At the Tata Steel annual general meeting (AGM) in mid-August, shareholders’ tributes for chairman Ratan Tata were louder than usual. Tata Sons, the holding company of the Tata Group, had just set up a panel to find a successor for Ratan Tata, who is the chairman of the group and several of its larger companies. “Don’t leave us,” implored one shareholder. “We cannot lose our Ratan (jewel in Hindi),” said another.

Ratan Tata will still be around at the next AGM; he isn’t due to step down until December 2012. He hopes to have some presence after that — as someone “sitting in the audience asking questions,” he told audience members at the AGM. But the question that is being asked today is: Who will succeed him?

Observers agree that filling Tata’s shoes is not going to be an easy task. In the early days after he took over from J.R.D. Tata in 1991, he was widely criticized for daring to take on the satraps, as the independent-minded CEOs of the larger group companies were then described. There were battles fought in boardrooms and the business press, but eventually the old guard retired. More recently, there was criticism that the acquisition of automobile manufacturer Jaguar Land Rover (JLR) and steelmaker Corus would deluge the group in debt. In results declared in August 2010, however, both Tata Motors (including JLR) and Tata Steel (with Corus) have returned to profits. The Tatas are also now the country’s most valuable group with a market capitalization of US$80 billion.

The Race for Succession

The frontrunner in the Tata race appears to be Noel Tata, Ratan Tata’s half brother who was recently promoted to overseeing the group’s international operations. Some 65% of the conglomerate’s US$70.8 billion revenue (April-March 2008-2009) comes from outside India, so this is a significant responsibility. Additionally, Noel Tata is the son-in-law of Pallonji Mistry, who owns 18.4% in Tata Sons, which makes him the single largest individual shareholder (most of the equity is held by charitable trusts).

But others are in the race, too. The Economic Times speculates that the internal candidates include Tata Sons executive directors Ishaat Hussain and R. Gopalakrishnan; and B. Muthuraman, Ravi Kant and S. Ramadorai, vice chairmen of Tata Steel, Tata Motors and Tata Consultancy Services (TCS), respectively. The younger group includes the CEOs of TCS (N. Chandrasekaran) and Titan (Bhaskar Bhat). But they are long shots at best, observers say.

There is also speculation that, given the group’s increasing global focus, the choice need not be an Indian. The Times of India says that the candidates could include Indra Nooyi of PepsiCo, former Vodafone head Arun Sarin and Renault Nissan chief Carlos Ghosn. “The selection process would consider suitable persons from within the Tata companies, other professionals in India as well as persons overseas with global experience,” says a Tata Sons press release.

Ratan Tata has also clarified that the new chief need not be either a Parsi or a Tata. (The Parsis are a wealthy business community in India, and the Tata chief has traditionally been a Parsi.) The Parsis are a shrinking community. Birth rates are very low and women who marry outside the community are excommunicated. There are now less than 60,000 Parsis left in India, and it is inevitable that the Tata baton will pass on to a non-Parsi sooner or later.

It will have to pass on to a non-Tata, too. The Tatas are a small clan. Apart from Ratan, there is his 80-year-old French stepmother, Simone, who is obviously not in the running for his job. His brother, Jimmy, is close to 70 and has retired from Tata Power. Aloo Tata (who is by birth a Mistry) won’t get precedence over her husband, Noel. And their three children — Liya, Maya and Neville — are still studying. So, Noel is the only Tata who is eligible.

The composition of the selection panel has some critics speculating that the choice of Noel is pre-decided. It consists of Tata Sons directors R.K. Krishna Kumar and Cyrus Mistry (who is Noel Tata’s brother-in-law), Tata veteran N.S. Soonawala, group legal advisor Shirin Barucha and independent member Lord Kumar Bhattacharya of the Warwick Manufacturing Group of the U.K. “There is only one external member,” says Pradeep Mukerjee, founder-director of Confluence Coaching and Consulting. Mukerjee, who has worked for several years in the HR area with Citigroup in the U.S., says that in the West, such selection panels have many more external members. “What good is a panel stuffed with internal members? I wonder what the true purpose is.”

