Special Series, Part 3: Getting ready for acquisitions and divestments
This article is the third in a three-part series about the important role supply chain executives play in corporate mergers, acquisitions, and divestments. Part 1 examined how supply chain executives can create value and prepare assets for sale in order to maximize the value for the seller. Part 2 considered the sign-to-close phase, including how to develop a transition plan. Finally, Part 3 discusses executing on those plans, including stabilizing the assets and integrating them.
For supply chain managers whose companies are involved in an acquisition, the work doesn't end when the deal closes. Integrating and optimizing a new asset into existing operations to realize synergies —while continuing to support the overall commercial objectives of the deal, of course—must be their priority following an acquisition. This drives value and helps confirm that the transaction delivers the benefits envisaged as part of the original deal thesis. The importance of this follow-through cannot be overstated. Fail to successfully integrate and optimize, and all the hard work undertaken during the pre-close and sign-to-close stages will have been for nothing. In fact, poor integration is routinely cited as the main reason for the failures of mergers and acquisitions.
This issue is becoming relevant to a growing number of supply chain professionals. EY's Global Capital Conference Barometer, published last year, reported that 49 percent of companies have more than five deals in the pipeline for 2017. Mergers and acquisitions (M&A) are now accepted as a permanent part of the corporate growth agenda as companies look to more regularly optimize portfolios. Supply chain executives should expect to be involved in M&A activity over the coming months and will need to prepare accordingly.
In the first of this three-part series, we looked at the pre-close period and how getting a seat at the table as early as possible in the sale process allows you to not only create more value but also simplify the transaction and reduce the risk of separation. Arriving at a later stage in proceedings leaves little opportunity to influence the outcome. Part 2 focused on the sign-to-close phase and highlighted the specific areas executives, for both the buyer and the seller, should focus on when planning the separation of a business unit in order to drive a timely and efficient transaction. Developing a detailed and effective supply chain management transition plan is the key to lowering risk while providing a smoother, more cost-efficient process. Getting this into place early makes the deal more secure and minimizes the chances of issues arising and destabilizing or threatening it during the transition process.
To conclude the trilogy, we take a look at the post-close stage and, predominantly from a buyer's perspective, discuss the three most important actions that will help facilitate the success of the overall transaction:
We also consider how supply chain professionals can accelerate the desired outcome.
As mentioned above, this phase focuses on business continuity. It includes establishing a governance structure that facilitates integration of the acquired asset, stabilizing the asset after the close by creating a "hypercare" organization to resolve problems, and by monitoring performance and regulatory compliance. Without these steps, there could be a significant risk to the new asset's market position.
Program governance. From a buyer's perspective, developing an effective governance model beyond the typical program management structure requires companies to proactively plan for integration. While most governance structures are functionally based, an integration program structure should reflect the deal's value drivers, as illustrated in Figure 1.
The goal of the integration program structure is to drive value-capture opportunities, help build a sustainable future state operating model (FSOM), and provide business continuity post-close. While the executive steering committee provides overall direction and vision for the transaction, the integration management office, in coordination with the functional teams, is responsible for its day-to-day management. This includes managing execution risks and cross-functional dependencies, as well as providing business continuity and stakeholder management (customers, suppliers, and so forth), among other things. Additionally, to expedite value capture and synergies, teams may recalibrate opportunities as necessary, build a detailed financial analysis, define the FSOM, outline necessary operational changes, and profile risks.
Often in divestitures there are transition services agreements (TSAs) set up between the buyer and seller for commingled operations. Managing simultaneous TSAs with varying durations can be complicated and can add risk to the acquisition. TSAs should be exited in a timely and structured manner; to avoid disruption, the buyer needs to take full control of processes and systems and should not depend on the target's parent to provide services for an extended period. Establishing a governance structure to administer these TSAs and facilitate a rapid exit, therefore, is crucial to both parties. Figure 2 shows a sample TSA governance structure.
A robust TSA governance structure reduces the overall administrative burden on the buyer as it focuses on the transition. For the seller, it reduces the number of requests for TSA changes and extensions of duration while allowing a faster full separation. (For more about TSAs, see Part 2 of this series.)
Post-close stabilization. A few weeks prior to deal completion, a "war room" should be established to report and resolve transition issues. We term this stage "hypercare," and it's a critical tool for managing stakeholder anxieties as the acquired business passes over to the buyer. The period of hypercare will vary, depending on the size and complexity of the newly acquired asset, but it typically lasts two to four weeks.
