Thanks to inflation, labor shortages and supply chain woes, companies are grasping for strategies to enhance revenue and mitigate risks.
And, like the virus, the financial situation stemming from the pandemic is lingering longer than many expected. To strike back, CFOs are taking a page from the private equity playbook and turning to procurement as major lever for EBITDA improvement.
Instead of viewing procurement as a back-office function, CFOs are embracing many of the same complex procurement strategies PE firms have relied on for years to make quick improvements in a portfolio company’s finances. Now, leaders see what good looks like and more companies are starting to catch on and adopt this fool-proof cost optimization method.
Working alongside their CFOs, procurement officers can dramatically improve their company’s EBITDA through procurement-related optimization, mitigate risk through supplier resiliency and achieve a competitive advantage in the marketplace.
Speedy procurement changes mean speedy savings
From the very beginning of the massive and unprecedented disruption caused by COVID-19, companies had to look for new avenues to drive savings. Private equity – long known for acting with speed – discovered long ago that procurement strategy is one of the fastest ways to accelerate value in their portfolio companies. Procurement changes can generate savings in months, as opposed to revenue growth, which can take years. When the pandemic hit, PE operators started using procurement as a lever almost immediately, while other organizations lagged. But they’re learning.
Over the last decade, most PE firms have invested in building operating teams focused on exiting several key strategies, often in parallel, to generate value focused on both top line (revenue) growth and margin improvement. In an environment where companies are being valued at >12x multiples of EBITDA, many private equity operating partners rely on procurement as a key lever to reduce costs. When utilizing this strategy, procurement value can be achieved in months, and the savings have a direct dollar-for-dollar impact on EBITDA. As an example, if a PE-owned portfolio drives $10 million of bottom-line savings, this could have a >$100 million impact on the company’s valuation.
Procurement in an inflationary market
Prices on nearly all goods and services, from raw materials to labor and transportation services, are skyrocketing. In the wake of the COVID-19 pandemic, demand for goods have surged, and supply chains are currently strained like never before.
And while it’s recognized that it’s difficult to lower procurement costs at a time of raging inflation, private equity operating partners are ensuring their company’s procurement strategies are not solely based on cost and price alone. Rather, using a Total Cost of Ownership (TCO) approach that includes utilizing demand and process levers, has proven to be an effective strategy to counter pricing increases and inflation growth.
As procurement leaders and CFO’s are taking a more aggressive view of procurement’s ability to impact earnings and earnings per share (EPS)—similar to PE’s view of valuation enhancement— below are examples of procurement’s TCO approach within an inflationary market:
- Price – With inflation continuing, there’s less room to reduce the cost of goods and services. So, which pricing levers can help a company achieve the most value for its spend? A full competitive bid, incumbent renegotiations, extension of a current deal to avoid price increases, and protection from future price increases should all be part of one’s procurement toolkit.
- Demand – How can an organization influence the demand or need for goods and services? Possibilities include SKU rationalization, schedule optimization, complexity reduction, usage rationalization, item substitution or rationalization and demand reduction.
- Process – How does a company procure goods or services in a way that maximizes value? Answering that question requires looking at parameters such as order size, compliance and lifecycle cost management.
Supplier continuity helps mitigate risk
Beyond cutting costs, reducing demand and changing processes, we’ve seen a major focus in the last 18 months on supplier continuity programs to mitigate supplier risk. If you can’t rely on key suppliers to fulfill orders for materials you need to make finished goods, you cannot drive revenue. When risk management begins in the sourcing stage through identifying and closely managing suppliers, threats can be identified early in the process.
To reduce risk, they need to broaden their supplier base by identifying new partners, including potential second- and third-tier suppliers. Other risk mitigation strategies include moving production to less expensive countries; relocating it to nearby companies to shorten the supply chain; and shifting to JIC (just-in-case) supply chains, which involves purchasing in greater volume to maintain extra inventory.
Procurement changes can add up to 40% EBITA improvement
Do these procurement strategies work? The answer is yes.
A 1% decrease in spend will increase EBITDA by more than 1%, our experience shows. In most cases, a company’s procurement spend is many times its EBITDA, so a 10% reduction in spend may improve EBITDA by 20% to 40% improvement. Compare those results to the $5 to $20 in new net sales companies need to generate a single dollar in EBITDA impact. There are few savings levers that offer such a dramatic, immediate impact.
Significant cost savings through smart procurement strategies can change that – as can vastly improve procurement data collection and analysis, a weak point of many organizations. Savings that make a measurable difference to EBITDA achieve the financial predictability C-level executives are looking for. Alignment between procurement leaders and CFOs can be a company’s greatest weapon in difficult financial times – and help leave competitors in the dust – pandemic, or no pandemic.