Infosys: Looking on the Outside

Mukerjee contrasts the Tata situation with the nominations committee at Infosys, which has just embarked on the task of finding a successor for chairman and chief mentor N.R. Narayana Murthy, who retires in August 2011. The Infosys nominations committee consists of Cornell University professor of law Jeffrey S. Lehman; HDFC Standard Life CEO and managing director Deepak M. Satwalekar; and ICICI Bank non-executive chairman K.V. Kamath.

“We do not discuss internal processes while they are going on, lest the discussion give rise to misleading speculation,” Lehman told India Knowledge at Wharton. “Let me state simply that the leadership duties of the board chair are well understood and we are committed to selecting an individual who will carry out those duties with full professional competence. We do not have any ‘litmus tests’ that we apply regarding the individual’s background. I am absolutely certain that we will make a decision and we will make a public announcement with appropriate lead time.” (Incidentally, The Economic Times predicts that Kamath is likely to take over from Murthy.)

These two headline-grabbing selection processes have cast in the shade similar exercises going on in corporate India. At Larsen & Toubro (L&T), for instance, there is speculation that Ravi Uppal, who has come in from multinational ABB to head the power business, has already been selected to replace chairman A.M. Naik when he retires in a couple of years. At family-owned but professionally run groups like Dabur and Godrej, “facilitators” and committees have been appointed to look at succession issues. “There is a strong succession plan for more than 150 senior managers across the group,” says Godrej group chairman Adi Godrej. “It covers two aspects — sudden resignation or demise, as well as for when the manager retires…. Godrej group companies have very strong boards — the independent directors are professionals with expertise in their fields, not industrialist friends of the family.” According to Raveendra Chittoor, assistant professor of strategy at the Hyderabad-based Indian School of Business (ISB): “Over the past decade, there has been a growing trend of appointing professional CEOs even in family-owned companies.”

Raphael (Raffi) Amit, Wharton professor of entrepreneurship and management, says Ratan Tata’s and Narayana Murthy’s desire to find professionals to lead their companies — not necessarily family members or insiders — is in line with the findings of substantial research he has done in this area. “On average, when these types of succession issues come up, the business is better off finding a professional manager rather than a family member,” he says, citing a May 2006 paper he co-authored, titled “How Do Family Ownership, Control and Management Affect Firm Value?” (The study was written with Harvard Business School professor Belen Villalonga, and it was published in the Journal of Financial Economics.)

“While you are inclined to find a family member to lead a particular business or the group as a whole, first and foremost you want to make sure the longevity and prosperity of the business that you have started — or was started by the previous generation — is maintained,” Amit says. “Often, a family member is not available or willing, or not as capable as a professional.” What Tata and Murthy are doing in this matter “is in the best interests of the long term sustainability, longevity and prosperity of the businesses,” he adds.

“[There] is no reason to believe India should be different in succession planning,” he says, referring to the findings of his research. However, generally speaking, in Asia, “cultural issues” are perhaps more prevalent than in the U.S. or Europe, he notes. “The belief may be [that] non-family members cannot be trusted to the extent family members can be trusted. That is one of the biases for them to appoint family members, whereas the most appropriate person may not be a family member. Even though rationally people understand the issues, emotionally people have a hard time thinking that a non-family member can be trusted to the extent a family member can be trusted. It is not so much an economic or business issue as it is a cultural issue.”

According to a study by global business and strategy consulting firm Bain & Company, attention to succession planning in Indian companies is woefully inadequate. “Research in 2008 showed that board members discussed CEO succession at least once a year in more than 60% of the S&P 500 companies,” says Ashish Singh, Bain India managing director. “In India, we find the picture very different: More than 75% of the respondents in Bain’s survey of 44 leading Indian companies said their boards did not discuss CEO succession planning at all. This gap needs to be addressed if we are to significantly improve corporate governance.”

It is a failure of the board of directors, he continues. “The independent directors can — and should — play a more active role in demanding that succession planning be implemented, given that they have less at stake in being on the ‘right side’ of the CEO or the promoter. Boards in India — with several notable exceptions — have a long way to go to play the governance and oversight role that they play in developed markets. We are long overdue for an accelerated transition to more engaged boards.”