Hypercare is both cross-functional, impacting supply chain and other functions—such as information technology (IT), finance, and commercial—and global, impacting all transitioning regions. The exercise of preparing for hypercare will confirm that the help desks have been made aware of the hypercare period, and that they will continue to use their existing lines of communication. It also will make certain that key subject-matter experts will be made available to resolve high-impact issues. Just two of many possible examples of critical issues hypercare can help to quickly resolve include an order that was misdirected to the seller instead of the buyer that needs to be rerouted to the buyer, or an import shipment that was stopped at customs because officials did not receive documentation related to the new owner.
The hypercare period begins on day one—that is, the first day of operational control of the asset under the buyer. There should be a previously established set of criteria that can be used to validate that operations are working correctly. Any issues are logged in the hypercare "master issue log" and the priority for resolution determined. The hypercare team determines whether the problem is related or unrelated to the transition and provides a solution if the problem is one it has handled before and knows how to address. If the problem needs to be escalated, then the resources acquired with the new asset should try to resolve it first, as they are most familiar with their own operations. Otherwise, it can be raised to the buyer's regional lead or, if a major issue, to the buyer's global lead, who can coordinate more assistance.
The value to a transaction of such an approach is threefold. Firstly, it will preserve deal value by de-risking day one cutover activities. Secondly, it accelerates the post-close transition by quickly resolving cutover issues. And finally, it creates a "safety net" to deal with unforeseen challenges.
Monitoring of performance and compliance. Having acquired a new asset, the buyer needs to carefully monitor its supply chain during the first 100 days for any signs of impaired performance. If as part of a divestiture the buyer is receiving services from the seller via a TSA, diligence is needed to confirm that service is provided at agreed-upon levels. (As discussed in the previous article, service levels usually are expected to be consistent with historical levels or the seller's own target levels, and the seller will typically use its own reporting mechanisms instead of developing a new one.) For example, if a company's on-time in-full rate (OTIF) usually sits at around 97 percent and slips down toward 90 percent during the transition, then alarm bells should start to ring.
The buyer also has a responsibility to audit and assess the purchased assets to make sure they are compliant with government regulations and corporate policies. The new asset must comply with policies based on the buyer's risk tolerance, which may differ from those of the seller. Any compliance issues must be remediated in an appropriate time frame. Possible examples might include a facility-related problem, such as something failing to meet government-issued workplace-safety standards, or noncompliance with trade regulations, such as not effectively performing denied-party screening for international shipments.
If the buyer is to realize the synergy benefits that were part of the original deal thesis, it must integrate the acquired asset into its existing operations. Effective change management; standardization of business processes; and careful treatment of transition agreements, IT, and legal considerations all play a role in a successful integration.
Change and people management. Throughout the life of a company, its strategy and people define and build processes, and as it grows organically or inorganically, the number and complexity of these processes increase exponentially.
From an organizational standpoint, when a new asset is merged into the buyer's company, there are likely to be cost efficiencies that can be realized through headcount reduction, but the buyer should take steps so that it is done in such a way as to reduce talent "leakage." This also provides an opportunity to review and possibly revise employees' roles and responsibilities within the supply chain function. Change management is an important consideration during this phase as new people are brought into the organization and existing workers may experience changes to their roles.
Process standardization. After the acquisition, standardization of business processes across the buyer and the target establishes one performance standard across all operations, thus achieving true integration from an external stakeholder's perspective. For example, the asset being transferred may allow "maverick" (without approval) purchases from vendors for miscellaneous goods, but the buyer could have a more regimented process that requires approvals for purchases above a specified spend level and allows purchases from approved vendors only.
The standardization of such differing business processes should have positive outcomes for the business:
For maximum benefits to be realized from the deal, synergies between the new asset and its existing operations must be matched by the buyer as speedily and efficiently as possible. Time scales for realizing these synergy-related benefits obviously vary by company, but the supply chain management function should be prepared to realize some initial benefits within the first year. Larger, more strategic benefits should be visible within two to three years. Often, the commercial strategy and technology systems will dictate what processes look like; when that is the case, process standardization should be carried out with an eye toward developing a strategy for moving the purchased asset into combined systems (or vice versa, if the new acquisition has better existing structures).
Technology transfer. Leveraging cloud-based technology to support key supply chain processes (such as demand planning and inventory management, among others) can significantly enhance deal value from both a buyer's and a seller's standpoint while accelerating speed to closing. For example, benefits of a cloud-based enterprise resource planning (ERP) system include the opportunity to rapidly "right-size" processes and applications for the asset, and to have flexibility and scalability for the deployment and transfer of the system to the buyer.
