What can we learn from Private Equity?

Historically, there has been the misperception that Private Equity makes its money by cost-cutting and asset stripping, not investing in the business and having a short-term focus. However the recent downturn in the economy has made it apparent that to survive private equity firms need to do more than concentrate on transactions but they need to focus on the running of the businesses in which they have invested to ensure good returns, especially as they are likely to hold these companies for a longer period of time.

So what are the more successful private equity firms doing and how can businesses learn from these successes. The following key practices were discussed at a recent meeting of the PARC (Performance and Reward Centre) led by Lisa Stone of HgCapital.

·         Focus on growth

·         Medium to long-term focus

·         Plans and priorities

·         Focus on people

·         Effective Boards

·         Alignment of incentives

In this blog I am going to highlight how reward strategies can support Private Equity businesses with their turnaround agenda.

HgCapital data has shown how for every pound invested twice as much value comes from revenue growth than from margin (ie reducing costs). With Private Equity the time horizon to drive more growth is likely to be around the five-year mark. Where growth is required revenue would normally be the highest weighting in the short term incentive plans (50% based on Revenue, 25% on profit and 25% on other targets would be quite common).

Strategic metrics which align to the business plan and are cascaded and owned by the management team are also important to ensure that the strategy is clear, accountable and measurable. Therefore key indicators such as Net Promoter Score (Customer Satisfaction) or sales conversion rates could also be included in the incentive plans.

In times of change the incentive measures are often changed annually to react more tactically to the new strategy and business plan.

Private Equity firms normally appoint non-executive directors but they are entirely dependent upon the management team and continued engagement of the staff. This requires a particular focus on people and in particular employee engagement. If your business has implemented metrics to monitor employee engagement then consider included these metrics in the management incentive plans.

As with most companies the remuneration packages of the Private Equity boards will comprise of base salary at the market rate for the industry and bonuses of around 100% for the CEO and 60-70% for the CFO. As mentioned above the bonus plans are likely to be tactical and linked to the critical criteria of the business plan for that particular year.

Equity plans will most likely be two-fold; plans which receive the executives own investment (usually at about 1 x salary) and those which are provided by the Company. For a CEO the equity provided by the Company is likely to vest over the planned investment period and pay out only where there is a successful exit from Private Equity status. The value of the equity provided to the CEO at the end of the investment period will vary considerably but is generally distributed to the top 20 executives with the CEO perhaps receiving 5% of the value of the business and the CFO receiving 2%. Of course Private Equity deals are generally highly leveraged and therefore there is the risk of the Executives losing their own investments as well as the potential upside.

The two biggest contrasts between Private Equity and PLCs are with the short-term and long-term incentive plans and using these to support delivery against the business plan.

The focus on the bonus plan being tactically used with a few measures which change each year – rather than the desire within PLC for a balance of financial measures and continuity in their bonus design.

With the equity plans it would be very difficult to persuade the Rem Co and the shareholders that a single event should be the criteria for vesting rather than market related performance criteria such as EPS.

So although there is much to learn from the success stories within the Private Equity arena there must also be a recognition that Corporate PLC needs to align to shareholder interests which are much different to those of the senior executive team.

Interview with Mike Lawrie, new CEO of CSC

Week 2 at CSC and is the interview below with a reporter on the Wahington Post a snapshot into Mike Lawrie's 100 day plan? I await with interest to see what unfolds in relation to the changes he will make in the organisation sturcture and how he will align the Board and the senior leadership team. I will play my part in what I can do to align the compensation strategy and systems to enable the business strategy to be executed and to role model the values which will be expected of the senior executive team.


