It seems that just about every other day there's a new billion dollar merger or acquisition announced. But 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 $5 billion manufacturer who has not focused too heavily on procurement in the past probably could save at least $50 million (perhaps over $100 million ) annually from a range of Spend Management initiatives. This could translate to a huge EPS improvement -- enough to even double 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 The McKinsey Quarterly 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 (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.