Return to Gunpowder

 This Issue—April 2005
In this fourth edition of Gunpowder, we have included an updated article from our quasi-regular columnist, Jason Busch. The article comes from Spend 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:

Sourcing and 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 Matters.

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 market share.

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 region.

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 them.

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 Asia.

Beyond 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 priced supplier.

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 delivery.

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




This newsletter is published by Aptium Global Inc a direct material advisory firm based in Chicago, IL. With offices in the UK, China, India and a network of global associates, Aptium Global works with small and medium sized manufacturing companies to save money on direct material purchases. Smaller companies face the same cost pressures as the Fortune 500, yet often lack budgets for cost reduction services. Aptium Global works with organizations on a pay-as-you-save™ basis, minimizing impact on cash flow and maximizing impact on the bottom line. We aim to publish this newsletter on a monthly basis but reserve the right to miss a few deadlines here and there.

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