Laying the Foundation for Successful M&A: A Supply Chain View
by Tompkins Solutions Staff

A Supply Chain View

James A. Tompkins, Ph.D. CEO
Tompkins International
www.tompkinsinc.com

January 2012

Introduction

This paper lays the foundation for a successful merger or acquisition from a supply chain perspective. Why does supply chain matter in M&A?

Supply chain is a key consideration for M&A, beginning with due diligence all the way through acquisition and integration. By taking a supply chain perspective, organizations can create the most value from a business combination, spur growth and increase market share, and when supply chain becomes part of acquisition strategy, initiate a company to a whole new business area.

Far too often, M&A fails because of:

1. Synergies – Cost savings and/or revenue growth are anticipated, but not realized.

2. Related Parties – Sales revenue and/or purchase prices cannot be retained due to a previously existing, undisclosed related party activity. Related party activities are business deals or relationships between two parties who are joined prior to the M&A activity.

3. Corruption – The balance sheet and/or the profit/loss statement are not what they appear to be upon closer scrutiny.

4. Culture – Organizational “change readiness” prevents the integration of the acquired firm.

5. Information Technology – Different platforms and/or inadequate technology require unforeseen capital expenditures and result in substantial delays in achieving integration.

Knowledge gained in this paper will help business leaders avoid these mistakes.

For product companies (companies involved with the PLAN, BUY, MAKE, MOVE, STORE and/or SALE of products), the supply chain plays a major role in creating value through M&A. Value creation, as shown in Figure 1, is a result of profitable growth, margin improvement and capital efficiency.

After the basics of M&A are completed, a pursuit team must be put in place to avoid the mistakes noted above and maximize the opportunity for value creation. The key elements of a successful M&A roadmap include:

1. M&A Basics

2. Supply Chain Due Diligence

3. Supply Chain Value Creation

Elements #1 and #2 noted above are examined in this paper. For more information on #3, read the Tompkins companion paper, “Acquiring Supply Chains for Value Creation.“

1.0 M&A Basics

Strategy should always precede structure. In all cases, the strategy of a business precedes the consideration of M&A. Therefore, M&A strategy comes before the identification of M&A candidates, and the strategy of pursuing a specific candidate precedes the due diligence of the candidate.

Obviously, M&A basics begin with a keen understanding of the strategy for value creation of the business. This allows stakeholders to determine if the value creation is best achieved via organic growth, joint venture, alliance or acquisition. If acquisition is the best approach to maximize value creation, then the next step is to pursue the 11-step M&A basics process outlined below.

Step 1: Establish the business strategy of acquisition:

1. Core objectives of acquisition

2. Target acquisition products

3. Geographic focus

4. Critical success factors

5. Candidate criteria

The initial stage in developing a proper acquisition strategy is to examine all types of growth strategies: diversification, market development, product development and market penetration, as shown in Figure 2. The supply chain becomes a key focus in all aspects of growth. Two vital questions for each strategy are: (1) Can the existing supply chains be leveraged, and (2) can they handle the additional capacity the growth strategy promises to deliver?

Step 2: Develop a long-list of candidates based on the companies that fit the profile for the acquisition strategy in terms of revenue, product/service, geographic focus, and profitability.

Step 3: Screen candidates based on critical success factors and the candidate criteria.

Step 4: Profile short-list of candidates and refine list.

Step 5: Evaluate level of interest of the short-list of candidates and refine list.

Step 6: Sign non-disclosure agreement.

Step 7: Conduct preliminary financial review. This review typically includes:

1. Available financial reports and budgets

2. Accounting practices/policies and assess quality of financial data

3. Working capital history

4. Analysis of revenue streams to determine if handshake agreements exist that are not disclosed in company documents. Relationships may exist that can be dissolved after the acquisition, resulting in an unplanned loss of revenue. Third-parties can speak with larger customers anonymously to uncover any issues. Review all sales contracts thoroughly to determine potential effects of an acquisition.

Step 8: Potential corruption in the financial documents through the use of accountants and other third-parties experienced in M&A. Anti-corruption due diligence can uncover existing corruption problems, risk investigations, criminal charges, penalties and other fines, reputational problems, loss of expected profits and market opportunities. Any of these issues could cause a dramatic loss of value in the company being acquired.