By shifting commingled operations into a cloud-based platform ahead of the closing, the seller kick-starts the separation while reducing the scope and duration of TSA services. If the buyer inherits a stand-alone system supporting supply chain processes, it will reduce both ongoing operating costs and one-time costs and risks associated with integrating/standing up systems, thereby enabling the buyer to focus on business without the pressure of dealing with a TSA. Multiple separation strategies can be combined and tailored to the unique needs and opportunities of the asset, while cloud-based ERP strategies provide higher value-creation opportunities compared with alternative approaches, such as application cloning or TSAs.
Legal entities. Sometimes a seller will require the buyer to change the name of any purchased legal entities (LEs) and to remove the seller's name within a certain time period. This will have several implications for the supply chain. Examples include the need for manufacturing plants that sit within these legal entities to acquire new establishment licenses before continuing production. If the buyer is an importer, then it may need to reapply for any import licenses. A caution: There may be a mandatory blackout period on imports during the reapplication processing period, which means inventory will have to be deployed in-country prior to that time. The buyer will also need to create new labels and packaging to reflect the new LE name, and customers have to be notified of the name change so they can update software they use to purchase goods from and pay the buyer (that is, their vendor).
Exiting transitional agreements. Naturally, the buyer will be looking to exit the TSA as soon as possible, because it may be paying an above-market-rate premium for the seller to provide a service, or it desires to gain more control over its own supply chain operations. The seller generally also wants to close that chapter in its book and focus attention on the remaining core business. An example of a tactic that has helped some companies speed their exit from a TSA is leveraging a third-party logistics (3PL) service provider to more quickly set up capability for distribution operations in a specific geography.
The buyer also needs to exit any transitional manufacturing agreement (TMA) at the optimal time. As the name suggests, the TMA (which we discussed in detail in Part 2 of this series) provides the buyer time to set up required manufacturing processes and operations. A TMA not only includes the agreement for continuous product supply but also the transfer of technology (assets, processes, and knowledge) to the buyer.
The TMA exit should be planned based on the buyer's proficiency and confidence in its capabilities and capacity to meet customer requirements. Depending on the industry, a TMA may last several years, with examples we have seen ranging from several months all the way up to 10 years. However, a TMA is not meant to be an indefinite reliance on the seller. Delaying too long will prevent the buyer from taking control and realizing deal value quickly. Conversely, too early an exit could catch the buyer unprepared for volatility in customer demand or to meet established quality standards and customer expectations on delivery/service. It could also limit the buyer's ability to achieve process efficiencies based on tacit knowledge. All of these could negatively affect the deal value and brand.
The buyer should continuously monitor the progress of the transfer plan toward an exit based on its available capacity to meet both current demand and future growth needs as well as the regulatory approvals that are required for certain industry sectors. Additionally, both sides need to adhere to the contractual agreement; either side's violation of its contractual obligations would defeat the purposes of the carefully crafted agreement and technology-transfer plan.
For the buyer, optimizing the supply chain is one of the most important ways it can realize synergy benefits once the new asset has been successfully integrated into its existing operations. It does so through a portfolio of supply chain performance improvements, which support both commercial and operational objectives. As described below, these improvements can range from "quick hit" opportunities, such as the realization of sourcing synergies shortly after the close, to longer-term, transformational improvements, such as rationalizing the manufacturing and distribution footprint.
Future state operating model. The future state operating model, which we introduced in the previous article in the series, describes how processes, people, and systems within an organization could be arranged to achieve optimum efficiency and identifies where to prioritize change to achieve the greatest benefits.
The FSOM helps the organization achieve its vision and strategy by driving alignment among leaders, employees, key stakeholders, and partners. It should create a framework for balancing stakeholder interests and managing risks consistently across the organization, and it should improve decision making by clearly outlining key priorities. It also defines a balanced set of quantitative and qualitative performance metrics in support of the organization's strategy and vision, and it creates a structure aligned to service delivery that enables clear allocation of responsibility and accountability. Finally, a well-implemented model enables strong governance and process controls and is the tool that translates corporate strategy into operational plans. Benefits of this approach to developing the FSOM may include improved operational efficiency, strategic dexterity, customer intimacy, and product innovation and leadership.
A well-designed model can be valuable when international supply chains are involved. For example, the FSOM may lift strategic, high-value-adding business processes and functions out of current countries and co-locate them regionally or centrally to provide the right level of service to the market and end-to-end visibility across the supply chain. Importantly, this can help to confirm that local operating units are focused on the execution of core processes. With the increased pressures on operating margins in developed markets and a need to drive growth in emerging markets, this model needs to evolve in a way that balances local market dexterity and responsiveness while still driving scale economies and innovations in operational excellence.
