By Jeremy Smith, Client Director at 4C Associates, an award winning management consultancy specialising in procurement, savings delivery and managed services.
The era is long gone when Private Equity was heavily reliant on financial engineering to generate the necessary returns from portfolio investments. Over the last decade, European financial market dynamics have meant that Private Equity firms have needed to increasingly focus on improving operational efficiencies of the underlying assets to generate the required returns.Jeremy Smith
As a result, we have seen a growing importance placed on the roles of PE portfolio executives at Private Equity houses across Europe. The remit and expectations are extensive but the teams are often small, relying on one or two individuals to cover a wide range of investments.
Simply put, there are three main sources of value capture which a General Partner will be trying to maximise at exit – Revenue growth to enhance EBITDA; Cost optimisation and enhanced working capital to enhance EBITDA; Obtaining a higher Enterprise Value, through financial management.
But Procurement can help with these three areas to deliver more value than is traditionally expected.
Revenue growth to enhance EBITDA
Procurement teams are widely seen as the ‘hatchet function’ who slash cost, and leave others in the business to fix the relationships. A harsh assessment, but sadly one that’s true at times. But there is so much more to procurement. In situations where an investment has been made with the intent of growing the top-line revenue, procurement should not only be focused on pure cost cutting, it can work to better publicise the leadership and revenue growth opportunities it can bring to the boardroom. Things will differ depending on the type of industry the investment is in, but working with the logistics supply chain partner to increase performance, agility and end-customer service can be value generating and doesn’t mean you have to pay more for the service. Marketing, both ATL and BTL, is another area where stepping away from the traditional cost reduction approaches will allow reinvestment into growth opportunities and also retain a working relationship which focuses on growth, rather than working against each other in a rigid, contractual manner.
Supplier Relationship Management, when executed properly, can help drive value to both parties’ mutual benefit using innovation within the supply base that is rarely tapped into when taking a blunt approach to cost cutting. Releasing value from the supply chain is also an area that can give a company competitive differentiation with its market as this is an investment that many companies do not have the vision, capability or resources to undertake. Large multinationals with internal procurement functions may have made this leap but mid-size organisations have an opportunity to identify supply partners with whom there are mutual synergies. Partnerships are something to invest time in due-diligence as it must be certain that the power dynamics are appropriate. This is a long-term commitment and one that will need to ensure motivation remains for both parties throughout the term. Having one dominant party in the relationship will erode the dynamic and could leave the business open to the risk of post contractual opportunism, by the dominant party.
European Private Equity owned companies are some of the biggest supporters of procurement benefits and whilst it is no secret that most of this is focused on the cost cutting type activities, more and more focus is on growth opportunities underpinned by cross functional working within the organisation by both Operations and Procurement. Leading procurement teams play a key role in business strategy to go beyond simple cost cutting practices.
Cost optimisation and enhanced working capital to enhance EBITDA
This approach to procurement is one that should be taken within the first year of an acquisition, when the growth plans are being developed and implemented.This is procurements’ traditional heartland, when asking‘non-procurement’ people. No-one wants to be addressing the emotive areas of cost such as internal salaried employees,as it is often sensitive and extremely risky. Executives of the Portfolio companies are strongly encouraged to look at third party costs with fresh eyes to identify EBITDA improvement opportunities. In many industries third party costs are well above 60% of total expenditure so the opportunity can be significant. Releasing this value may not always be a quick win and could require a more transformational approach.
These programmes are based on leveraging strategic sourcing principles to attain accelerated, yet sustainable, high impact on the business bottom line. In a portfolio company survey conducted by 4C Associates, it was evident that a significant number of portfolio companies across PE houses (primarily small to mid-size assets) do not have an established procurement capability, processes or policy. This suggests that EBITDA improvement opportunities through procurement are much more available than people anticipate.
Obtain higher Enterprise Value through financial management
This is an area where procurement has less of a direct impact on the assets, however it does not mean there aren’t areas where procurement can add value.
Debt can be optimised through the balanced use of Operating Leases, Finance Leases, Capex acquisition or Short Term Rental. Procurement can add value by enhancing financing proposals of the acquisition model (e.g. for commercial vehicles fleet) and help negotiate the terms and optimise the implementation.
Risk can be mitigated by Supplier Tail Management. Helping to reduce the sheer number of suppliers will reduce debtor situations in circumstances where integrated Purchase to Pay (P2P) does not exist across the full spend. Supply chain risks, operational as well as ESG (Environmental, Social and Governance), are magnified when an organisation has a large tail as there are often not enough resources to adequately undertake the required due diligence or supplier management. This will make the asset more attractive to potential buyers, or allow you to demand a higher value for the value provided.
Risk is also mitigated through the effective implementation of procurement policy and processes, which for mid-sized investments may also involve the implementation of systems to control spend, provide transparency and enable the most effective deployment of resources to the high value areas.
Procurement’s role at the boardroom table
Working capital is also something procurement can enhance.This has to be something well understood by the Board as the act of enhancing working capital often means extending payment terms which might be at odds with overall commercial value and could also increase supply chain risk by reducing cash-flow through the supply chain.
In summary, procurement can do so much more than simply slash cost and increase efficiency. Cross-functional engagement within the business can not only support growth plans, but actually enhance them. Risk management is also something where the appropriate policy and process implementation can help to underpin the effective control of spend across the organisation which then allows the right balance of cost cutting and growth enhancement to deliver increasing value to Private Equity boardrooms.
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