In a recent guest post on Private Equity News, Declan Feeney, Private Equity Director at Efficio discussed the five things private equity firms should consider when it comes to procurement.
The current low growth environment has brought the importance of cost optimization to the front of mind for Private Equity houses. But how many really understand the value procurement can bring to help drive earnings before interest, taxes, depreciation and amortization growth? Set out below are the top five things private equity groups should consider when addressing procurement across their portfolios or in due diligence.
Procurement spend will typically represent 30-60% of revenues in most businesses and it is often the number one cost. It is an easy cost to focus on because employees are not as sensitive to change in an area that deals with external spend. It is also easy to measure improvements if inefficiencies or value gaps exist.
In our experience, most businesses have one or more categories of spend where a 5-10% profit improvement target is realizable. If this spend represents 20% of the revenues of the group that is 1-2% of margin improvement which can typically be delivered within a six to 12 month period. For a business with a 10% operating margin that has been acquired for a 10x multiple with 40% equity, the procurement profit potential represents 0.25-0.5x the multiple of equity invested.
If the company in question is a mature business growing revenues at 2% a year, it would take five years of sales growth to get to the same profit improvement number that a procurement program could deliver in one year! On each deal, the main unknown is the spend addressability factor which will drive the absolute profit improvement the company and private equity owner can deliver.
Does the procurement department have a voice at the board table, and if they do are they living up to it? We often see that despite procurement being the biggest cost in the business that could be turned into an important profit driver they are still not recognized with a voice at the board. It is also important to assess the quality of the purchasing team. Are costs managed centrally and how much of spend is outside of the control of the team? Typically a weaker and understaffed team with limited central controls will present a greater profit improvement target.
3. The cost reduction levers
Assess both the supply and demand side levers to see where potential savings opportunities exist. Look at supply market leverage by consolidating volumes, competitive tendering and consortium buying, supply base restructuring and value added relationships via partnering, joint product development or revenue and risk sharing. On the demand side consider design and specification optimization, total cost management and process effectiveness and compliance.
4. The approach
Carry out an opportunity assessment of the procurement spend early on in your ownership or, if possible, during due diligence to establish the size of potential cost savings. Once the assessment is done, a savings implementation plan should be put in place to deliver the savings with or without external support and tracked on a monthly basis at a board level.
5. The tools and sustaining the benefits
Seek out specialist technology to track spending in the organization to ensure that overall cost savings are sustained over the long-run and not lost in annual supplier renegotiations or the year after external support has departed.
As many mature businesses complete their budgets for next year and look ahead to an uncertain 2016, procurement is one area where an EBITDA improvement target can be penciled into the financial plan by the management team and its private equity owners with more certainty than future sales growth in its core markets.