Within the evolution of FSOMs there are trends toward driving supply chain segmentation around products and geographies, furthering the globalization of key supply chain functions, and improving local-market supply chain service and cost, all of which should lead to accelerated savings throughout the supply chain. Just as an illustration of the kind of results that might be achieved, the model may reduce inventory costs by 15 percent to 25 percent, lead to procurement savings of 5 percent to 10 percent through a reduction in the cost of goods sold (COGS), and achieve logistics savings of between 10 percent and 20 percent. It can also improve manufacturing quality and efficiency. The evolved model is also an enabler of increased responsiveness to change and strategic events. The optimal FSOM enhances the speed-to-value for strategic business transactions, such as mergers, acquisitions, carve-outs, spin-offs, joint ventures, and the like.
The FSOM also focuses on creating a tax-efficient supply chain model so that the newly enlarged company can optimize both operating and tax benefits. Across the supply chain organization, new roles may be created in a principal company (PC) located in a tax-effective jurisdiction. The company is designed to manage the centralized business process across markets and functions, and to align organization, structure, and management reporting in support of the new structure. This creates additional benefits across the supply chain by simplifying and standardizing all transaction types, updating the transactional model to include the PC as the central buy-sell entity, and centralizing inventory control and management. These operating-model changes need to be aligned across supporting tax and transfer-pricing processes, creating an integrated business with a consistent set of operating policies, strong local execution, a competitive cost base, and a reduced effective tax rate.
Sourcing and manufacturing efficiencies. It's typical for a transaction to have a stated target, such as a specified level of gross margin improvement, which is allocated across supply chain functions and regional teams to deliver. One effective way to drive this value is to assess the manufacturing assets that have been acquired. Optimizing asset utilization and aggressive productivity improvements would help improve margins, increase return on assets, and enable growth—all key reasons for making acquisitions. Buyers can focus on achieving this value through sourcing efficiencies, manufacturing-footprint optimization, and overall equipment effectiveness (OEE) improvement.
In terms of sourcing efficiencies, the buyer and the target may source common raw materials or have common vendors. Aggregating spend and moving to preferred terms and conditions help to reduce the raw-materials cost component within COGS. Similar principles apply to the sourcing of indirect materials and services.
A strategy of manufacturing-footprint optimization requires a holistic view of how the buyer's existing and newly acquired assets are deployed. A global network of plants most likely has grown through a set of incremental, disconnected decisions. The buyer may have acquired assets that have similar production capabilities to its own; for example, a beverage manufacturing company's lines may have the flexibility to produce products from either of the two companies that are being combined. There may be excess capacity at the plants, and by shutting the less efficient facilities and merging them into more efficient units, it may be able to achieve a reduction in fixed-cost overhead and an improvement in the variable (per unit) cost of production.
The acquisition should trigger a review of these fixed and overhead expenses from a cost, flexibility, and "go-to-market" perspective. With an understanding of the needs of the combined future organization, the buyer should revisit the make-buy analysis, global network design, and enabling operations transfers. It's important to note that the manufacturing-footprint optimization should not be based on the current state OEE (a metric that assesses the percentage of planned production time that is truly productive, with no downtime). The buyer should, however, assess the aforementioned integrated business operations to understand the trajectory for OEE improvement. This means that the manufacturing plants can become more productive over time, increasing the opportunities for rationalization or for accommodating anticipated growth without needing to expand the manufacturing base as much as might otherwise be required. Productivity improvements can also be attained through improving OEE, which in turn reduces the cost of goods sold and increases throughput.
Distribution improvements. Similarly to the manufacturing footprint, distribution center (DC) networks represent a good opportunity to rationalize assets by eliminating redundant facilities, making better use of available capacity and achieving economies of scale. (A similar opportunity exists to merge call-center operations and reduce that fixed-cost overhead.) Unlike manufacturing plants, DCs often store a broad portfolio of different product types, so there may be even greater opportunities for consolidation. The key considerations when analyzing such opportunities are available capacity and capabilities by location. For example, do DCs have the necessary capabilities for storage of temperature-controlled products, hazardous materials, or materials requiring secure storage (such as controlled substances)? Do they have advantageous proximity to markets and bonded warehouse or foreign trade zone status?
