Overseas Investment: People Factors that determine Failure or Success

Gao Xiqing – China Investment Corporation (CIC) Vice Chairman and General Manager

Caixin China Economics & Finance, January 9, 2012

  • A "major challenge for China's new overseas investment drive is a lack of experience".
  • "Then comes a lack of understanding of foreign cultures and societies".
  • "Some countries have developed complex feelings towards China as it has rapidly grown".
  • "So we must research diligently and find top-notch consultants before investing."
  • "One big difference between Chinese overseas investment and that of developed Western nations is that we lack talent".
  • "Our greatest challenge is to establish a mechanism to attract talents, retain them and allow talents to rise to their full potential. It is not enough just to hire them; we must also be able to train them and build a reserve of talented individuals."

Overseas Investment: People Factors that determine Failure or Success

Overseas investments by Chinese companies are not only growing in number and value but also in variety. There are investments in financial instruments, acquisition of assets, minority stakes in companies, new project funding, carve-outs and full buy-outs of entire companies. There are increasing people related issues in all of these.

Even pure financial investments are requiring greater sophistication on the part of investment teams considering a broader range of complex financial instruments. Investments focused mainly on securing assets, technology or raw material supply are requiring more proactive management of internal and external stakeholders. But where the people issues really come to the fore are in the increasing portion of investments that are part of a longer term strategy to expand into international markets, especially those Chinese companies aiming to become "global champions".

This article aims to outline the major people related causes of failure and success of overseas investments, particularly those that come with or must grow into larger organizations. Collectively the short hand People Factors will be used as a label for these. Failure is listed before success because that is what will happen if these factors are ignored or dealt with superficially. Murphy's Law (what can go wrong, will go wrong) is the rule not the exception in overseas investment. There is no other area within overseas investments where this is more true than the case of People Factors.

There are several challenges in how to navigate these People Factors to avoid failure. The first is an objective assessment of your own team's capabilities and limitations to make the right calls on these People Factors. The second is identifying who else to involve who has the expertise and trustworthiness to help you get the calls right. In the past, many companies have relied exclusively on experts from legal and accounting professions, addressing these People Factors in a hit or miss way.

Fortunately there is an emerging discipline around these People Factors that can be provided by experts with strong and specialized professional qualifications. There are many tools and methods developed out of "best practices" from acquisitive Multi-National Companies (MNCs such as GE, Cisco and others). While the best practices worked well in the MNCs that developed them, they haven't always been effective in the hands of others. This is especially the case for consultants or staff that lack operating experience. In the pursuit of completeness, some have grown monstrously complex with overwhelming data collection requirements. In an effort to minimize variation, some of these approaches have become increasingly mechanical, unfortunately creating their own unintended risks.

Too many and too large "work streams" can be excessively costly, time consuming, disruptive and distracting from the critical issues. How do you make sure you are doing enough without getting dragged into a quagmire? Set the focus and priorities of each People Factor at the outset and regularly review where to pull back and where to dive deeper.

It is also essential to involve experts with operating experience, not just the transaction of overseas investments, but also experience in the execution and delivery of the intended operating results. They will have the judgment needed to anticipate issues, spot patterns and anticipate consequences. Small, highly experienced teams are most efficient.

These teams should be seeded with high potential talent from the Chinese parent company for a unique and powerful development experience while transferring the skills into the organization to enable increasing self-sufficiency and sustainability. This strengthening of M&A capability and capacity is important to not only the central M&A team but also to all support functions so they can contribute value early on and throughout the investment cycle.

While trying to be helpful, some parties assisting the deal process can be conflicted by their incentive to get the deal done. It takes a tough, principal investor mindset to press for the real story, no matter how ugly it might be. Risk identified is risk that can be acted on: priced-in, mitigated or walked away from (some deals are better not done even if for free).

The People Factors are not all down-side risks however. There is certainly upside potential but it is best to address these having fully understood and addressed the risks. The opportunities to leverage the People Factors of overseas investments are seldom fully anticipated and even more infrequently managed to fruition. Some of these opportunities will be touched on at the end of each section, although a more in-depth coverage deserves a separate discussion beyond this article.

Eight People Factors. Each People Factor is briefly introduced below, though this will be far from a comprehensive coverage of sub-elements. It is intended to provide the big picture, highlight select issues and stimulate interest in further exploration. The first two People Factors are related to key individuals and the remaining six are related to the broader organization.

1) People making the deal. Who are the key players and what do you need to know about them?

2) Leadership team. Who should be on the overseas leadership team and how to handle changes?

3) Organization Structure. How should the unit be organized and linked with the China parent?

4) People costs. How do you reconcile overseas people cost structures with Chinese operations?