What leadership skills does it require to do a major turnaround?
The starting point is trying to determine with your team what do you want to be the best at and how you want to differentiate yourself in the marketplace. The second step is to get a strategy together that allows you to achieve that vision. The next step is to get an organizational structure in place that allows you to organize your most important assets — your people, your human resources, intellectual capital — so you can execute the strategy. Once you decide on the organization, you need to recruit the right leaders to actually run that organization. Then you need to get your compensation systems, measurement system and management system to monitor the progress that you make and then make adjustments as you go along. I have used that basic formula for 15 years. To a large extent, that’s the process I am beginning here at CSC.
Your first stint as chief executive was at Siebel Systems. What would you have done differently?
I would have tried to get more conviction and buy-in from the board as to what needed to be accomplished and the threats to the existing business model. I don’t think I did a good job in clearly articulating that. I also think I was slower than I should’ve been in bringing a team in that could execute against that changing business model.
You are known for improving client satisfaction at Misys. How did you do it?
The first thing we did was ask our customers how we were doing. Up until that point we had never done that. I hired a third-party firm to do that. It turned out we were not doing very well. It wasn’t hard to see the four or five things that we needed to improve on. So we put a game plan in place. We listened and acted.
Do businesses do that enough?
I think it’s spotty. Even at CSC, we don’t have a uniform approach to customer satisfaction. That’s one of the things I’ve uncovered in the first few days I was here. We do not have a consistent approach to how we go about soliciting feedback from our clients. As a result we don’t have a laser-focused action plan to address some of their needs.
In a turnaround situation, you mentioned the importance of hiring the right leadership. What is the best way to do that?
The more difficult part is identifying someone’s values. That’s where I spend most of my time is getting a handle on the values that make them who they are. I’m very strong on values. If you don’t get the right values in senior executives, you won’t be able to get the right values in the corporation and that will impede your ability to be a highly successful enterprise.
—Interview with Vanessa Small - Washington Post

How can we mitigate auto-enrolment costs?

There is much talk in the industry about how auto-enrolment will encourage more employees to join either NEST or their company nominated pension arrangements for a much more financially sound retirement. Surely that is a good think for the workforce at large, but is this a good thing for the employers?

The increased cost burden on employers (especially smaller ones who have not offered a “good” company pension scheme to date) is not only in relation to the increased cost of contributions as employees join the pension scheme for the first time, but also the implementation costs of system changes, communication, advice on design, to name but a few.

So where can we look for ideas on how to reduce the cost of both implementation and on-going compliance with these requirements?

This was the focus of a recent workshop I attended with Bluefin where we were trying to play the part of the uncaring, cost-cutting employer (not too difficult for some).

Summarised below is some of the output from that session.

Systems

·         Investigate the capability and costs of your existing providers to comply with the requirements and negotiate that they will comply without passing on additional costs

·         Renegotiate your contracts with existing payroll, HR system and pension system providers to investigate any potential areas for cost reductions to offset any additional costs for auto-enrolment

·         Act in good time so you can review your options fully – if you need to make changes to systems at the last minute the cost is likely to be inflated

·         Ensure you are not paying for an overlap in any system capability

Processes

·         Consider how you can make it easy for employees to opt out without falling foul of the inducement rules

·         Design data feeds so that employees have time to opt out before payroll takes effect to reduce administration costs

·         Get providers to commit to what process changes they will deliver within their current cost models

·         Map your current and required processes to identify any gaps which could cause some unexpected administration costs to resolve

Communications

·         Segment your audience and tailor communications so you are only communicating relevant messages to those who need to take some action – there could be many groups of employees you do not need to communicate with at all.

·         If you have groups of employees for whom it does not make sense to join – then help them with that decision-making process by offering financial planning

·         Communicate badly to deter take up! (The communication specialists will hate that one.)

·         Don’t push employees to join – the NEST experience shows you can keep your take up rate 20% lower if you communicate but do not promote the arrangements

·         Integrate into your existing communications and channels – don’t make this a new costly communications campaign

Implementation ideas

·         Consider Salary Sacrifice to reduce employer NI costs

·         Speak to the Pensions Regulator if you are unsure whether you comply to see if you can continue without any change

·         What can be done from resource in house to reduce consultancy costs – can you pool resource with other groups or associated companies?

·         Good planning and project management to avoid any unforeseen issues and therefore costs

·         Can you restructure your organisation (or parts of it) to defer your staging date (well at least until 2017)

Design ideas

·         Consider levelling down to the minimum contribution requirements – at least for those employees who are not already members of your scheme

·         Reassess your contractual arrangements for agency and overseas employees to reduce the number of employees you need to auto-enrol

·         Use qualifying earnings instead of base salary as the pensionable earnings definition

·         Consider offering alternatives to pensions (but not inducements to opt out) or flexible benefits

·         Review your overall benefits to staff to ensure no cost savings in these areas (eg overlap of provision in different contracts)

·         Introduce matching contributions from the employees if you have a current non-contributory pension scheme

·         Consider different arrangements for different segments eg NEST for some and GPP for others to keep your annual management charges low

Pension Costs

·         Introduce a waiting period and align to the minimum age requirements

·         Phase the increasing of contributions to align with the minimum requirements – so start with the minimum and increase contributions each year as the minimum level rises

·         Require higher contributions from the employees

For more information contact your adviser or are these the ideas the consultants are not telling us about!