How should a supply chain executive approach the task of rationalizing distribution? For simpler networks, you can conduct analyses using spreadsheets. More often, and especially for complex global networks that involve both manufacturing and distribution, it is preferred to leverage commercially available network modeling and optimization software. In either case, the buyer should take an integrated approach to network design that takes into account several considerations. These include supply chain manufacturing and logistics costs, capacities, and service levels; tax considerations (sales tax, ad valorem tax on inventory, incentives and credits for being in a given location); global trade cost factors (customs duties, free-trade agreements, special customs regimes, foreign trade zones); and real estate and labor (specifically, market costs and availability).
Operations that distribute similar goods could be combined across multiple DCs to consolidate costs, and if the buyer and seller have the same customers, shipments could be combined to reduce transportation costs. However, if there are substantial differences in shipment characteristics—for example, one company's products are temperature-controlled and the other's are not, or if one has a bulk distribution model and the other handles small-order, e-commerce fulfillment, then it will be trickier to find synergies.
Beyond the rationalization of assets, network design may be another opportunity to move to more effective structures, such as a regional "hub-and-spoke" network or centralization of value-added processing activities. From a buyer's perspective, there may also be synergies to be found in transportation. Its combined spend with the acquired company will likely give it better leverage with carriers in regard to reducing rates. If there are common customers or common suppliers, there may be opportunities to combine orders to increase average shipment size or move to more cost-effective modes of transportation. Examples of the latter might include shifting from parcel to less-than-truckload (LTL) or from LTL to full truckload (FTL).
There are also opportunities to make improvements with regard to the use of 3PLs. The buyer should seek to migrate to preferred terms and conditions across both its existing contracts and contracts for the acquired asset that are reassigned to it. At the same time, a merger creates a larger pool of providers, which means more opportunities for benchmarking and comparison. For instance, the buyer can use analytics to understand the cost effectiveness of 3PL providers, and to compare different pricing mechanisms and different labor and real estate rates to enable a fair, "apples-to-apples" comparison. Additionally, the buyer can use "should-cost" modeling as leverage to reduce the rates associated with higher-cost suppliers.
Successfully integrating a new asset can also have the welcome side effect of being a catalyst for large-scale transformation within the parent company. The analysis of process and performance that occurs during integration invariably produces learnings and efficiencies that can be implemented across the wider organization, thus leading to improved performance and cost savings.
One potential area for transformation is the application of digital technology to supply chain operations. Companies across all sectors are beginning to harness technology, such as the Internet of Things (IoT), smartphones, and advanced analytics to drive improvements in supply chain visibility, demand forecasting, and last-mile delivery, to name but a few areas. Moreover, advances in machine cognitive capabilities and robotic process automation (RPA) are allowing companies to reduce the amount of human intervention and associated operational cost involved with supply chain activities, such as demand-and-supply planning, quoting, invoicing, contract management, and returns processing.
While synergy realization should remain a primary focus for the buyer in order to uphold the original deal thesis, supply chain professionals should also look for ways to leverage the transformational nature of the transaction to drive additional improvements. Identifying these opportunities is an important responsibility and should be seen by the individual as a chance to demonstrate his or her value to the enlarged and growing business.
The views expressed herein are those of the authors and do not necessarily reflect the views of Ernst & Young LLP.
During the post-close phase, the most important issue from the perspective of a supply chain professional on the seller's team is "stranded costs"—overhead costs that are left behind when revenue-generating assets are sold. These typically occur in a shared-services scenario; for example, a shared warehouse that has been partially vacated by a sold asset but the seller still has to cover overhead for the entire facility. Another example would be when the sold asset had partial responsibility for supply chain resources that are now underutilized; for instance, the seller is paying for a full truckload or container but is no longer using all of that capacity. A seller also needs to be aware that sophisticated buyers will anticipate the integration process and attempt to optimize toward their end-state earlier in the transaction timeline. This acceleration can put undue burden on the seller in accommodating the new model and could lead to higher stranded costs.
To prevent such problems, the seller should determine that cost allocations are calculated in an appropriate fashion. For example, basing them on a percentage of net trade sales may not reflect the true cost of fulfilling customer orders. Cost-to-serve analytics can be used to better understand the true cost drivers. A seller should also "right-size" its distribution network, as outlined earlier in this article. Another option is to convert to outsourced third-party logistics (3PL) warehousing (for example, a cost-per-pallet approach) to convert fixed costs into variable ones. The 3PL could take over an existing lease and charge only for space that is being used for the seller's operations, with the remainder being used for other customers.
A seller should also take a longer-term view of divestitures and acquisitions in the pipeline—it could be that a sale will be offset by a subsequent purchase. Supply chain leadership needs to have access to this type of information while still maintaining strict confidentiality regarding any future deals.