5) Talent and capabilities. How deep are the talent pool and capabilities in critical areas?

6) Communications. How to avoid crises caused by misunderstanding and build lasting trust?

7) Human Resources (HR) Practices. How to reconcile HR differences with overseas units?

8) Culture. How to understand and effectively bridge company culture differences?

1) People making the deal. There are many dimensions to this, a few of the questions include the following: Who are you buying from? What are their real motivations? Do they have the wherewithal to maintain stability and value through the deal process? Who is coming with the deal and why? Who is cashing out and why?

There are a lot of image, impression and story lines to cut through. It is an unnecessary risk to take answers to these questions on face value.An upside opportunity beyond a clean transaction is the establishment of a valuable and lasting relationship with key players based on a candid and fully informed discussion of mutually agreed facts about where interests are truly aligned. Back to list

2) Leadership team. The second most common People Factor addressed during overseas investments is the top leadership team of the new unit. This is arguably the most critical People Factor because it influences all the others. The default option of keeping the current leadership team in place is very common. If the unit is high performing and this is because of the leadership team in place, then it makes sense to not put the business performance at risk.

However, it is critical to assess current performance against the expectations for the future. Not only in terms of performance outcomes but also in terms of business model and markets. For example, if the investment case requires rapid expansion into emerging markets and the current unit is predominantly in developed markets (or vice versa) then a change in leadership team may be required to deliver this.

Another element to consider is which leaders are coming with the deal. Sometimes the top leader helps with the transition but either doesn't want to, or isn't invited to be a part of the unit's leadership team. This is a critical decision that must be handled carefully to maximize value for the investment. While members of the current leadership say they are eager to work as a part of the new company it is important to understand the level of their commitment and motivation. Equally important is to understand their true capabilities and compatibility with the new environment.

A deeper issue is the natural discomfort that many Chinese executives may feel in assessing the capabilities and motivations of people from other countries and cultures. This, plus the preference to avoid direct conflict, often leads to a deferral of that assessment. Unfortunately the consequences only compound and get harder to deal with when delayed. It can be embarrassing and disruptive to finally make a change a year or two later, especially if the business has suffered under the leadership team member in question. It can also be demoralizing when the staff below have recognized the misfit all along.

It is quite common to insert some trusted staff from the parent company into the unit's organization. When the position is the head of the unit, it is essential that the individual has the capability to command the respect of the management team. Position power and authority are not enough. Credible and relevant business experience and a reasonable management style is expected. Aside from selecting the right individual, the right support system is essential to ensure the new leader makes the right entry and stabilizes in the new environment.

As with MNCs, excessive use of expats can stifle growth. This is especially the case where expats fill the whole leadership team of the overseas investment. This doesn't always happen at once, an expat leader may gradually bring in old colleagues and work around the local members of the team. This is often done for the convenience and comfort of communicating in Chinese and directing the work with others who are used to the same management style. There are many negative consequences to letting this natural tendency spread. Fortunately there are proactive means to setting up the new leadership for success in working together.

Often overlooked is a third option beyond using existing leaders from the unit and parent company. This is external recruitment. Done right, it can bring in upgraded capabilities and provide objectivity to help unify the unit with the parent company. Done wrong, it can demoralize existing staff and create a new fiefdom.

The upside opportunity to establishing a strong leadership team, whether comprised of existing or new members, is a base to build around for long term growth. They become a model for other overseas investments. In the future, senior global leaders of the parent company can rise from these teams. Back to list

3) Organization Structure. If the previous leadership team is kept in place, the balance of the organization structure also often stays the same. So this People Factor is sometimes overlooked. Rarely is this justified. Any changes to the business strategy, operating model and cost structure will require at least some adjustment to the organization structure. Sometimes this is dramatic, as in the case of a business shifting from a domestic market focus using a functional organization structure to an international market focus with a geographic organization structure.

It is also important to understand how services are provided internally between units and by headquarters. When the acquisition is a carve-out the buying company needs to decide how to handle them. Transition Service Agreements (TSA's) with previous service providers that are not part of the deal are usually, for several reasons, adequate only as a very temporary solution. The roles either get built back into the operating unit if it is going to stand-alone or is picked up by the new parent company if the unit is going to be integrated.

The go-forward organization structure needs to clearly define the new roles and resourcing requirements. Assuming the unit's existing staff can pick up these duties can be a big mistake if they lack the experience and expertise to do so. Same can be said for the parent company. Having an organization plan to establish and evolve these roles can provide a roadmap that will reduce dropped balls, conflicts and other business disruptions.

