Boomers, Gen X, Millennials, they have different attributes based on our perception of when they were born.

But from a leadership perspective, the ability to create engagement, it’s all driven by the same sets of leadership skills: the ability to inspire trust and build relationships and motivate and influence and foster teamwork and team leadership. These are all the same things that you need whether you’re a Millennial or a Baby Boomer working in a company, whether you are a frontline manager, a middle manager, executive management, or top management. From my perspective the generational piece is not as important from a leadership perspective. I’m sure Andrew can share his perspective on this. The generational piece is important, probably from an engagement perspective, would that be correct, Andrew?

Andrew Sherman: Yeah, let me agree with Keith and pick up where he left off and answer your question, John, a little bit more granularly. My research, and the research that I researched to write this book, says that it’s deceptively generational. When we hear the word disengagement we think about young people pointing the finger at old people, that it’s the Millennials saying to the Baby Boomers, “I’m disengaged because you’re not engaging me, and I have different expectations as to what engagement and happiness look like, and you’re not willing to meet me halfway.” And there is some truth to that. 

But the research also plays out that the Baby Boomers who thought they were nearing retirement and now need to work another 10 years, or who feel threatened by the fact that the Millennials will be ruling the workforce within eight years, they’re almost more disengaged than the Millennials because they’re frustrated. To Keith’s point, they’re further along in their work cycle and they thought they were going to be in a different place. At least a 25-year-old could be frustrated, but has 40 years of his or her work career ahead of them to be hopeful for. If you’re 58 or 60 and you’re still frustrated, there’s not a lot of change coming your way in all likelihood. 

I would say that it’s very widespread and it’s less generational than people think, in that the common perception is that, this 27-year-old wants to be entertained every day, like a video game, and the 55-year-old doesn’t feel like babysitting them and therefore there’s a disconnect between the two. I would say that if you’re interested in this topic in the context of M&A you’re going to find in your due diligence of companies that are disengaged or have workforce that are disengaged that it’s not unique to a certain age demographic or a certain racial or gender demographic. 

I’ll tell you one other thing that’s actually very, very interesting, that I found out. It’s not unique to the people at the lower rungs versus the upper rungs. There are people highly engaged that work in your copy room and there are people that are highly disengaged at the C-suite. One of the false assumptions is that, just because my title begins with a “C” I must be highly engaged because I’m making $300,000 a year. Not true.

John Lester: Good points. Does the research indicate that this problem is particular to the US, or did the research not even cover that?

Andrew Sherman: It’s global. There are some cultural differences in places like Asia. But in Europe the levels of disengagement in most parts of Europe are even higher than they are here in the US. One study that came out a couple of years ago showed a UK government workforce describing themselves as almost 50% disengaged to highly disengaged. You see it in various cultures. It’s interesting, in certain Eastern cultures where people define themselves not by how much they make but by the impact they have in their jobs and the impact that they add to the greater good, people are slightly more engaged because they’re not falling into the trap of defining themselves by two cars, four color TV’s, and a big house in the suburbs. There are definitely cultural distinctions, but in the more common Western culture I would say these levels pretty much cut across the board.

John Lester: Keith, in your work, because you’re working primarily with leadership teams on both sides of the transaction, are you hearing that this is a concern? Are you hearing that this is even recognized? What’s going on at that level?

Keith Dunbar: I don’t think, particularly the clients I’ve engaged with or what I’ve read from larger consulting firms, I don’t know that they think about engagement as this topic that they need to be thinking about as they go through an acquisition. For example, we all know that one of the first things that most consulting firms want to come in and do is a cultural assessment. And then depending on what cultural assessment instrument you’re using from whichever consulting firms, some of them do take into account some form of engagement questions in the survey, so they can find something out from that perspective. And maybe uneducated is the wrong word, but I don’t think they’re aware of the importance of the engagement piece for an acquisition. You can see that by how these things play out.

Even in the work that I do I think the typical model of leadership assessment in acquisitions is really just to focus on the executive leaders and the target company. What comes of that is that the acquiring company assumes that it has the leadership capability to make this acquisition work because they’re the ones that have won. They won the right to own this new company as part of their own. The reality is they have their own engagement issues in their own company, and now you’ve just created engagement issues if there weren’t any in this company that you’re acquiring because of the uncertainty about what’s going to happen and whether I’m going to have a job. It just kind of creates this conundrum.