Step 9: If the acquisition is to be integrated with an ongoing operation, perform a preliminary analysis of the following:

1. The accretive nature of operating margins

2. Advantages or disadvantages that the combination could yield with customers, suppliers or other stakeholders

3. Integration synergies and/or challenges

Step 10: Develop and sign a letter of intent.

Step 11: Establish pursuit teams that include:

1. Financial due diligence

2. Legal due diligence

3. Supply chain due diligence

4. Structure and contract

The supply chain due diligence team is very important to the overall success of the due diligence process. Key traits of this team include deep knowledge and experience across the supply chain, industry experience, geographic experience, and a clear understanding of the overall due diligence process.

The remainder of this paper presents the process that should be pursued by the third team: the supply chain due diligence team.

2.0 Supply Chain Due Diligence

Supply chain due diligence explores the performance of the company’s supply chains to provide valuable input into the M&A decision. The output from a supply chain due diligence is a portfolio of initiatives that defines the supply chain path forward, as well as likely consequences of M&A.

The portfolio of initiatives addresses the supply chain opportunities and challenges that will result if the M&A were to be pursued. These initiatives consist of supply chain cost reduction, opportunities, revenue growth opportunities, constraints, and risks. These supply chain initiatives will be prioritized into DO NOW, DO NEXT and DO LATER bullets to present a clear path forward if the M&A is pursued. The overall approach to performing a supply chain due diligence is depicted in Figure 3. The next four sub-sections describe the four-pronged approach to supply chain due diligence.

2.1 Define the Supply Chain Baseline

The objective of this first step of the supply chain due diligence process is to gain a high-level understanding of the supply chain, to capture leadership’s view of the supply chain, and to document the performance of the supply chain.

As presented in section 1.0, strategy must always precede structure. Therefore, the baseline begins with an understanding of the strategy for value creation of the business – and an understanding of how this impacts supply chain strategy. This supply chain strategy is the foundation for the supply chain due diligence process. Further, documentation of this strategy will provide the supply chain due diligence team with a high-level understanding of the acquisition candidate’s supply chain.

Based upon this high-level understanding, the supply chain due diligence team then interviews the candidate’s key supply chain staff to gain their view of the company’s supply chain performance. The overall performance of the supply chain should be viewed from the perspective of PROCESS – PEOPLE – TECHNOLOGY. Figure 4 illustrates the interlocking nature of this supply chain performance view.

Next, it is necessary to assess supply chain performance by evaluating the cost, agility, quality, and customer service resulting from the supply chain and evaluate the essential PROCESS – PEOPLE – TECHNOLOGY topical areas.

PROCESS: Methodology and Performance

• Sourcing (to include duties/customs and compliance)

• Network Design (locations and real estate)

• Distribution and manufacturing operations (to include quality and controls)

• Transportation (domestic and global)

• Inventory (levels, policies and deployment)

• Environmental (energy, water and sustainability)

PEOPLE: Organization and Performance

• Organization (structure and head counts)

• Competence (performance, team work and continuous improvement)

TECHNOLOGY: Systems and Performance

• Planning

  • Forecasting/demand planning/S&OP

  • Inventory management/replenishment

  • Capacity planning/production planning

  • Sourcing/procurement

  • Supplier compliance management

• Execution

  • Purchasing

  • Production scheduling

  • Manufacturing execution

  • Order management

  • Warehouse management systems

  • Transportation management systems

  • Supply chain visibility and event management

  • Trading partners collaboration and supplier relationship management

  • Supply chain performance management

Once the performance of these topical areas is completed, the first step of the supply chain due diligence processes, “define supply chain baseline” is complete.

2.2 Define Relevant Benchmarks

One of the outputs from the “high-level understanding of the supply chain” will be knowledge of which topical areas should be included in the supply chain due diligence. For each of the applicable topical areas, begin by establishing the present performance level for this topical area. Next, compare this performance level to relevant benchmarks for companies like the candidate company to determine where opportunities, challenges, constraints and risks exist if the acquisition were to be made.

Tompkins’ benchmarking and best practices Supply Chain Consortium covers the entire supply chain (PLAN – BUY – MAKE – MOVE – STORE – SELL) and has over 500 companies’ current data upon which to benchmark the acquisition candidate’s performance. Examples of the type of information that the Consortium’s supply chain database provides is shown in the figures below.