Moving quickly to the right organization structure allows the organization to stabilize more quickly and get on track to deliver the business outcomes expected. When operating units are expected to be integrated, this becomes a critical path action. Delaying this trades immediate stability for future, usually much more costly, instability. Endless tampering with the organization structure creates costly instability and confusion on the part of employees and customers.

Another structural element is the interface between the overseas unit and the parent company headquarters in China. Solid or dotted reporting lines are not enough. Mutual understanding of roles, decision making processes and communications expectations are essential. Other People Factors come into play here as well.

The headquarters staff in China will expect the overseas unit to be responsive to its requests as it is the parent company and, by definition, higher in the hierarchy. The overseas unit may feel differently, especially if they previously were managed more independently. If the staff of the overseas company feel their company is more developed than its new "owners", they may expect to "teach" the headquarters staff about their supposedly advanced methods and ways of working. While going beyond organization structure, setting up clear expectations for roles and staffing them accordingly is a very challenging but important set of actions.

The upside opportunity of getting the organization structure right early-on is a scalable foundation and focus to drive sustainable growth. Back to list

4) People costs. While current purchase prices may appear to be exceptional bargains it is not wise to skip over getting a deeper understanding of the overseas unit's cost structure. The People Factor relevant here is people costs, broadly defined to include what is driving them now and in the future. The usual and obvious elements in this People Factor are those that need to be captured by due diligence and incorporated into the valuation model based on cost accounting, planning and actuarial disciplines. Typically this involves collecting and verifying the full picture on people costs (usually the largest controllable operating cost), including compensation, benefits and pension liabilities as well as contracts with labor unions, human resources vendors and senior executives.

What is required here is not simple number crunching as a significant measure of judgment is required. Internal data needs to be supplemented with market data and knowledge to make reasonable assumptions on future trends, risks and opportunities. Overseas people cost structures are often difficult to comprehend in comparison to their Chinese counterparts. Comparisons of individual figures are hard to reconcile in isolation. Total work processes, methods and outputs need to be considered. Some cost differences are due to legal and regulatory requirements, though these are sometimes used as an excuse to maintain the status quo.

Other cost differences are due to corporate controls and staff functions intended to ensure adherence to centrally defined standards. Simply cutting out all of these is dangerous. While it seems safe to leave everything as is, this can cause compounding problems that become harder to address later. Sorting through what is there and why can enable prudent decisions to be made that better allocate costs according to the investment objectives. Involving experienced professionals who can work credibly with the overseas management team helps to get to an objective and simple explanation of the what and whys, making the tough decisions a lot easier.

It is important to look for the key drivers of current and future people costs, especially if the Chinese investing company aims to integrate the overseas unit and maintain a competitive cost advantage over their global rivals. Examples of drivers beyond local labor market conditions are employee turnover trends and employee population mix changes (e.g., aging workforce, geographic shifts).

Facility locations are frequently in the wrong place to meet future plans and cash flow gains can be captured through real estate sales and shifting to lower cost locations. However, there may be offsetting benefits from a dedicated workforce and supportive local community. This is especially true where the location has high historical and emotional significance to employees and the company image. An insensitive handling of a facility can create an unexpectedly strong negative reaction by customers, the public and government officials.

Sometimes the objective is to find cost redundancies and leverage, though just as often units are expected to be kept separate and operate under a two systems approach. The people cost analysis can also discover areas where moderate cost increases, as investments, are actually needed in the parent company's current operations (for example, compensation to retain and attract certain talent).

Fairness issues eventually arise when two systems are maintained (this predictably shows up with different travel and expense policies). An upside opportunity that pays huge dividends is to start early to define an overarching framework that reconciles the two systems into a single, principle-based approach that the company can apply globally, (including future overseas investments). Back to list

5) Talent and capabilities. Too often the question of the sufficiency of the broader talent pool and capabilities is either addressed superficially or left for later. In the best case, the depth of talent and capabilities in critical areas will be addressed in the course of due diligence. At a minimum, it should be addressed during transition planning ahead of the deal closing. This is to enable the securing of critical talent to ensure they are retained and to provide a running start for actions required to shore up talent needs and build capabilities. Both take a longer lead time for actions to turn into results.

It's too late to wait until these issues start to show up as causes of performance shortfalls. An objective assessment against the competition overcomes a too proud denial of a problem by defensive and internally focused managers. The upside opportunity is a talent pipeline for the parent company and other operating units and capabilities and methods of building them that can be transferred as well. Back to list

6) Communications. All oversees investments will have at least some communications efforts. Aside from the essential government and investor communications, this involves at least some press releases and announcements to customers, employees and other constituents. This People Factor is probably the most under leveraged factor of all. This is because it is low cost and very high impact.

