In this fourth edition of Gunpowder, we have included an updated article
from our quasi-regular columnist, Jason Busch. The article comes from
Matters, an industry blog. In his entertaining diatribe, Jason
argues that sourcing and spend
management should become greater factors in mergers and acquisitions.
Next, our trusty European correspondent, Stuart Burns, offers some
perspectives on the scary similarities between Rover
and GM. Rover, once one of Britain’s premier car companies,
is being liquidated as we write. Will GM go down the same highway
to disaster? Last, our regular contributor Lisa Reisman interviews
Alistair Stewart of the Chicago Manufacturing Center (CMC) about the
role and limits of total
cost of ownership in sourcing decisions. Prior to joining the
CMC, Stewart spent several years at Giga, an industry analyst firm
recently acquired by Forrester, where he helped pioneer the notion
of total cost business and IT decisions.
Disagree with us or got an idea for an article? Let
us know: email@example.com.
Spend Management: The Future of M&A?
It seems as though small and mid-sized companies
are being bought and sold with greater frequency. If you dig below
the surface of many of these deals, you'll find only a handful of
reasons for the flurry of deal activity in the past few years. From
buying companies because they're accretive to earnings or to expand
product reach and geography, acquirers tend to rely on only a few
primary drivers for their renewed interest in non-organic growth.
But even these drivers ignore the zeal of private equity firms who
buy and sell companies for a living, looking to uncover undervalued
assets and find new areas of growth for their portfolio organizations.
As I've sat on the sidelines of deal activity for
the past few years—nearly a decade ago I worked on private
transactions as a junior analyst for a small merchant bank, and
a few years back I worked on a handful of software acquisitions
as part of a corporate development role—I've come to look
at M&A from the lens of an outsider. And what I've seen is that
organizations and private equity firms tend to buy companies for
the same reasons. And what has surprised me is that very few deals
happen because of the potential to maximize shareholder value from
Spend Management initiatives.
What do I mean by this? Well, for starters, a typical
$50 million manufacturer who has not focused too heavily on procurement
in the past probably could save at least $2–3 million (perhaps
up to $5 million) annually from a range of Spend Management initiatives.
This could translate to a huge EBITDA improvement—enough to
strongly improve a valuation based on comparable multiples.
Despite these numbers, rarely do we see organizations—or
private equity firms—acquire companies when Spend Management
is the primary driver. Why is this? I would argue that it's due
to a number of factors.
First, cultural hurdles limit the ability of finance
executives—those typically tasked with doing deals—to
fully grasp the potential of operational improvements from Spend
Management initiatives. They're too wrapped up in financial metrics
and financial wizardry to drill down to the operations level. Second,
along similar lines, few financial and executive leaders—not
to mention the investment banks advising companies—can understand
potential cost savings from improving Spend Management capabilities
around direct materials, specifically (the potential largest area
to address). Third, a fear of supply chain disruptions from Spend
Management activity continues to permeate the air of executive suites,
and many view Spend Management initiatives and sourcing as introducing
supply risk (especially when initiatives involve changing suppliers).
Fourth, and perhaps most important, organizations and private equity
firms lack the right types of spend analysis and visibility tools
to understand the potential for Spend Management saving during the
due diligence (and even pre-due diligence) process.
But I believe this will change. It's my hypothesis
that in the future, innovative acquirers and private equity firms
will do deals where Spend Management initiatives will be one of
the primary levers on which they rely to improve valuations and
increase shareholder value. And it won't just be indirect spend
that they're looking at. By way of background, check out an older
article in on the subject.
What will these organizations do to introduce Spend
Management as a primary deal driver? Most important, they'll develop
an integration strategy to rapidly identify and analyze spend data
in the due diligence process. Next, they'll need to build a direct
materials Spend Management competency (especially in the case of
manufacturing organizations). This might be gained through a third
party if it's not available internally.