The Cons of Traditional Succession Planning

Peter Cappelli, Wharton management professor and director of the school’s Center for Human Resources, notes that the problems extend to U.S. boards. “Most U.S. firms do no succession planning,” he says. Cappelli, who has done a great deal of research on the subject for his 2008 book, Talent on Demand: Managing Talent in an Uncertain Age, feels that succession planning as traditionally performed doesn’t work very well. “The reason is that it has to anticipate today what the job will require years in advance,” he says. “And it also has to assume that the person you are picking today will still be of the caliber required years in advance — no scandals, no illnesses. If anything changes in the business or with the people, the plan doesn’t work.” And today, the world is changing faster than ever before.

Cappelli notes that earlier there were two common methods of choosing a successor: the “relay,” where the person is appointed years in advance, or the “horserace,” where several candidates are competing until the end. The most common method now in the U.S. is the third, where companies get help from a search firm to consider possible candidates from outside as well.

The Tatas have gone down this road before. In 1981, group company Voltas hired a search firm to find a CEO. “There was a worldwide search,” says P.N. Singh, who was in charge of HR at Voltas when the exercise took place. “A global agency was employed. There were ads in global media and people were asked to apply for the job of CEO. Finally, Ramesh Sarin from tobacco-to-hotels major ITC was chosen as MD.” The experiment worked for only a few years. Chairman A.H. Tobaccowala and Sarin fell out. “It was a question of culture and control,” says Singh, who is now chairman of Grid Consultants, which conducts Blake & Mouton grid seminars. “ITC had a different culture and Tobaccowala had a different idea of control. He was unwilling to let go. Tobaccowala was an ‘entrepreneur’ and Sarin was a manager. So the two should actually have worked well together.”

Amit strongly urges “unbundling” ownership, control and management. “You can control and be the owner, but you don’t necessarily have to be the manager,” he says. “Data points to the fact that by making a distinction between ownership and management, you don’t lose but gain.” What’s more, if the business does well, it helps boost “family harmony and happiness; there will be less conflict in the family. If we care about the happiness of the family and the prosperity of the business, it is prudent to appoint the most competent and most capable people to run these businesses.”

But in Singh’s opinion, however, it is generally a mistake to bring in someone from outside the organization. “Personally, I think it is a weakness if you have to go out to search for a leader,” he says.

Insiders Have the Edge

Traditionally, in India and elsewhere, the insider has had the edge. “Outsiders are about change: insiders are about continuity,” says Cappelli. “So when things are going fine, insiders are preferred. When they are not, outsiders come in.” Adds Singh of Bain: “For most companies, an internal candidate makes sense. Not only do they know the business very well, but they are also completely in tune with the culture, which is essential. However, in those situations where a transformation is required, or where performance has been lagging for some time, an outsider may be the right person to shake things up, to bring in new perspectives, to break some sacrosanct shackles, and to inject additional external talent into different parts of the organization.” Notes S. Raghunath, professor of corporate strategy and policy at the Indian Institute of Management Bangalore (IIMB): “The outsider can make a huge difference when a company needs radical change. The insider may not see how much needs to be changed. The insider would be more focused on implementation issues.” According to Amit, “External candidates have a lot of cost associated with them. They may not know the company and the industry, and people may not be happy with the way an external candidate leads the company; people don’t like change.”

Former Citibanker Mukerjee lists the reasons why companies go outside to find a CEO:

  • Change of strategy, business models or nature of business that require a significant change from the way the organization ran earlier;
  • No one successor clearly identified;
  • Identified successor not ready;
  • As part of good governance, looking for the best person rather than only from within; and
  • For enhancing the image of the organization by hiring a well-known CEO from outside.

There is another reason that some observers cite: to keep talent from leaving the company. If three people are in the running for the CEOs job, two would probably quit when the third is appointed. Getting an outsider — which is often regarded as a temporary arrangement — postpones the fight and flight to another day; it keeps the hopes of the prospective CEOs alive.

Downside of Insiders

The downside of appointing an internal CEO can perhaps be seen at ICICI Bank. After it was publicly made known that Chanda Kochhar would be the next managing director and CEO, there has been a hemorrhaging at the top. “No organization can afford to lose so much top talent in so short a time,” says Mukerjee. “But it does depend on your bench strength.” Adds Singh of Grid Consultants: “The leadership pipeline has to be full.”