If communications are mishandled, an enormous crisis can ensue. The entire investment can even be threatened. Hiring a good Public Relations firm can help with external communications though it can backfire if the company is seen to be hiding behind the PR agency. Some PR firms can also help with internal communications but this should be seen as a supplement to management's own efforts.

The real power of communications is what is conveyed, and not conveyed, by the parent company leaders and by the leadership team of the overseas investment. Understanding the audiences involved is essential as is a direct, frequent and consistent delivery of key messages. Feedback loops are needed to ensure the messages are being received as intended and corrective communications made immediately before misunderstanding spreads. The upside opportunity of establishing effective communications with overseas investments is a cushion of trust that will allow the many challenges that arise to be worked through with the cooperation and understanding of everyone involved. Back to list

7) Human Resources (HR) Practices. This People Factor is often overlooked before the investment is completed. HR Practices and the management of the function as a whole is a substantial topic on its own. This is true with other functions such as Finance. In fact, both functions deserve a priority focus in overseas investments because people and financial issues crop up early with an enormous impact.

The analysis of the overseas unit's HR practices during due diligence can surface hidden costs and regulatory exposures as well as critical differences in operating model and company culture. When the overseas unit involves organized labor, the stakes are even higher. Experienced HR professionals with knowledge of both Chinese and the overseas practices can accomplish this efficiently.

More importantly, these professionals can plan the needed actions required to ensure a smooth as possible transition. The HR team structure and staffing need to be done early on because they have to be ready to effectively support the same for the rest of the overseas investment unit. The professionals involved can also build the capability and knowledge of the parent company's and overseas unit's HR teams and prepare them to work effectively with each other.

Their biggest challenge will be to establish the overarching framework that will enable both HR teams to reconcile their differences and move forward under a unified approach. The upside opportunity is a set of HR Practices that are scalable in existing operations and replicable to new overseas investments, enabling sustained growth and longevity of the company's unique culture. Back to list

8) Culture. Company culture is the most elusive of the People Factors. It both influences and is a reflection of the other factors. Company cultures are related to but distinct from the country cultures they are embedded in. Not all Chinese companies have the same company cultures and the same goes for companies from other countries. However one can expect that the greater the difference between country cultures the greater will be the difference between the cultures of companies from those countries.

Too often this subject is reduced to simplistic do's and don'ts and references to superficial characteristics and stereotypes. Focusing on these aspects misses the point and can increase frustration when the underlying problems continue to get worse. Misunderstanding of cultures creates misinterpretation of actions and motivations, these in turn create suspicions and distrust. Distrust is quickly sensed by the other party and a defensive reaction only serves to accelerate a negative spiraling decline of trust. Once trust is lost, it is extremely hard to rebuild.

Understanding and effectively bridging company culture differences between the Chinese parent company and the overseas investment company is vital to the success of that investment. Effective bridging of cultures begins with an objective understanding of both cultures. This is not easy to do having lived entirely within a single country culture, even more so if the individual has spent their entire career within a single company. Involving staff who have lived and worked overseas helps but is usually not enough to get this right.

This difficult subject can be facilitated by involving professionals who know how to quickly grasp company cultures and are skilled at explaining both to build mutual understanding. When this is done right, problem solving produces solutions that are better than either could have done separately. The upside opportunity is a strong foundation of mutual trust that can be sustained through difficult times. Further upside opportunity is the evolution of the parent company culture so that it is inclusive of its overseas employees and genuinely embraced by them.

Beyond Individual Overseas Investments: Going Global. Perhaps the greatest long term challenge for Chinese companies investing overseas is making the transition from managing discrete international investments to establishing a complete global enterprise. Several suggestions were made above regarding how to build towards this while working through the overseas investment at hand.

Interestingly, the heart of the challenge lies not overseas but at home in China, in the center of the company. Building global leadership capabilities at headquarters is especially difficult since staff there are immersed in their domestic environment, part of a particularly strong hierarchy that is resistant to change and are measured by more subjective performance measures. Sending talent on overseas assignments helps but these have to be set up for success. Even if they are successful, returning to an environment that is still fundamentally operating with a domestic mindset, they are at risk of reverting to their old ways or leaving the company.

A multifaceted and integrated approach is required to build sustainable gains into a global company. Fortunately there are many lessons and practices that can be adapted to the specific needs of Chinese companies from the experiences of companies attempting the same transition from bases in US, Europe, Japan, Korea and others. The good news is that the previous mistakes do not have to be repeated and China can continue to make and attract extraordinary development. Back to list

Lee Hawley is Managing Partner of HRT Edge Limited, a boutique service firm advising top executives of Asian and Global firms transforming their organizations to achieve their strategic objectives, both organically and by acquiring and integrating overseas businesses.

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