Cost-reduction dashboards

With the global credit crunch limiting exit options and pressuring exit multiples, private equity general partners (GPs) are accelerating efforts to drive operational improvement and bottom line profitability within, and across, their operating company portfolios. Burdened more than ever with the need to demonstrate value-add as well as EBITA improvement, some firms have already begun implementing cross-portfolio purchasing programs, which allow them to improve cost structures and drive greater operating efficiency across their entire portfolio. By consolidating the demand for goods and services across their operating companies and leveraging their collective spend within common spend categories, GPs are effectively merging the disparate supplier bases of their operating companies and dramatically augmenting the purchasing power of each through high-volume supplier discounts and other benefits.
How successful is this approach? Best-in-class firms who have implemented these programs are reporting as much as 25 percent in total savings, by negotiating supplier contracts for everything from common direct materials such as steel and resin, to indirect goods such as IT hardware and corporate services such as transportation and insurance. These firms have learned that proper implementation of a sourcing initiative requires more than merely gathering some spend data from all of their CFOs and leaning on suppliers for better deals. It requires the right processes and technology to drive and track compliance to the new and improved contracts. It requires getting board-level support from each portfolio company to work together to aggregate individual company spending. When executed properly, this leveraged sourcing approach will permanently reduce cost structures as well as yield much improved EBITDA and higher resulting valuations. So, how should the GP execute?
A successful cross-portfolio purchasing program begins with a solid business case backed with conviction, hard data, and finesse.
Only when armed with these three attributes can the GP sell the value of the program to the operating companies and corresponding deal teams within the firm to ensure broad board level support across the portfolio. A typical program might involve five to 10 operating companies with a combined $75 million to $100 million in spend. The program can span anywhere from 12 to 24 months and involve between five and 10 projects. GPs that undertake such programs can expect, on average, to deliver cash savings of five percent to 12 percent or $3.75 million to $12 million; returns on investment of between 7 to 1 and 12 to 1; and an exit multiple of 6x.
Driving buy-in and execution of cross-portfolio purchasing programs capable of delivering such results might seem like a no-brainer. But it actually requires expertise. There are two approaches GPs can take to get it: hire or outsource. Some firms take the route of creating a centralized procurement department. Other firms, however, opt to outsource the function to a third party that has the category expertise, market knowledge, technology and processes needed to drive it.
One leading private equity firm focused on middle-market investments was able to implement a global sourcing initiative designed to generate savings and efficiencies on behalf of one of its portfolio companies leveraging third party expertise. Initial success allowed the program to expand the initiative quickly to other operating companies to improve cost structures and operating efficiencies across an entire portfolio of companies. By partnering with specialists that could provide globally deployed category specialists, market knowledge, sourcing technology and best practice processes, the firm was able to identify the best mix of suppliers that provided for the unique needs of each operating company in a way that benefitted the entire portfolio. With a dashboard in place that mapped company spending patterns across the portfolio, the firm had visibility into all operational costs and performances.
Once firm support has been secured, GPs can reap similar results by following these five steps in the development of an effective cross-portfolio purchasing program:
1. Get accurate spend data from all operating companies. If they don’t know how much they spend on what and with whom, they aren’t managing their spend.
2. Prioritize managed spend by sourceable category according to market conditions, expected savings, difficulty sourcing, contractual availability, and company willingness to switch suppliers.
3. Consider leveraging a third-party sourcing specialist that can help with spend classification, analysis of the current state of each category at each company, and create a complete business case for the program. When evaluating such specialists, be sure to consider the capabilities of their in-house spend management technology as well as their sourcing/procurement expertise to not only tee up projects, but also follow projects through to completion and keep the program on track. The fees for such vendors vary and may be structured as fixed retainers, may be tied to results or may vary by project. It is also possible to forgo the hiring of a third party in favor of creating a management team at the firm level to own and drive the program headed by a purchasing executive or Chief Procurement Officer makes sense. Depending on level of experience, such talent can be acquired for between $65,000 and $240,000.*
Either way, it is important to have a separate team specifically focused on program development and execution. Do not be tempted by calls for a laissez-faire approach that lets operating companies manage themselves. Companies focused on their own bottom lines can’t be expected to engage in a genuine cross-portfolio program with the appropriate neutrality and dedication to driving results at the portfolio level.
4. Be sure to establish sound processes not only for sourcing, but also for selecting the appropriate suppliers, communicating awards, and negotiating contracts.
5. Finally, and most importantly, there must be a way to enforce compliance to ensure companies are buying from the selected vendors at the negotiated rates. Visibility into purchasing activity at the line item level not only adds credibility to the firm’s contention that profit was improved from X to Y, it ensures that profit is achieved in the first place. Many GPs and Operations Groups are taking a page out of corporate sourcing organizations at diversified holding companies by investing in dashboard tools that pull purchasing data from their portfolio companies’ accounts payable and other systems to create a bird’s-eye view of all purchasing patterns. These dashboards not only reveal new savings opportunities – such as when contracted vendors have made new rates available to other customers – they can also be used to ensure the newly negotiated contracts are in fact being utilized.
To provide a clear and accurate view from which meaningful analysis can be performed, such dashboards should provide companies with ongoing visibility into and control over both purchase order and non-purchase order spend across all categories, systems, and divisions throughout their entire procure-to-pay cycle. The data should be aggregated and displayed by commodity code structure as well as additional supplier information such as parentage to help better leverage spend in negotiations. And users across different geographies, departments and roles should be able to access the data through the dashboard using customized, role-based permissions and views. Users should be able to generate pre-packaged reports that provide meaningful intelligence regarding spend, supplier performance and procurement processes.
Purchasing cost reductions are critical to operational improvements at any portfolio company. GPs have a unique ability to create operational leverage throughout their portfolio to establish these cross-portfolio programs. The business case is clear in that significant value can be created, but there still remains much work by the way of lobbying, prioritization and execution to get these initiatives off the ground. Leveraging proven methodologies and innovative sourcing, dashboard and other technologies assists in both defining and achieving bottom line goals.