INTRODUCTION
This paper reviews and assesses the market conditions and dynamics for the sale/acquisition of industrial manufacturing operations. Due to transformational changes in many infrastructure and industrial markets owing to COVID-19, large corporations are carefully reassessing their strategic positions and directions, potentially leading to the sale of assets that no longer fit their evolving business models. In some cases, corporations have been surprised by the pace of change in the markets they serve, leading to forced sales of some assets. Opportunities abound for the careful investor.
The COVID-19 pandemic has, without doubt, had a dramatic effect on the global economy, and, as the world slowly emerges from the first shock wave, investors find themselves confronted with a changed scenario in terms of investment opportunities. Two main factors are at play. Firstly, the crisis has caused a global economic reset. Even with the impressive bounce-back of the stock markets, the true business impact on operations and growth does not bode well for many companies in the industrial sectors. This means that private equity firms looking to invest in companies and make improvements will see a higher relative return on those improvements than before the crisis. Secondly, with many firms experiencing liquidity issues, or simply revaluating their portfolios in light of the new economic conditions, the likelihood of viable businesses coming onto the market in the coming months has increased. These two factors mean that post-COVID-19, profitable investment opportunities will be available, providing that investors are able to assess in detail the possibilities for improving the businesses that come onto the market.
ADDRESSING WHAT MATTERS
What really matters to rapidly improve GM or Drive Profitable Growth!
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In sectors such as power, electrical transmission, and distribution, oil & gas, or process industries, there are three critical focus areas in the operational due diligence and commercial due diligence processes for when considering the purchase of a supplier of industrial equipment:
- Product Management
- Supply Chain Management
- Services
Detailed examination of these three areas determines whether an acquisition can rapidly transform its cost base and expand its operations into lucrative complementary business areas.
Potential investors will, therefore, need to enhance their due-diligence efforts even further to trigger realization capabilities allowing identification of the best opportunities going forward, paying particular attention to market-fit assessment post-COVID-19 pandemic.
PRODUCT MANAGEMENT –
THE VALUE DRIVER
The function of product management is two-fold: first, to be the “eyes and ears” of the business in their markets in order to fully understand the positioning of their products and services; and secondly, to develop a market roadmap for future technologies and product refreshes.
Product management includes the responsibility to drive value-engineering processes across the organization to ensure that product design and cost structure is optimal, thus maximizing the potential gross margin per product.
However, many businesses have not recognized the true potential of effective product management for their operations. Market-leading companies are those that understand the importance of this and are able, as a result, to enjoy considerably higher margins on their products relative to the competition. They do so by deploying the two-fold product value creation approach and driving it via a product management organization.
An in-depth review of the product management function within a company can reveal real areas for improvement and profitability. These principles are relatively easy to establish within companies, and positive results can be realized very quickly.
SUPPLY CHAIN MANAGEMENT –
THE MARGIN DRIVER
Traditionally, and still the case in many companies, businesses have evolved their supply chain around relatively local, trusted suppliers. This approach stemmed from the belief that these established suppliers could meet the exacting requirements of the engineering design functions.
Over time, product design would be built around this established supply chain, combined with in-house capabilities, with more and more implicit knowledge included in the specifications and requirements. Furthermore, because the trusted suppliers ‘know how the company wants things done,’ finding new suppliers and training them can be a task such companies only take on reluctantly, out of necessity.
This approach of ‘incremental adjustment’ to the supply chain enables some limited cost reduction but does not deliver the meaningful, structured, cost-reduction of components redesigned to meet cost and performance criteria. Ultimately these businesses see their operating margins erode, fall behind the competition, and lose their value.
A more strategic approach, using value engineering practices driven by strong product management, will deliver significant cost-out, anything up to 40% of a specific key, fully machined component, or sub-assembly. This, in turn, enables the use of a much broader, competitive supply chain structure, taking full advantage of the global practices available today.
SERVICES – THE SUSTAINABILITY
AND GROWTH DRIVER
Properly maintained industrial machinery can and is expected to, remain in service for decades. This creates the opportunity to generate long-term service revenue streams from a large installed base of operating assets. The Original Equipment Manufacturer (OEM), in principle, holds a massive competitive advantage to serve this installed base throughout the full lifecycle of its products.
Therefore, the third focus area for any potential acquisition target is the potential to increase the aftermarket so that the business maximizes its competitive advantage by fully serving its installed base. Achieving this requires having the right level of product management to ensure the service offerings are relevant, differentiated, competitive, and value-priced.
Moving from selling spare parts to having a comprehensive service offer requires a fast-acting dedicated service organization, including engineering and supply chain professionals, that can react at the lightning speed needed to support often mission-critical equipment running at customers’ sites.
The prize in providing services is that such speed, and proximity to the customer, commands a premium price. It also builds a long-term sustainable business that makes maximum use of the company’s inherent product knowledge and consolidates product feedback through greater knowledge of performance in the field.
THE ROLE OF GENERAL
AND SPECIALIST ADVISORS
Generalist advisors play an essential role in overall due-diligence processes for acquisitions, using processes and methodology to quickly assess the structure and fabric of a carve-out.
However, such advisors do not, and cannot be expected to, have detailed knowledge about specific industries, and therefore, either engage specialists who can provide the added intelligence to assess a proposition, or provide a less complete picture.
The ability to understand how, and to what degree, a company’s product management, supply chain, and after-sales service functions can be transformed to increase profitability is the domain of the industry-relevant specialist consultant.
Therefore, to understand acquisition targets in-depth and to provide the best available information to investors, it is advantageous for private equity firms to engage boutique, industrial specialist consultants who provide in-depth reports, identify true opportunities and uncover all underlying risks.
Doing so would help acquisition teams to strengthen their operational due diligence and commercial due diligence processes and get a real insight into the extent of an investment’s untapped possibilities and the improvement potential of the business.
SUMMARY
The opportunities abound for funds to identify substantial growth opportunities at the right price levels. Investors will need to strengthen their due-diligence processes further to ensure that the untapped improvement potential fully factors into the evaluation of an investment.
The three key elements to assessing and improving industrial business operations are: effective supply-chain management (the margin driver), strong product management (the value driver), and services (delivering sustainability). Investors must have the capability to assess these elements.
Generalist advisors have a role to play in assessing the overall health of target businesses, however, specialist advisors are crucial in operational due diligence and commercial due diligence processes in evaluating and defining the real potential and risks in industrial engineering acquisitions.