Bench strength doesn’t just happen; it has to be created. Says Chittoor of ISB: “In well-managed companies, there is a focus on developing a long pipeline of talent. In such companies, managers are groomed for senior management positions right from the time they join. Just as there are other forms of capital, I believe companies also possess what I call ‘talent capital.’ The talent capital of the company is determined on the depth of management talent it possesses, though many companies do not pay attention to this. In companies that are well endowed with talent capital, there are multiple candidates-in-waiting for each senior management position, including that of the CEO. CEO succession planning in such cases boils down to selecting the best candidate among those already identified and groomed for the job.”

Amit doesn’t feel naming an insider as a successor should necessarily lead to the departure of those who are not selected. In fact, he points to “a retention advantage” in communicating that internal candidates are being considered. “It’s a fantastic way to retain talent by communicating that there is the chance for you to be the CEO,” he says of a well-orchestrated succession process.

What about those who don’t make it? K. Ramkumar, executive director ICICI who looks after HR, says that people put two and two together and make 10; it is just coincidence that so many top-level people left ICICI in the months after Kochhar took charge. “Of the list [who quit ICICI Bank], there is only one person who left because she was in the reckoning with Chanda Kochhar for the top job,” he notes. “Irrespective of who was selected, the others would have left. This happens time and again in all global organizations. It is naive and idealistic to expect anything else. The others were talented, but some had interests which ICICI could not have met given its institutional charter, a few had misplaced notions and thought themselves bigger than the organization. They were asked to move on — by former CEO Kamath, and not Chanda Kochhar. They had no place in the way ICICI Bank was chalking out its future strategy.”

Ramkumar has his own take on the broader issue of insider vs. outsider. “There comes a time when every organization has to fearlessly de-clutter its leadership and put in place a team which is relevant for the future,” he says. “Jack Welch, Paul Polman, Ratan Tata and Kamath, to name a few, have shown the way to do it. Purging and de-cluttering leadership is an important part of succession management and enabling the organization for the future. The key question here is: Does the organization have sufficient leadership depth and bench? If it is like GE, Unilever, Tata and ICICI, then it is possible to carry out this strategy. Look at Unilever. In 2008, the company appointed Paul Polman — from Nestle but originally from archrival Procter & Gamble — as CEO. He brought in a new chief financial officer — Jean-Marc Huet. This is a clear case of an outsider taking over and creating enormous disruption in the system. If one examines the performance of Unilever over the past few years, the company clearly required that disruption. This is positive disruption.

“When Ratan Tata took over the Tata Group, he was an insider. In the early days, he was pilloried for taking on the satraps. In the first five years, he created a huge amount of disruption. It was needed. Similarly, Jack Welch spent his early years at GE cleaning out the cobwebs. Kamath at ICICI Bank was an insider-outsider. [Kamath had joined ICICI — then the Industrial Credit & Investment Corporation of India, a development financial institution — straight out of business school in 1971. He left in 1988 to join the Asian Development Bank. He was wooed back to ICICI as managing director and CEO in 1996.] Kamath also was a disruptive influence. He brought in a focus on technology and innovation.” He continues: “The point I am trying to make is that the debate should not be about insider vs. outsider. What is important is the context. What matters are the time and the environment. Was Gandhiji an insider, outsider or insider-outsider? Does it matter? If Gandhiji had returned to India 20 years earlier — when the political landscape was dominated by strong-willed people like Bal Gangadhar Tilak — he would never have been the leader of the freedom movement.”

Not Just How, but When

Do Tata and Infosys have their timing right? Says Cappelli: “I’m not a big fan of picking a successor way in advance. I think the better approach is to develop candidates, several of whom could step in. Then very near retirement — if that’s the change event — the successor gets named in time for people to get comfortable. But the downside of naming a successor is that if it turns out that things change and that person is not appointed, then their career is really damaged.”

Singh of Bain agrees that succession planning is a process, not an event. “The ideal succession planning is evergreen,” he says. The formal announcement of a successor depends on factors such as size and scale of the business. For a group of Tatas’ scale and diversity, a long transition is required. For most companies, a six- to 12-month overlap and transition would be appropriate. Announcing anything earlier than this simply invites trouble for both the incumbent and the designee and may lead to the unintended and costly departure of one or both, besides resulting in dysfunctional organizational behavior.”

In practice, though, there are often disasters. Why? Says Raghunath of IIMB: “Failure of succession planning has its roots in the mindset that all termination is an unpleasant act — if not death — and the ritual leading up to it is painful.”