The impact of procurement transformation for private equity
For a Private Equity business, addressing procurement spend is one of the key levers to improving profitability and increasing equity valuation.
For most businesses, external costs can account for up to 70% of total costs. Every pound, dollar, or euro saved is a pound, dollar or euro improvement to profitability. (Compare that to an incremental improvement in revenue with only the gross margin percentage finding its way through to the bottom line).
But, it’s not just cost reduction that is key. Better procurement drives significant softer benefits also; improved service levels, improved quality, access to best suppliers/prevent competitors access, improved supplier relationships, compliance/assurance, lower supply risk/lower supplier financial risk, lower stock/increased availability and innovation in product and service.
Better procurement drives significant
For private equity owned businesses, procurement excellence is competitive advantage and this is reflected in the valuation multiple.
There are three stages to make the impact.
1) Identify the savings potential and build an execution plan
The output of the Opportunity Analysis enables the PE partner and portfolio company management to build the business case for change. An external view often provides the catalyst for action.
Post-acquisition is the perfect time for procurement cost reduction, when portfolio company resources (management and operational resources) are most open to change and this is often built into the 100-day plan.
2) Deliver a programme of procurement cost reduction
Delivery of savings is not straightforward. It is likely the easy actions are already taken. A professional, managed programme of procurement cost reduction will be required; typically 6-8 months of procurement split into multiple category workstreams each going through a process of strategic sourcing. Quick wins will come out in 2-3 months and will usually ensure the project is self-funding.
Implementation is everything. The impact is real only when supplier invoices are paid at a lower price. Dollars, pounds and euros on powerpoints are worthless.
Procura augments existing procurement teams to add drive, capacity, capability and expertise to realise the identified savings. At the same time, transferring knowledge to ensure savings are sustainable.
3) Transform and build capability to ensure improvement is sustainable
Sustainability is important. The Six Key Enablers of Procurement Excellence can be measured and developed as part of a Procurement Transformation, often in parallel with the savings delivery programme. We work with clients to ensure that when the consulting team leave, having delivered the savings, the organisation has built and put in place its own high performance procurement function so that savings are not only sustainable but can be drive year-on-year.
The outcome: EBIT impact with multiplier effect on equity valuation
Savings on external expenditure will deliver a direct 1:1 impact to the P&L, uplifting EBIT.
Improving embedded procurement capability ensures savings are not only sustained but benefits can be improved year-on-year, driving multiple improvement.
As an example:
Consider a manufacturing company with a $100m revenue (just to keep the maths simple!), with 60% of costs which are bought-in goods and services and operating with a 5% profit margin. Generating $5m of EBIT and on a multiple of 10 (for simple maths again!) the company is valued at $50m.
A procurement cost reduction programme is likely to be able to address, lets say half of that bought-in spend, $30m and saves an average of 7.5% (fairly conservative but reasonable). So, the total saving in $ terms is $2.25m.
So, there is an immediate profit impact of $2.25m. EBIT jumps from $5m to $7.25m – a 45% increase (which is nice to report in your first year of ownership) and the valuation jumps to $72.5m. One of the key points to consider is that to get to the same level of EBIT through the top-line, you would have to increase sales from $100m to $145m. No easy task.
The final point is that by transforming the capability of the procurement function, the valuation multiple also increases because the improvement is sustainable. Win-win.