2.3 Define Supply Chain Opportunities & Challenges

The third step of the supply chain due diligence process includes:

1. A gap analysis of the “baseline (Step 1)” against the “benchmarks (Step 2)”.

2. The assessment of all gaps and the translation of the gaps into cost reduction and/or performance enhancing opportunities.

3. The identification of any opportunities to grow revenue from supply chain enhancements.

4. The identification of all significant constraints and risks associated with the M&A candidate’s supply chain.

2.3.1 Gap Analysis & Gap Analysis Assessment

Figures 9 through 16 demonstrate a review of the labor costs of benchmarked companies versus a candidate, identifying a significant gap in the cost of DC labor and transportation. Through gap analysis, a cost reduction opportunity has been revealed. Thus, costs can be brought in line with benchmarked companies as part of the M&A supply chain due diligence process.

2.3.2 Growth Opportunities

Gap analysis and assessment defines the cost reduction opportunities available by pursuing the identified merger or acquisition. A key point, however, that is frequently missed is that the supply chain presents opportunities to both reduce costs and to increase revenues.

Supply chain due diligence should very clearly identify opportunities for profitable growth that would occur by pursuing the merger or acquisition candidate. The “profitable” potential comes via cost reduction and deals with the bottom line of the candidate. The “growth” potential comes via increases in revenue and deals with the top line of the candidate. The two major growth drivers in which the supply chain can either contribute to or sometimes even create are:

1. Capture new markets/customers

2. Outperform competitors

Understanding the impact of these two major growth drivers will significantly contribute to the due diligence of the candidate, as it presents a view of what could occur after the merger or acquisition is completed. The next sub-section describes these growth strategy opportunities.

Create New Markets/Customers

Growth strategies are a means to leverage the power of M&A and should be reviewed in the supply chain due diligence effort. The key to finding the right growth strategy is properly matching it to the candidate and its specific marketplace. Typically, several combinations of strategies are used within a candidate’s strategic objectives (Figure 2 shows high-risk and low-risk strategies). Potential profitability should be examined before any type of growth strategy is deployed.

Outperform Competitors

Top-performing companies often maintain a dual focus: meeting and exceeding profitable growth objectives and outperforming competitors. In order to achieve these goals, it is critical to have a strategic market plan and the supply chain capabilities in place to deliver superior results (surpassing the competition). It is also vital that this strategic market plan address both internal and external activities. Within this section of the paper, three key areas (market focus, communication and responsiveness) that enable companies to outperform competitors are examined.

1. Focus on the Market

   The prime attribute of most top-performing companies is the most basic of business strategies: a focus on the market. Top-performing candidates regularly develop and revisit a Strategic Market Plan (SMP) to ensure that they understand customers’ needs and wants better than their competitors. In support of an SMP, organizations need to continuously gather information about customers and markets, but this is just the starting point. Additionally, organizations should understand what is happening within the global environment. It is important to gather and track information on government regulations and policies (local, national, and international), industry technological advances, current and future industry trends, and last but not least, what direct competitors are doing.

2. Communication

   Sources for this information include trade publications, industry conferences and events, corporate and individual networks, and internal and external research reports. A mountain of information is available, and there are numerous ways to attain it. Yet, the real value can only be unleashed if it is packaged and delivered in a meaningful manner.

   This leads to the second key requirement in enabling candidates to outperform their competitors: communication.

   Candidates that go through all the work of understanding customers, markets, operating environments, and competitors must also ensure that they have a way to communicate this information throughout the organization. There are various means of communication ranging from informal and low-cost alternatives – such as newsletters, e-mail blasts, and management Q&A forums – to more formal technology-driven solutions, such as market databases and CRM applications. But, the mode of communication is not nearly as important as consistently sharing business intelligence that employees can use to strategically respond to the market. Many of today’s global supply chain information technology applications support both the collection, as well as the dissemination, of this critical data in a timely manner.

   In addition to being able to convey customer and market information to employees, strong internal communication also directly affects profitable growth through higher employee retention rates and getting more input from employees in ways that will improve the business. Furthermore, candidates that outperform their competitors are the ones that coach and mentor managers to communicate effectively with employees, follow a formal communication process, and connect employees to the company’s business strategy.

3. Respond to What Has Been Learned

   Lastly, top-performing organizations not only collect the best information and communicate it throughout their organization, they also respond to what has been learned. Generating and communicating the information is one thing, but unless there are changes based on what is learned, nothing has truly been accomplished.