In addition, these organizations will have to put
in place a plan to analyze on-shore and off-shore purchasing options
as well as a process to analyze and benchmark the current mix of
their potential acquisition targets. They'll also need tools and
templates to understand how pulling potentially simple levers (e.g.,
standardized payment terms) can impact cash flow and savings. Perhaps
they'll even get as sophisticated as building models to understand
the potential for Spend Management BPO–Business Process Outsourcing
(or develop a relationship with a BPO partner who comes in prior
to deal close) as a cost savings lever. They might also examine
aggregation potential (between the acquiring organization and other
portfolio companies, in the case of private equity firms) early
in the process as well.
These are just a few areas where acquirers of the
future will focus on to help make Spend Management a competency.
Clearly, those companies—and private equity firms—focusing
solely on financial wizardry and top-line growth will be leaving
a tremendous amount on the table when their competitors rely on
Spend Management to not only improve the financial performance of
their acquisitions—and portfolio companies—but to evaluate
the right types of deals in the first place.
Jason Busch is editor
of the blog Spend
Can GM Find a Detour Around
the Road Taken by Britain’s Rover?
In the week that Britain’s only remaining mass market car
producer limps into the scrap yard, we should ask ourselves what
does the future hold for America’s mighty GM and could the
same happen there? But first, some background. Rover has been beset
by problems for the last 20–30 years. For example:
- The firm was too small and lacked the resources to develop and
manage its brands
- It had a massive and unbridgeable pension funding gap
- The company continued to maintain outdated mass manufacturing
production techniques (relative to Toyota and others)
- The firm could not get past its staid image
So what are the specific similarities with GM, the largest car
maker in the world, you ask? While both firms might appear at opposite
ends of the spectrum to an outside observer, both firms still share
many challenges in common. For example, GM cannot be accused of
lacking the resources to develop new products, yet it has failed
to bring out new models to keep some of the most historic brands
in the automotive world popular, killing off Oldsmobile and keeping
Pontiac on life support.
This shows up in the numbers. GM’s share of the North American
market has slipped from over 30% in the mid 90’s to a little
over 26% today. Relentless competition from more efficient and innovative
Japanese producers has made steady inroads into GM’s once
dominant position of selling one out of every two cars sold in the
USA. And even in the SUV segment, Japanese rivals are bringing out
more fuel efficient and exciting models which have cut into GM’s
Since GM has inflexible labor relations in many of its plants which
make it economically unviable to reduce production, the company
has had to offer massive discounting to keep its production numbers
up. How bad is the situation? It is widely believed GM’s core
auto business hasn’t made money for years overall. Europe
is barely breaking even and Brazil is firmly in the red. Only in
China, where GM has just lost its CEO and guiding light Phil Murtaugh,
has there been a bright spot. Murtaugh’s services will be
sorely missed at a time when GM has a golden opportunity in the
It is no secret that GM makes more money as a financial institution
than as a car maker. GM has used its size and creditworthiness to
raise cheap money and lend it at a profit for mortgages, car loans
and businesses. But with its bonds recently downgraded to near junk
bond status, one has to ask how much longer the financial side of
the business will keep the rest of the company afloat?
With 1.1 million current and former employees, GM has a tough pension
and healthcare challenge. The sheer size of the employee base creates
massive pension funding demands. By some estimate these already
amount to US$ 2000 per car. Regardless of how much clever financial
smoke and mirrors the firm’s accountants employ to try and
hide the consequences, there is no getting away from the US$ 5.6
billion health care spending GM will incur this year, making them
the country’s largest medical provider. The United Auto Workers
Union will fight tooth and nail to resist any reduction in those
benefits just at a time when the firm can least afford to keep paying
So, as far apart as Rover and GM may at first appear, the two share
a whole host of challenges. Faced with rising health care costs,
fierce competition from more productive Japanese rivals and outdated
union contracts and relationships, Rover headed down the wrong path
for decades before taking a final nose-dive into the scrap yard
this past month. If history is any lesson, GM could be on the highway
to disaster as well. It might be a long trip, but all of the road
signs are pointing in the wrong direction for the ailing giant.
Stuart Burns is Managing
Director of Aptium
Global where he leads the firm’s practice in Europe and
Total Cost of Ownership (TCO)—An Interview with Alistair Stewart
Where do you see small and medium
sized businesses (SMBs) falling short of sourcing decisions based
on total cost of ownership?
