Sourcing and procurement practices have evolved significantly over the past decade to such a degree that many consider them to be a major driver of EBITDA. For private equity firms, enhancing sourcing and procurement practices has opened up a new opportunity for value creation that has the potential to span an entire portfolio, and to produce large savings throughout the lifecycle of a deal. Because procurement spend represents a significant percentage of revenue for middle-market companies, improving the efficiency of procurement practices can exponentially enhance EBITDA growth while solidifying supply chain operations. A dollar of procurement savings often represents as much as three to four times the financial impact of a dollar of incremental revenue.
Especially in times of heightened inflation, supply chain disruptions, and the uncertainty brought on by climate change, sourcing and procurement should be put at the very center of a value creation plan, even before a term sheet is in place. Optimization should begin during the due diligence process with an initial examination of operational spend data. With many middle-market target companies lacking the proper analytic tools to measure the impact of their procurement decisions, this may require a deeper dive into specific agreements with major suppliers, with a distinct focus on the length of key agreements and the number of suppliers engaged in a specific area of spend, as well as the overall financial health of the suppliers.
Key vendor agreements, especially long-term ones, can reveal a great deal about how a company conducts its business. The following can be signs that management may be purchasing goods or services at sub-optimal pricing – and thus indicate opportunities for PE firms to implement value-creating changes with long-term impacts, such as renegotiating terms and pricing or even switching vendors altogether.
- Major vendor relationships that have not been competed in the prior 12-24 months
- Evergreen agreements with no explicit expiration date or option to terminate
- Pricing structures that contemplate automatic annual price increases
- Lack of contractual provisions tied to specific supplier performance metrics
- Non-arm’s-length supplier agreements
Some sophisticated PE firms have moved to hiring specialists in procurement to conduct detailed diagnostic analysis and drive operational improvement in order to create a systematic approach to EBITDA growth that can be deployed across an entire portfolio.
Including key suppliers in the value chain can also have positive benefits; PE can often accelerate the implementation of a new process improvement, such as optimized billing and invoicing, by working alongside both internal procurement leaders and key suppliers.
An increasing number of PE firms have taken the approach of consolidating the sourcing and procurement of products and services common to all portfolio companies, such as benefits and certain insurance offerings, office products, cybersecurity, transportation, and many others. The consolidation and centralization of this purchasing allows each PE firm to maintain increased pricing power over the suppliers and obtain key products and services at significant discounts relative to solely purchasing at the portfolio company level.
While these sourcing and procurement improvements can rapidly yield significant benefits in the short term, they are not the end of the job; it’s important to maintain a consistent sense of urgency in this area throughout the lifecycle of the investment, and continuously re-evaluate. This will require defining key performance indicators – contract terms, spend data, billing trends, competitive pricing, and other points – and securing and deploying the analytical and tracking tools needed to monitor them. With active and ongoing management oversight, savings can be sustained, and potentially even grown, all the way through to the point of exit.