   This step is the hardest one to implement because it crosses so many functions within a company. Having an integrated and responsive Sales, Inventory and Operations Process (SIOP), combined with more timely and accurate information than competitors, as well as a proven, consistent means to communicate that information throughout the company, is what enables top companies to consistently outperform competitors. Responses to changes in customer needs, wants, or market conditions may include updates to current products, new product introductions, entering new global markets, new distribution channels being opened, outsourcing of non-core activities, and shifting of inventory or components from one region to another, to name a few.

   Candidates that achieve profitable growth and outperform competitors utilize an SMP process to deliver timelier, more robust, and better business intelligence than the competition. These same candidates have proven means of using global supply chain technologies to share information throughout the organization to provide employees with business intelligence in a constant, clear, and succinct manner. Lastly, the candidates that have proven SIOP processes in place – enabling them to take what has been learned and respond accordingly – will outperform their competition.

2.3.3 Constraints and Risks

The last component of the supply chain due diligence effort is the assessment of existing and future supply chain constraints and risks of the candidate.

Supply Chain Constraints

A supply chain constraint is any supply chain condition that interferes with or limits the profitable growth of M&A. The 10 supply chain constraints typically reviewed when conducting due diligence are:

1. Supplier Constraints – The capacity of a supply chain is limited by the available capacity of the most constrained link in the chain. Not only must the supply be available, but it must also be available at the right place, right price and right times.

2. Market Constraints – The supply chain of a merger or acquisition could be constrained by the demand in the market or by the strength of the competition. To address market demand, a market analysis must be conducted; to address the strength of the competition, a competitor intelligence analysis must be completed.

3. Financial Constraints – The future of a merger or acquisition could be limited by capital, liquidity and/or working capital. Supply chain concerns here often involve inventory and the cash-to-cash cycle of the merger or acquisition.

4. Company Policy and Cultural Constraints – Just as oil and water do not mix, there are often policies or cultural challenges that constrain M&A success. Challenges to be considered here have to do with the whole range of organizational characteristics. For example, aggressiveness, accountability, social norms, communication styles, teamwork, company cars, time clocks, neck ties, lunch rooms, and reserved parking all are characteristics that come into play.

5. Facility Constraints – Manufacturing, distribution and office facilities must have sufficient capacity to allow a supply chain to prosper. But facility costs should not be a burden to an organization and constrain its ability to be profitable.

6. Technology – Obsolete or improperly maintained technology can be a significant constraint upon the profitable growth of a merger or acquisition. Supply chain information technology is a key requirement for efficient and effective supply chain operation.

7. Staff Constraints – The quantity, quality and skills of a candidate’s human resources are one of the most important resources of an organization. It is essential to have the right number of supply chain people with the right skills and the ability to adapt to new requirements for M&A to prosper.

8. Management Constraints – Just as the supply chain staff is critical to M&A, so too is the management team. The management team provides the leadership vision, motivation and culture for the supply chain to adapt to evolving business requirements.

9. Regulatory Constraints – Supply chain regulations involving global trade, customs, duty, taxes, transportation, environmental and others need to be understood and constraints to profitable growth identified. Supply chain regulatory requirements may also beget financial requirements that into themselves can become an M&A business constraint.

10. Time Constraints – It is not unusual today for an organization to be running so lean that even though many supply chain constraints can be mitigated, there is simply not enough time for this mitigation to take place. Pursuing M&A without the available time to totally commit to the process is a center path to failure.

For each of the supply chain constraints identified, a clear plan must be developed. After the plans are developed, if substantial concerns still exist about supply chain constraints holding back the organization’s profitable growth, then the due diligence should raise the question about viability of the merger or acquisition and/or include this in the financial M&A evaluation along with the cost to remove the supply chain constraint concerns.

Supply Chain Risks

Supply chain risks have to do with the supply chain of the merger or acquisition being exposed to a loss. This loss could potentially include:

1. Materials, assets or goods as a result of a natural disaster, terrorist attack, pirates, accidents, theft, pilferage, or obsolescence.

2. Capacity as a result of natural disaster, terrorist attack, labor dispute, supplier capacity, supplier bankruptcy, loss of key employees, or inflexible third-party relationships.

3. Customer satisfaction as a result of quality problems, delivery problems, forecast accuracy, weather delays, and inventory accuracy problems, as well as the challenges of meeting schedules when material, goods, or capacity losses occur.

