The Hindu Business Line : Banking M&As: Fusion and fission

The banking scene presents a strange spectacle of banks intensely competing with one another without being competitive, that is, cost-efficient. The mergers and acquisitions route provided a viable alternative to non-viability. The real test of the success of a merger is making people connect to each other.

I VIVIDLY recollect an incident that took place a few years ago. A senior bank executive met me in one of the usual half-yearly courtesy-cum-marketing calls.

Incidentally, the previous day, there was a media announcement that his bank would be merged (acquired) with a foreign one. He had also come to know of the merger from the media announcement. Tension and stress were writ large on the countenance. He just muttered: "Merger? I do not know what my position and responsibility would be in the new entity."

He had been with the bank for over 15 years. If that could happen to a senior executive, what about the rank and file?

I met him again that same evening over dinner. Though the usual bonhomie was missing, he appeared more composed and confident. He whispered that he had received an e-mail from his boss informing him in detail the grand plan and what his responsibility/location could be in the new entity. I felt the emotion of only one out of the 40,000 staff of that bank. The moral of the story is too obvious to state.

Such is the people side of merger which conventional due diligence cannot capture. My friend's initial reaction was not on the merits or demerits of the merger. But he had reacted to merger news in relation to him and I would imagine the rest of 40,000 would not have reacted differently.

The Indian banking scene presents a strange spectacle of banks intensely competing with one another without being competitive, that is, cost-efficient.

Competition is impacting prices and not costs. Well, this is not sustainable. In similar situations elsewhere, the M&A route provided a viable alternative to non-viability.

Many banking honchos are smitten by the acquisition bug. They are mesmerised by bigness. The talk centres around economies of scale, scope, synergy, pan India footprint, and so on. The debate is more on what can be achieved through merger and not how to realise/execute it.

It is useful to look at the M&A history in the US which saw a massive and feverish consolidation drive with over 2,000 mergers in the financial sector.

While the first wave of consolidation was marked more by management hubris, the second wave was more consistent with the theme of restructuring for efficiency and global positioning.

Research studies by academicians at Wharton and Harvard clearly bear out that a merger would be successful if only the merged entity attains profit and cost-efficiencies and enhanced market power.

A number of studies have measured the success in terms of these three important parameters. The success of a merger hinges on how well the post-merged entity positions itself to achieve cost and profit efficiencies.

It is difficult to rely on measures of economies and diseconomies of scale in banking, whereas cost and profit efficiencies are far more reliable and measurable indicators and create value.

Mergers elsewhere in the world have helped reduce operating expenses by 0.5 per cent (per cent to total assets). That would translate into a few thousand crores of rupees for Indian PSU banks.

Vertical versus horizontal merger

Can horizontal mergers with overlapping product profiles achieve profit efficiency?

A horizontal merger no doubt adds to size but the attainment of profit efficiency is sub-optimal. A vertical merger (entities with different product profiles) may help in optimal achievement of profit efficiency. Consolidation through vertical merger would facilitate convergence of commercial banking, insurance and investment banking.

Values of economies of scope are evident more in vertical, rather than horizontal, mergers. A vertical merger may be reassuring more to the rank and file than the top management.

A merger to be successful, it should create new capabilities and offer more and better value propositions to the combined entity's customers.

The product range spanning savings and investment would help capture all the needs of the customers. Customer profitability and the number of products per customer would also improve significantly.

Cross- and up-selling opportunities

This would address the problem of PSU banks that have shorter and fewer revenue streams per customer.

Thanks to disintermediation, big and or well-rated customers are no longer profitable. There is more juice in moving money and shifting risks for corporates than taking capital-heavy and risk-laden exposures. A vertical merger, unlike a horizontal one, would connect diverse capabilities and not just assets. This connectivity is a real source of synergy.

Insurance, commercial banking and investment banking entities merger would be a good vertical that would diversify revenue streams, and not just credit and geography risks.

Merged entities would also be well-placed to capture wallet share, which is more rewarding than the bleeding market share.

A vertical merger also offers opportunities to create new capabilities in risk intermediation, which would offer more value to corporate customers.

Cost-efficiency

In the Indian context, would it be feasible to achieve cost efficiency, particularly non-interest operating costs, in the post-merger scenario? Operating/intermediation costs are one of the highest on global standards.

Consumers and the economy, in general, can benefit from the mergers if only the operating costs come down. Of course, they are not uniform even across PSU banks.

So, a merger of two banks with the same range of operating costs does not by itself result in the much-needed cost-efficiency. And a merger of two banks with varying range of operating costs would end up in averaging the costs rather than cost-efficiency.

Thus, the merger goes beyond financial and accounting issues. There has to be a pre-merger gameplan to achieve cost efficiency. Cost-efficiency is not inevitable but requires deliberate and imaginative action. Conversion of fixed to variable costs has the potential to offer cost-efficiency.

Merger and human resource imperatives

An empirical study of mergers elsewhere reveals that post-merger productivity has a tendency to drop, post-merger. This is mainly on account of not adequately addressing the concerns of workforce about their retention, relevance and/or redundancy and integration.

However, productivity bounced back fast wherever there was workforce planning with clarity on where employees would fit; what they will do, who they will work for, and how their career track will be affected; whether they can retain compensation and benefits.

These are not trivial but critical people issues and the success of the new combined outfit would depend on how well these are flagged and addressed.

Post-merger, financial due diligence becomes a redundant document. A successful merger goes beyond legal, financial and accounting issues.

Mergers, which focussed on financials alone to the exclusion of people issues, have lost value and some even never integrated. Integration is a key issue. It is in this context that communication with trade unions helps.

A merger is an emotive issue both at the individual and collective levels and, more so, in the Indian context where the employees are recruited for the organisations and not for specific jobs. The real test of the success of a merger is making people connect to each other. Upping the hostility quotient does not help.

Coming together to be competitive enough to face the future successfully is a more appropriate approach. People strategy and involvement would be the differentiator between success and failure of the combined entity.

Real value is created early when the integration process is handled well. Mergers that just end up averaging strengths and weaknesses rather than creating new capabilities and averaging costs and profits cannot go far enough to be globally competitive.

In mature markets, intangibles contribute to more than 50 per cent of the market value of enterprises. It is useful to preserve these intangibles of the merged entities.

The typical example is the acquisition of Orange by French Telecom, the latter using the brand of the former to market its products and its marketing expertise.

Lowell Bryan, in his book, Race for the World, groups all industries into three categories — globally-, nationally- and locally-defined. Of about a dozen industries classified in the locally-defined category earlier, only one remains — funeral services. The others have leapfrogged to the global category.

Such is the pace of race for the world. Whoever tried to keep and operate a globally-defined industry on local standards got cannibalised. Globalisation has gone thus far.

Who would like to be in the company of funeral services? Not certainly bankers.

(The author is a senior bank official.)

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