Indirect procurement a key lever for private equity value creation
Indirect procurement could be the value-creating talisman for private equity firms in an uncertain economy – capable of saving up to $25 million for a $1 billion revenue portfolio company. This is according to performance improvement experts at Alvarez & Marsal.
Creating value with minimal risk is essentially the job description at private equity firms – a particularly tough ask at a time of unprecedented disruption. Cost saving is always an effective option: the question is of where to dial-up and ramp down.
Many focus on optimising direct procurement spending across their portfolio, such as lower raw material and packaging costs, etc. Overlooked is the vast but sub-optimal world of third party spend on business enabling overhead in supply chain areas such as logistics, maintenance and in corporate functions such as IT, HR, Legal and facilities.
For Alvarez & Marsal experts, private equity firms are missing a pivotal trick by shunning indirect procurement. Using analytics to examine and monitor spending across a portfolio can expose actionable saving areas. The resultant value created can boost private equity fund performance across the investment lifecycle – from due diligence through closure all the way to exits.
Take the pre-deal phase, when most sellers are stirring up a bidding war. Indirect procurement is often a secondary priority for sell-side management, and a proactive approach on this front can be a powerful differentiator, particularly when dealing with global and de-centralised targets. “Typically deliverability confidence in pre-deal saving plan is a key concern for deal-makers and portfolio management teams” explained Naresh Kumar, a London-based director at Alvarez & Marsal.
To have an actionable value creation plan (VCP) on Day 1, it is critical to have a “standard and repeatable” diagnostic toolkit that builds the bridge between category savings and target company specific improvement measures.
Clinching a deal aside, indirect procurement can also be the star of the post-deal show – mainly owing to delivery speed. Unlike headcount reduction, procurement can rapidly unlock value by primarily leveraging suppliers and situational momentum such as Covid-19 and M&A. “In our experience, all indirect procurement savings can be realised within 24 months post-close, with up to 70% achieved during the first year and up to 20% in the first 100 days,” noted Alvarez & Marsal managing director David Jones.
Companies that can sustain and continually improve on the cost transformation process by annually reviewing and resetting their indirect spend can outperform competitors by up to 5 percentage points on both revenue growth and margins. Money saved can be deployed towards hiring better talent or investing in digital transformation. Combined, these factors build up a company’s exit margin and enterprise value as well.
A handful of forward-thinking large private equity firms have taken note of these end-to-end benefits, pushing indirect procurement up the board agenda as a result. Cloud and artificial intelligence are being used to power better spending analytics; ecommerce is playing a larger role in indirect procurement; harmonised spending strategies are being applied across the portfolio; and short outsourcing contracts are being used to deliver cross-portfolio value without creating long-term interdependency.
Key challenges
That said, the majority remains stuck in the unidimensional paradigm of direct procurement optimisation. What’s more, procurement strategies are lopsidedly focused on the supply side, with an emphasis on the best deal or and the lowest asking price, even though “upwards of 50% of indirect procurement savings can come from effective demand management,” according to Ray Berglund, a managing director at Alvarez & Marsal in London.
More spending transparency, alignment between individuals and the business, and a savings mentality can all be effective, although few operating teams focus on managing demand. “Pragmatic zero-based budgeting is a lever for management teams to effectively restructure their spend, especially third-party spend, to realign the business in order to internally fund the strategic ambitions of growth and innovation,” explained Berglund.
These challenges persist, enmeshed in cultural and conventional inertia. In response, the experts have laid out a private equity operating partner’s playbook – four key insights drawn from leaders in the field who have been successful in transforming procurement strategies.
Optimising indirect procurement
For one, there is a large un-conquered gulf between spend management at a company level and cross-portfolio “leveraged procurement” at global private equity firm level – the latter being “exponentially more complicated” according to Kumar. Secondly, careful recruitment can make all the difference, and many private equity firms are starting to build in-house capability stack by hiring 2 in 1 ‘operator and advisor’ type procurement operating partners to effectively support their portfolio companies to unlock top-end of deal value plan.
Third is the importance of clear benchmarks in the lead up to a deal – to highlight the value added by indirect procurement transformation. Lastly, supplier relationships can be segmented into priority ties and less business-critical relationships, which paves the way for tech-based tools to optimise supplier transactions.
Private equity firms can draw tremendous value from these strategies. Indeed, a firm with over $1 billion in revenues could save up to 2% more of its earnings – adding up to a healthy $25 million. This is in addition to the minimal risk involved in creating value through procurement strategies.
“Almost without exception, private equity firms are looking to carefully manage portfolio risk and build robust investment theses in the wake of the Covid-19 pandemic. The role of procurement is changing fast, and Covid-19 has only intensified the pressure on organisations to leave ‘business as usual’ behind,” concluded Jones.