4. Financial performance as a result of inventory violations, poor forecasts, exchange rates, bad debts, poor inventory management, theft, poor management of contingent liabilities, unrealistic expectations of acquisition synergy, loss of synergy when a spin-off is no longer a part of their prior parent, key customer failure, or misunderstanding competitor strengths.

For each supply chain risk identified, it is important to fully evaluate the probability of the loss occurring and the magnitude of the loss. Figure 17 presents a way of quantifying risks so as to ensure that the most important ones are adequately addressed prior to moving forward with M&A.

There are two paths to address supply chain risks viewed as critical (“red”):

• Proactive mitigation of risk to reduce the probability of the risk occurring; or

• Reactive contingency planning to reduce the magnitude of the loss.

An essential element of due diligence involves mitigating and establishing contingency plans so as to reduce all “red” supply chain risks of the merger or acquisition into the “yellow” or “green” zones. The costs of this mitigation or contingency plan must be rolled up into the M&A financial model. Figure 18 presents some examples of mitigation strategies and contingency plans for the supply chain.

2.4 Define and Document Supply Chain Initiatives

The first two steps of the supply chain due diligence process (“1. Define Baseline and 2. Define Relevant Benchmarks”) define the AS IS of the candidate supply chain and lay the foundation for the third step of the due diligence process (“3. Define Supply Chain Opportunities and Challenges”). Step 4, then, is taking Step 3 and connecting the opportunities and challenges to prioritized supply chain initiatives that will be addressed given that the merger or acquisition occurs.

The supply chain initiatives result from synthesizing the following major deliverables from the third step of the due diligence process:

1. Cost reduction and/or performance enhancing opportunities;

2. Revenue growth opportunities; and

3. Constraint and risk challenges

Then, this synthesis of deliverables goes into a portfolio of initiatives to potentially be pursued given the M&A occurs. This portfolio of initiatives forms what is called the “TO BE Vision,” illustrated by Figures 19 through 28.

The remaining task in preparing the final supply chain due diligence recommendations is to prioritize the portfolio of initiatives into these categories: DO NOW, DO NEXT and DO LATER. This prioritization should be based upon the logical flow of the initiatives, the benefits, the risks and the speed to achieving results.

Conclusion

The M&A process can easily become so time compressed and chaotic that supply chain impacts are not given adequate consideration. Using the supply chain due diligence path presented here, a foundation for successful M&A is assured. The organizations and stakeholders involved will benefit by knowing that the supply chain view reveals:

• A viable candidate for an M&A target;

• Portfolio enhancements of the M&A target to create value;

• Associated constraints and risks that exist and how to mitigate them; and

• Useful information in valuing the M&A and in defining representations, warranties and price concessions.

A key part of any successful M&A activity, especially supply chain due diligence, lies in the competence of the group of people pursuing this process. Critical competencies will include deep knowledge and experience:

1. Across the global end-to-end supply chain;

2. In the industry in which M&A is being pursued;

3. Of the countries where M&A is being pursued; and

4. In conducting supply chain due diligence.

In fact, it is a good idea to perform a type of due diligence on the experts who will be performing the supply chain due diligence – as the results will only be as effective as those involved.

The value proposition for using a third party to conduct supply chain due diligence is based on their extensive experience to lay the foundation for a successful M&A. Access to benchmarking information to determine optimum network designs and efficient supply chain operations is a strong advantage.

Third parties also need a thorough understanding of industry best practices, because this gives them the ability to execute initiatives successfully and in a timely manner based on experience and “pitfalls to avoid.” Choosing the right supply chain due diligence team yields the best picture of companies’ supply chains and can typically save organizations 5-10% in operating costs.

The supply chain perspective for successful M&A reinforces the truth that due diligence is not just about “financial engineering”; it is also about uncovering opportunities to create value through supply chain improvement and integration.

Contact Information

Tompkins International
info@tompkinsinc.com

About Tompkins International

Tompkins International transforms supply chains for profitable growth. For more than 35 years, Tompkins has evolved with the marketplace to become the leading provider of growth and business strategy, global supply chain services, distribution operations consulting, information technology implementation, material handling integration, and benchmarking and best practices. The company is known for innovative, practical solutions that improve supply chain performance and produce value-based results. Headquartered in Raleigh, NC, Tompkins has offices throughout North America and in Europe and Asia. For more information, visit www.tompkinsinc.com.

Transforming Supply Chains for Profitable Growth