I always go back to the definition of insanity, doing the same thing and expecting different results. Well, we still have an extremely high failure rate in mergers and acquisitions and I believe in large part that’s because of leadership capability challenges. And now, hearing from Andrew, I believe there’s an aspect of the engagement piece which is driven in large part by the leadership piece that is really causing some challenges in making these more successful. 

Andrew Sherman: Let me build on what Keith just said, because he’s raising a really, really, really, that’s triple really, important point. Think about the parties to the transaction. On the sell-side leadership and governance is usually going to be in denial as to the extent, the depth, and the breadth of the engagement problem and, to Keith’s point, may or may not have it on its radar screen and may or may not have any metrics or solutions to right the course of the sinking cultural ship. 

But let’s make it worse, because that’s just from a sell-side. On the buy-side you have leaders buying companies who think, rightly or wrongly, that they have the magic elixir, magic wand, for curing the cultural defects on a post-closing basis. I’ve actually heard leaders say, “Oh yeah, the engagement there stinks. But, you know, once we buy them it’s all going to be better.” Yeah, right. Like we’ll just wave our magic wand and they’ll be so happy to work for “ABC corporation” instead of “XZY”, that they’re all going to come in with a spring in their step and improve productivity by 80%. That’s exactly what’s leading to these failure rates in deals, the seller doesn’t recognize the problem and the buyer’s so sure that they have the solution, that it’s like the blind leading the blind.

John Lester: The vast majority of transition out of any organization is during times of uncertainty.

The notion that by the time day one rolls around and you now start to say, “How are we going to integrate the acquired staff and the acquired team?” The better ones have already figured out what their next move is because you have not told them what the expectation is, what the future looks like, and why they want to be part of it.

Keith Dunbar: Yeah, that’s absolutely true. The other thing you have to realize is that as soon as that deal is announced in an acquisition recruiters are swooping in like vultures engaging with this company that you just announced that you’re acquiring to scoop up as much of that great talent, which is partly the reason you’re making this acquisition.

It adds to the level of uncertainty and it adds to the level of engagement, particularly in middle management and employees, as they see these top executives that they know that are really good that are jumping ship before the acquisition is even final.

I’m kind of drawn back to some studies. Recently one of the large consulting firms asked CEOs, “How important is leadership in their organization, and how effective are they with their current leadership?” There’s a big gap between the importance of leadership and how effective these CEOs think leadership is in their company, and it’s growing. And so this again leads to this perspective, we see these increasing disengagement numbers and we see this increasing perspective that leadership capability in our companies is widening. I think we can see there’s no reason why we shouldn’t believe that we’re at this point with engagement.

Andrew Sherman: My fantasy is that, back to Keith’s point, engagement does become a critical piece of the due diligence process, a critical piece of the M&A planning process, a genuine reflection or component, of the valuation process. If you’re buying a company where only 4% of the people consider themselves high performing and you’re paying an above-market multiple for the company, A) you’re going to end up looking like an idiot at some point and, B) we shouldn’t be scratching our heads wondering how did this deal not succeed three years later. I mean, come on.

John Lester: Let’s get a little prescriptive then. How does either side actually identify these issues of disengagement in the diligence phase, and are there tools available?

Andrew Sherman: I think adding at least some basic questions, or some surveys, or asking the seller when they last did an engagement survey, what they’ve been doing to improve engagement. Just hearing those questions would make me feel a lot better. Also, not accepting the first answer as the right answer. Since the book has come out I’ve been working with some companies on this issue and had chief human resource officers tell me, “Oh yeah, we’ve got engagement in the company. We’ve got free diet soda Fridays and a ping-pong table down in the basement. People are engaged.” Really? A ping-pong table and some free diet soda. I’m afraid that’s not going to do it. That’s particularly true, as an example, when you listen to the average Millennial and they talk about their desire to get mentoring and to get access and empowerment in the decision-making, and influencing outcomes. That’s more important, I think, to a lion’s share of the workforce than even what their Christmas bonus looks like, at least from a happiness and engagement perspective.

John Lester: And especially at that age.