Small and medium sized organizations tend to lack the discipline
to understand the full spectrum of costs going into any kind of
sourcing decision. It’s easy to look at the one-time acquisition
costs. But it’s difficult for them to look at many of the
recurring costs. For example, a small manufacturer might be equipped
to identify the cost centers and departments that will be impacted
by a purchasing decision but they will typically fail to analyze
and understand the ongoing operating supporting and maintenance
costs for the majority of investments. With any new supplier, there
is an element of risk because you don’t know what you don’t
know. Typically, a SMB will conduct due diligence including a supplier
visit to identify potential issues when significant dollars are
involved. Some of these issues get resolved during this qualification
visit, but many will not. It is rare that SMBs really understand
how to satisfactorily resolve all key issues and they often get
pushed aside because something else takes higher priority. This
often becomes a “silent” risk due to lack of follow-through.
And that is just focusing on the issue that they were able to identify.
The issues that they weren’t may present even greater risk.
In the rush for companies to
source globally, what are the three most significant elements that
tend to get overlooked?
One element that often is overlooked is the whole notion of risk.
A supplier might have been terribly aggressive on price but there
might be additional risks associated with sourcing from the lowest
This risk leads to the next element that is often
overlooked—supplier stability. SMBs must decide how best to
analyze their supplier’s financial health during the participation
by suppliers in a bidding process. Is this supplier likely to make
it or not make it? Are there any predictors of risk (e.g., credit
rating) that we can examine to gain a better understanding of risk?
What is the supplier’s competitive position? What will the
supplier’s owners do if their business is fatally compromised?
Sell? If so to whom, and what are the acquirer’s motives?
Requests for Information often are a part of the picture, yet the
survivors are expected to not compromise performance such as on-time
A third area that is typically overlooked revolves
around product innovation. Is the supplier innovative? Have I picked
a company that is going to bring new ideas, materials etc. to me
or am I having just a supermarket type of transaction with them?
How can I tell if over time, I am really in a value-based relationship
vs. a series of low price transactions?
What is beyond total cost of
ownership? What are companies not looking at?
I see several areas beyond total cost of ownership that all SMBs
should be looking at: One area would be to better understand all
of the benefit streams from switching suppliers—particularly
around product innovation and quality (and the revenue associated
with that). For example, if by switching suppliers, a SMB frees
up 240 hours of QA man hour time…how does that get factored
as a benefit? Another benefit occurs downstream. It’s really
a deferred benefit and that is when you pick the right supplier,
you don’t have to keep “picking” the right supplier.
I’ve also seen that new suppliers tend to be hungrier for
business—they will actually work harder to achieve the benefits,
and please the company.
I’ve mentioned the notion of “risk”
earlier. When sourcing from China, for example, do companies understand
the market dynamics and the geopolitical risks (e.g. increase in
oil and freight costs) involved? How will the burgeoning middle
class in China—and hence the insatiable demand for construction
oriented materials including steel—impact an SMB’s ability
to effectively source from China long term? There is no easy way
to quantify these risks. If you buy a stock, you’ll look at
the risks of the company. Every line item about that company can
be assigned a cost and a benefit. It’s easier to create a
column to cover all of the risks and assign weights to the items.
TCO does not offer this type of risk weighting.
Of those elements, how do you
begin to quantify the value of these?
One method might be to begin taking into account the number of man-hours
it takes to execute the sourcing decision. If you pick the right
partner, you have avoided at least some part of that cost if not
all of it, and hence you have incurred a benefit.
Theory of Constraints and Throughput Accounting offers
another lens through which to view benefits. If a supplier uses
TOC (Theory of Constraints) and uses Throughput Accounting it’s
possible that the supplier is using a more sophisticated costing,
pricing and bidding approach than the buying company can handle.
These suppliers may also be much more competitive than others when
the market, and not capacity, is their constraint.
Often, the strength of total cost of ownership models
can end after a sourcing decision is made. And all too often recurring
costs and other value-added costs are not quantified.
Alistair Stewart is Senior
Business Advisor of The Chicago Manufacturing Center. He can be
reached at firstname.lastname@example.org.