Leading private equity houses are generating value in their portfolio companies through procurement improvements despite a low growth economy and highly competitive deal market. Is your firm doing enough?
Private equity value creation from portfolio companies faces a number of headwinds. Yet there are three levers PE firms can pull to grow EBITDA and generate good returns for investors.
- Acquisitive strategies – buy and build – to build scale and increase multiples on exit is one strong trend that has played out over recent times.
- Building top line growth, by means of increasing sales, working to improve pricing structures and entering new geographic and sub-sector markets is another key means of growing equity.
- Optimizing the cost base is the third key trend through improving the efficiency of procurement and supply chains to reduce spend. This is also a lever that can be pulled effectively in buy and build situations through procurement rationalization.
The procurement evolution
What we’re seeing is an increasing interest among many private equity firms on the third strategy to produce large savings – not just in the short term, but through the whole deal life cycle. If you consider that in most businesses, procurement spend is between 50% and 80% of the company revenues, the potential growth in EBITDA is significant through cost base optimization. Yet this often does not get the attention it deserves.
As an example, let’s take a portfolio company with turnover of €300m and EBITDA of €30m that spends €200m on procurement. Typically, a procurement savings program can address 50% or €100m of that spend, Efficio would expect to deliver 8-12% savings or €8-12m on the spend addressed. At current median PE market multiples of 8.4x EBITDA, that represents a €67-100m value creation opportunity and a 26-40% growth in EBITDA. At an acquisition price of €252m (8.4x€30m) and assuming a €100m equity investment, the procurement initiative could deliver a 0.67-1x multiple of equity invested.
So what are some of the leading practices private equity firms can follow to reduce the procurement and supply chain costs in your portfolio companies?
Take a systematic approach
Operating partners can be part of the answer. The trend over the last 10 years for firms to hire in industry expertise to drive operational improvement is leading some private equity houses to develop a highly systematic approach to targeting procurement as a means of driving EBITDA growth.
Ensure speed is of the essence
In the past, reducing costs and working on supply chain and procurement processes was often only considered if a portfolio company was not performing to plan. Over the last few years, there has been a shift in some firms to place procurement cost reduction at the core of business performance improvements across the portfolio and from the outset.
Leading players recognize that early cost savings have a significant impact on EBITDA and therefore long-term value creation. And while there is often a member of the firm’s team dedicated to improving procurement, some start work on plans even before the deal has been completed. Bringing in expert help at due diligence stage and then making a detailed, diagnostic assessment of potential savings that can be generated up to two months ahead of ownership means that improvements can start to be made from day one, freeing up capital for investment in growth or producing immediate profit increases.
For example, in a recent situation, we were brought in to a service business ahead of the deal closing to ensure that procurement saving implementation could be started as soon as the transaction completed. This helped the business to gain three months and start year one with a positive EBITDA growth trajectory.
Make savings stick
Procurement improvements can produce rapid benefits. However, it’s important to create real, lasting value by embedding the necessary tools and savings tracking into portfolio companies’ cost analysis and processes. Our work increasingly involves helping private equity firms make use of new technologies that collate and analyse company usage and spend, track the pricing of the company’s supplier competitors and billing patterns, and link the data to the company’s KPIs to create a procurement and savings tracking dashboard.
With the continued help of outside procurement experts, some firms now ensure there is ongoing monitoring of procurement and supply chain costs in portfolio companies, enabling them to conduct regular reviews (annually or even quarterly, in some instances) of their spend and identifying where additional improvements could be made and to track contract compliance. This active management approach ensures that savings are genuinely realised and then sustained over the long term.
The value of bringing in external experts is that companies can accelerate savings opportunities and, at the same time, ensure that in-house staff are trained and coached in best practice. This helps not only with building understanding but also creates a culture within the organisation of driving procurement efficiency.
Moving up the agenda
With some challenging times ahead, private equity firms can’t afford to miss the opportunity to reduce procurement and supply chain costs and improve buying efficiency if they are to generate maximum returns for investors. Firms leading in this area are devising a systematic approach to procurement, getting in early to identify savings and embedding changes to ensure efficiencies are sustained over the long term. They are also ensuring that procurement is discussed at board level and covered on a monthly basis. What is your firm doing?