Andrew Sherman: Because they’re not carrying two mortgages and five car leases. Not yet.

Keith Dunbar: I think that just indicates the importance of leadership and the way that leaders take these skills that they have and whether they are skilled or unskilled or overuse their leadership skills to create this culture of engagement in their organization. One of the things that two companies going through a deal and integration can do is have a leadership engagement workshop where you bring these two groups together to work on going to be the direction, can we get alignment and commitment to this new future for the company and try to create engagement in the leadership cadre, and then take that down through the organization. 

Another key aspect, we’ve been working with a company out of Denmark that does organizational network analysis. Understanding who your key influencers are in the network is really important, because these are the people that are well-connected throughout the organization. They may not even be a middle manager or a front line supervisor but they are the ones that people go through and get their information. Knowing who those people are ahead of time and working to ensure that they understand the reasons behind the deal, they’re engaged in making it successful for the company, that can then filter down throughout the organization. I think there are a number of things that you can do to address the engagement piece, but you first have to understand whether you have the leaders with the right leadership skills, I think.

Andrew Sherman: We need to develop a better tool set for people engaged in M&A due diligence around engagement and disengagement. There are some red flags and warning signs. One, as Keith mentioned, dysfunctional leadership. You can look at high turnover rates. You can look at an excessive number of negative social media posts on job-related or other websites. You look at lack of succession planning, or obvious turfsmanship or protectionism. You look at compensation systems that are not aligned with corporate objectives, declining rates of profitability, lack of innovation, lack of patent filings. All of these metrics certainly indicate all kinds of problems, but one of the problems that they clearly indicate would be a low level of employee engagement.

John Lester: With the expected synergy on pretty much any transaction from a financial perspective being somewhere in the 2% to 4% range, is it safe to say that if somebody were able to get in front of this problem they might add a point or two to their synergy?

Andrew Sherman: I think so. I think even maybe more. I think that just by asking the questions and forcing the leadership team of the seller to deal with these issues you’re certainly going to get a more transparent, better price, transaction. And now I’m putting on my lawyer hat, it took me 30 minutes into the podcast to get there. But if I see some of these tell-tale signs that I just went over I’m going to start crafting specific reps, warranties, covenants, indemnities, around them. Ultimately, the good M&A lawyer is the one that takes this data that they get from the due diligence teams and crafts the agreement accordingly to protect against a disengagement risk. At the end of the day that can increase the chances of success, or at least increase the risk management profile of the buyer.

John Lester: Is the problem of recognition of the severity of this issue, mostly in the area of the leadership team, the middle management team, or the consulting team?

Andrew Sherman: In the book I talk about the crisis of disengagement as being both a bottom-up and top-down problem, and I think it’s unfair to make it one or the other. I think that leaders need to do a better job of understanding the problem and understanding the cures. Employees need to do a better job expecting things that are realistic relative to their jobs and careers. 

The part that really bugs me about the data we opened with, it’s the 19% that are actively disengaged. I mean, if you hate your job that much and you’re actively recruiting others to hate; just to do yourself a favor and leave. Go find something. Don’t stay there and be a disengagement cancer within the company. I think it’s both parties accepting responsibility to make things better.

And then the middle level manager’s job is to help execute, to be the front line and themselves be engaged. A lot of times when the middle level managers disengage there’s almost no way to get his or her work teams engaged.

John Lester: Keith, in your research, especially the most excellent article you did for the Harvard Business Review, you’re talking about the distinctions between middle management and senior management on the acquirer’s side and the acquired side. Could you take that perspective and address this question? Because it seems like there would be different expectations on each side.

Keith Dunbar: One of the questions I wanted to know were whether senior executives or middle managers had a greater effect on M&A success. And for the acquiring company it was senior executives, and that made a lot of sense to me because they’re coming up with the strategy, they’re executing on the acquisition portion of that and making that work. For the target companies it was really interesting, it became middle managers had a greater effect. As you sit back and you think about that, again, in this very complex uncertain environment, not in every case obviously, but in a lot of cases small and middle market firms that our family owned or even larger firms, the CEO and the top executives don’t stay with the company. 

