www.efficioconsulting.com February 2013

Improving procurement: What CPOs can learn from private equity

Private equity funds have invested €233 billion in Europe since 2007 and 22,000 companies across Europe are private-equity owned. How does private equity (PE) deliver these improvements and what part does procurement play in it? There is no doubt that PE has refined business process improvement techniques to reduce costs and improve performance extremely effectively so that an impressive return on investment can be quickly realised. Contrary to widespread perception, PE is not just about taking on troubled firms and reducing headcount. It is about improving their performance, and the advantage is that you can take a longer-term view on change as you do not have quarterly/annual public company targets to hit. Industry figures show that PE investments in large European companies have improved their productivity by 7 per cent annually. Through our experience at Efficio of working with PE-backed companies, we believe the sector has a lot to offer CPOs in terms of the efficient approaches to procurement it often employs. In this Viewpoint we highlight the approaches typically used by PE houses to add value to the companies in which they invest. We hope CPOs will use some of the techniques to deliver business success in their own organisations. Declan Feeney Director, Private Equity When a PE firm acquires a company, it will typically examine all its business processes to identify ways of adding value whether through sales growth, acquisitions or margin improvement. Very often, one of the key levers is to scrutinise third-party procurement spend. For PE operators, procurement is an important driver for value creation where substantial savings can be made. It is clear why: in most organisations, procurement is a key factor in the overall cost base and can account for upwards of 60 per cent of revenues in a typical manufacturing company (see Figure 1). If such a company achieves a 10 per cent profit margin (EBIT), and can cut 10 per cent from its addressable direct and indirect procurement spend, this can create an increase in profits of around 33 per cent. Procurement is a very powerful profit improvement lever.

www.efficioconsulting.com February 2013

Figure 1

Central to the formula is simply that the PE approach introduces a fresh pair of eyes to the procurement operation. As experts in business processes, PE houses are masters in spotting quickly-achievable improvements that may have historically eluded the incumbents. Without an array of shareholders to consider, PE is able to bypass cumbersome management hierarchies and enable fast decision-making. Potentially conflicting business functions are more easily enabled to compromise and align behind a common objective. In public companies, where certain business process changes may result in a dip in short-term earnings, management teams may be less inclined to go ahead with changes despite a potentially large longer-term return on investment (ROI). PE managers, however, are powerful stakeholders who can quickly create incentives to align a company’s management with its investment group. Their recommendations are usually easily implemented. In the procurement function there is often great potential for fast value creation because the team may sit in a technical silo, applying the same techniques year after year and resisting pressure to change. PE ownership tends to free up the ability of CPOs to make the necessary changes. Generally speaking, the biggest obstacle to effective strategic sourcing is lack of cross-functional alignment in a company’s top team. In our experience, to combat this PE investors will typically deploy an individual to the company board to serve as an effective facilitator across the various members of the management team. This is good news for procurement, which requires greater cross-functional alignment to succeed. Another major problem for many procurement functions is that they generate “negotiated savings” on paper but are not accountable for driving these through the P&L. PE usually

www.efficioconsulting.com February 2013

brings a much greater focus on real results, which again helps procurement to be more effective. Smaller PE-owned companies often do not have sufficient spend to be credible in the market and lack dedicated procurement resource. Some PE houses drive leveraged deals across their portfolio companies, typically in indirect spend areas like car rental, couriers, stationery and IT hardware. Such deals can bring relatively easy savings in non-core areas. Strategy and how private equity succeeds Typically a PE-backed firm will start with a 100-day plan addressing many parts of the business including procurement and will be actively involved in the annual budgeting process which may include a number of procurement initiatives. Like others in the business world, most CPOs are familiar with the returns private equity firms are able to achieve. In Europe buyout funds have produced an average annual internal rate of return (IRR) of 8.3 per cent from 2001-2011 compared to minus 4 per cent for the public market index. The question for CPOs, therefore, is what you can learn from private equity to help improve procurement operations in your organisations. There are certain clear pointers to success:

Procurement must be given a strong mandate, and targeted to deliver real results

For procurement to succeed, interests must be effectively aligned across the various business units and/or functions impacted by procurement. It is imperative that this alignment is reflected at top management level

All stakeholders - finance, the CPO and the cross-functional sourcing teams - must be quickly mobilised and engaged in the improvement process

The company must be willing to upgrade or supplement the procurement team by bringing in new or additional people or consulting support

Granular measurement tools must be introduced to ensure savings are delivered to the bottom line, converting “paper savings” to “realised savings”

If all these criteria can be achieved, PE-backed companies usually deliver improved results and procurement will have been a major contributor to the equity value created by the company. Conclusion Freed up from the constraints faced by public companies, PE-owned organisations are able to implement a range of positive measures to add value quickly and effectively. However, the techniques employed by PE are not unique to the sector. They are available to all those endeavouring to improve procurement efficiency and effectiveness in their own organisations. Procurement professionals can learn from the approaches employed by PE houses. The lessons for CPOs across all industry sectors are clear: if PE can do it, so can you!