In fact, there’s a really good book by an author that looked at retention of senior executives in a number of different industries between the 70’s, 80’s, 90’s, and 2000’s. By year three over 60% of the executives were gone after a deal. If you take that into consideration, it makes it really important to know what you have in the middle management cadre of both middle managers and front-line supervisors. Because, again, they’re the ones that have to keep the employees, in this case talking about Andrew’s book, they have to keep them engaged, focused on continuing to perform at the levels that they’re supposed to so this firm can continue to grow and be successful. I think in a lot of cases we don’t focus any time or energy on middle management, and that’s a challenge because it sets you up for potential failure down the road.

Andrew Sherman: The converse is also true. I agree with everything that Keith said. I can think of, anecdotally, one company that we sold. We were a law firm to the sellers. They sold to a Fortune 500 company. The middle level and upper level management team, but not the most senior team but the two rungs right below them, did stay in place and the company was doing about 80 million when it was sold, within a couple of years that exact same team, by keeping them intact and empowering them with the resources of the buyer, were doing almost a billion dollars in sales.

Keith’s right, if the team doesn’t stay in place value diminishes. If the team does stay in place and is properly motivated and has access to resources, it can really be impressive performance. 

Keith Dunbar: That’s a fact.

Andrew Sherman: If you’re listening to this as a buyer I hope you’re taking careful notes. And remember what Keith said earlier, when the news gets out and the rumor mills and the water cooler conversations start a lot of people do run for the hills because they don’t want to wait to find out who’s buying them. And so it could be that by the time the transaction closes there’s significant parts of the middle management team that’s decimated. You’re not going to get bumped to a billion if you’ve got the team that really knows the customers, really knows the products, really knows the services, knows the distribution channels, all heading for the hills, but worse yet, going to competitors.

John Lester: I just want to add one component to that. Starting third quarter 2007 where you had the prospect of a better job diminishing over the course of a few years. Now we’re in a market where it is easier for an employee to leave and to find better employment. I remember somebody speaking recently said, “If you’re in IT, as an example, and you haven’t gone out into the market to search for a new job in the last three years you’re diminishing your earning power.”

Andrew Sherman: And that gets into a classic debate about which is more important to people, the compensation or the culture. Obviously, we all need to eat, but one of the points I make in the book is that you start get into interesting variables relative to the US standard of living versus other countries. I mean, if you’re making … I’m just throwing out a number … $175,000 a year and living quite comfortably is it really worth for another 25 grand to leave a culture that you like and you’re engaged and you have leadership roles versus one that’s going to stink?

I think we assume that everybody is leaving for the bigger numbers, but every survey repeatedly shows that compensation is important, but how people are treated, how they feel, how they feel about each other, how they feel about their leaders, what they can tell their families when they get home from a hard day of work, all those softer variables are also very, very important. What I’m trying to say to our listeners is if you think that your solution to improving engagement is all about a bigger Christmas bonus, please think again.

That’s just going to get people to stay through Christmas.

John Lester: Last thoughts as we wrap this up. Keith, why don’t you go ahead first.

Keith Dunbar: I’m really impressed by the work that Andrew has done, and I think if I had any advice for companies looking to make acquisitions or either sell themselves as part of an acquisition, is they really need to consider the engagement piece as well as the leadership piece, because they kind of go hand in glove. It’s not something that you can separate one out from the other because in large part, again, the skills and the behaviors that leaders have in organizations in a lot of cases are really driving the culture and the, either, lack of engagement or the great engagement in companies. I think if they can just spend a little bit more time looking at those two pieces as a joint issue that they need to address in acquisitions I think what you’ll see is a much better success rate than a failure rate.

John Lester: Andrew, last thought?

Andrew Sherman: Last thought. 88% of the value of the S&P 500 is made up today in intangible assets. These intangible assets have two components, human capital and intellectual capital. And I would submit to you and Keith and to your listeners that if you don’t have engagement as a foundational element of your culture you will have neither intellectual capital or human capital value and it’s the beginning of the end of your company, and certainly going to directly impact the valuation of the business in an eventual exit transaction. This is very much an M&A issue and it’s very much a crisis.

Keith Dunbar: Yup, totally agree.

John Lester: Thank you very much. Absolutely fantastic insights. Great luck with the book, Andrew. Everybody go out and get it. And, Keith, I’m looking for your next blog post. Thanks so much, and have a great day.